Healthcare is witnessing a critical transformation across verticals, including pharmaceutical companies, healthcare delivery and so on. Litigations over product patents, drug price regulation, mergers/ acquisitions, evolving global compliance standards, dynamic market conditions, and a shrinking pipeline of patented drugs are factors that combine to throw up significant accounting implications. Companies should be aware of these issues to ensure robust compliance with accounting requirements. Every activity has accounting implications, especially seeing how global accounting standards are evolving. Key issues that significantly impact the financial reporting of healthcare companies include accounting for revenue arising from out-licensing research or products, accounting for expenditure on research and development in new drug discovery or generics, revenue recognition for franchisee arrangements, accounting for collaborations, rebates and charge-backs, impairment test procedures, and accounting for expiries (especially for distributed inventories).

R&D costs

Indian pharmaceutical companies have realised that R&D in product innovation or process improvements is the only sustainable business model.

There has always been debate over whether R&D expenditure should be capitalised, whether such accounting is subject to the business model of the entity (that is, new drug discovery or generic molecule for first to file). The accounting standards carry that debate forward with the US GAAP (generally accepted accounting principles) specifically prohibiting capitalisation of R&D spend, while the International Financial Reporting Standards (IFRS) and Indian GAAP make a clear distinction between a research cost and development expenditure, permitting the latter to be capitalised.

Companies should have a robust process to capture information on the phases of a drug discovery and trial, and an ability to demonstrate how a particular expenditure is towards “development” and not research.

Further, companies should ensure periodic impairment assessment of the molecules/ products under development.

Acquisitions and reporting

Inorganic growth adds a different dimension not only to the business cycle of a company but also its finance function. Transitions take months and years to bring the target company to the same platform as the acquirer. Such a transformation brings multiple accounting implications, with the key ones being

Aligning accounting systems, processes, policies and practices;

valuation and accounting for acquired intangibles (especially new drug discoveries);

identification of assets implicit in a transaction, such as long-term collaborations, customer arrangements, and franchisee and lease arrangements;

identification of cash generating units to determine impairment testing strategy;

determining useful lives of the tangible and intangible assets (could be of significance from the acquirer’s perspective);

revisiting contracts (guarantee supply) to determine if they are onerous.

Finance teams should also be mindful of validating all market authorisations, licence arrangements and committed supply agreements for change in ownership clauses — such clauses are common within the industry and can have serious ramifications on accounting as well.

Guidance and clarity

Indian GAAP requires a lot more guidance and clarity, specifically on revenue recognition, accounting for business combinations, and recognition and subsequent measurement of development costs. IFRS, which is fairly principles-based, should consider adding specific guidance on revenue recognition, given the diversity of arrangements in the industry. US GAAP should move towards aligning its standard on research and development with IFRS.

The author is a chartered accountant

Related Topics