Biotech has recently completed its Phase 2 trials of its revolutionary new Drug during 2017.

Biotech has recently completed its Phase 2 trials of its revolutionary new Drug during 2017. On January 1, 2018, Biotech and Pharma entered into the License and Collaboration Agreement (LCA) under which Pharma licensed the rights to the Drug for future commercialization. Additionally, under the LCA, Biotech agreed to conduct the Phase 3 studies and submit the New Drug Application with the FDA if the Phase 3 results are positive. If approved by the FDA, Pharma is then responsible for all activities related to commercialization (production of Drug, marketing, sales and distribution). Pharma has agreed to pay Biotech as follows:

  • $100 million upon execution of the LCA
  • $50 million upon filing of NDA with the the FDA
  • $75 million for first commercial sale
  • 15% royalties on net sales
  • $20 million for first year in which net sales exceed $500 million
  • NOTE: If P3 results fail, then Pharma can terminate the LCA without any additional compensation beyond the initial $100 million payment.

Biotech commenced P3 trials in January 2018, with total expected costs of $50 million in 2018 and $25 million in 2019. Actual costs were in line with estimates. The P3 results were concluded at the end of 2019 with positive results. In Q1 2020, Biotech submitted the NDA with the FDA, and approval was obtained in Q2 2021. Pharma launched Drug in Q1 2022. Net sales totaled $300 million in 2022 and $600 million in 2023.

Due to the significant uncertainties involved with drug development and the significance of possible reversal of revenues, Biotech believes that it would be inappropriate to include contingent consideration based on any expectations of positive P3 results or FDA approval until such events occur. However, if P3 results are positive, then Biotech did not have any reason to doubt that it would file the NDA. Additionally, with FDA approval, Pharma was required to commercially launch Drug, or else it would lose its rights to the license (and Biotech could then sell it to another company).

Biotech has estimated the relative fair values of the license and P3 studies to be $160 million and $80 million, respectively. Biotech has concluded that granting the license and conducting the P3 studies are each performance obligations. Additionally, the license was for a right to use functional IP that was delivered in January 2018.

REQUIRED: Determine the appropriate revenue recognition for each year from 2018 to 2023. Please also indicate to which performance obligation such revenue would be allocated. Please consider the guidance for the allocation of variable consideration.

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