FASB Emerging Issues Task Force

Transcription

1 EITF Issue No FASB Emerging Issues Task Force Issue No Title: Milestone Method of Revenue Recogntion Document: Issue Summary No. 1 Date prepared: October 20, 2008 FASB Staff: Maples (ext. 462)/Elsbree (ext. 453)/Bement (x233) EITF Liaison: Bob Uhl Dates previously discussed: March 12, 2008; June 12, 2008; September 10, 2008 Previously distributed EITF materials: Issue Summary No. 1, dated February 29, 2008; Working Group Report No. 1, dated June 9, 2008; Working Group Report No. 2, dated August 13, References: FASB Statement No. 5, Accounting for Contingencies (Statement 5) FASB Concepts Statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises (Concepts Statement 5) AICPA Statement of Position 97-2, Software Revenue Recognition (SOP 97-2) AICPA Statement of Position 00-2, Accounting by Producers or Distributors of Films (SOP 00-2) EITF Issue No "Revenue Arrangements with Multiple Deliverables" (Issue 00-21) SEC Staff Accounting Bulletin No. 104, Topic 13, Revenue Recognition (SAB Topic 13A1) EITF Issue No , "Revenue Arrangements with Multiple Deliverables" (Issue 00-21) EITF Issue No. 08-1, "Revenue Arrangements with Multiple Deliverables" (Issue 08-1) The alternative views presented in this Issue Summary are for purposes of discussion by the EITF. No individual views are to be presumed to be acceptable or unacceptable applications of Generally Accepted Accounting Principles until the Task Force makes such a determination, exposes it for public comment, and it is ratified by the Board. 1 These discussion materials were discussed in conjunction with Issue EITF Issue No Issue Summary No. 1, p. 1

2 Background 1. At the March 12, 2008 EITF meeting, the Task Force considered how an entity should attribute multiple customer payment streams to a single unit of accounting in a revenue arrangement. 2 An example of an arrangement with multiple payment streams is an arrangement in which a service provider receives an up-front payment upon signing a service contract with a customer and then receives additional payments as services are provided to that customer. Other examples can be more complex, such as in biotechnology and pharmaceutical research and development arrangements, because they may involve multiple deliverables, up-front payments, payments for specific services, and payments upon achievement of certain clinical milestones. Determination of the appropriate attribution model is further complicated if delivery of a single unit of accounting spans multiple accounting periods. 2. The ultimate objective of attributing arrangement consideration to a single unit of accounting is to determine when the arrangement consideration should be recognized as revenue. The fundamental criteria of revenue recognition are set forth in Concepts Statement 5, paragraph 83, which states that "recognition involves consideration of two factors, (a) being realized or realizable and (b) being earned, with sometimes one and sometimes the other being the more important consideration." Generally, revenue is considered both realizable and earned when each one of the following four conditions 3 is met: a. Persuasive evidence of an arrangement exists b. The arrangement fee is fixed or determinable c. Delivery or performance has occurred d. Collectibility is reasonably assured. 3. At the March 12, 2008 EITF meeting, the Task Force discussed this Issue but was not asked to reach a conclusion. The issues presented at that meeting were: 2 For simplicity and unless otherwise specified in this Issue, references to a single unit of accounting refer to arrangements that include a single revenue generating activity (single deliverable) or multiple revenue generating activities (multiple deliverables) that are accounted for under Issue as a single unit of accounting (that is, multiple deliverables that cannot be separated for revenue recognition purposes). 3 References to the four conditions can be found in SAB Topic 13A1; SOP 97-2, paragraph 8; SOP 00-2, paragraph 7, and other revenue recognition accounting literature. EITF Issue No Issue Summary No. 1, p. 2

3 Issue 1 Whether, under certain facts and circumstances, it may be acceptable to use a multiple attribution model to account for a single unit of accounting consisting of a single deliverable Issue 2 Whether, under certain facts and circumstances, it may be acceptable to use a multiple attribution model to account for a single unit of accounting consisting of multiple deliverables. 4. The Task Force requested that the FASB staff perform additional research on the transactions that give rise to the practice concern addressed by this Issue, including the formation of a Working Group, if necessary. 5. At the June 12, 2008 EITF meeting, the Task Force was informed that a Working Group had been formed to provide recommendations to the Task Force on this Issue. The Task Force discussed the initial findings of the Working Group but was not asked to reach a conclusion. The Task Force instructed the staff to continue to develop this Issue with the assistance of the Working Group for discussion at a future Task Force meeting. 6. At the September 10, 2008 EITF meeting, the Task Force discussed the results of the Working Group meetings held on July 15, 2008 and August 7, 2008, including the specific practice issues that had been identified and discussed during those Working Group meetings as well as the Working Group's recommendations. 7. The Working Group agreed that revenue recognition for a single unit of accounting depends on the nature of the deliverable(s) composing that unit of accounting, the corresponding revenue recognition criteria, and whether those criteria have been met. The Working Group also agreed that current guidance does not explicitly address many of the issues encountered by entities in practice. As a result, entities have adopted various accounting methods to attribute revenue in arrangements that have multiple payment streams that are accounted for as a single unit of accounting. Those practice issues can generally be arranged into the following two categories: those impacting the determination of the unit of accounting under Issue and those related to revenue recognition attribution methods. The Working Group identified the following as areas EITF Issue No Issue Summary No. 1, p. 3

4 in which issues have been encountered in practice when entities consider the appropriate attribution model for revenue with multiple payment streams: Unit of Accounting: 1. Whether "access or standing ready to perform" can be a deliverable 2. Whether and how contingent deliverables should impact revenue recognition 3. Whether the fair value threshold requirement of Issue needs to be revised Revenue Recognition Attribution Methods: 4. Whether the milestone method is an acceptable attribution method of revenue recognition 5. How the proportional performance model should be applied to a single unit of accounting composed of multiple deliverables 6. Whether recognition of revenue on a straight-line basis is acceptable when the goods or services may not be delivered ratably over the period. 8. The Working Group discussed the six practice issue and recommended that the Task Force not provide guidance on Issues 1, 2, 5, and 6. However, the Working Group did recommend that the Task Force provide guidance on Issues 3 and The Task Force discussed Issues 1, 2, 5, and 6 and tentatively agreed with the Working Group's recommendation not to provide guidance on them. Some members of the Task Force noted that in order to address those issues the Task Force may need to create a definition of a deliverable, which they believed would take longer than one year. The definition of a deliverable is currently being addressed in the Board's revenue recognition project. Task Force members also noted that changing the objective-and-reliable-evidence-of-fair-value threshold in Issue (Issue 3) might reduce or resolve some of those issues without requiring additional standards setting. Therefore, the Task Force tentatively agreed not to provide guidance on Issues 1, 2, 5, and The Task Force agreed to proceed with the Working Group's recommendation to provide guidance on Issues 3 and 4. In addition, the Task Force also agreed with the FASB staff recommendation that Issues 3 and 4 be split into two separate EITF Issues for discussion at a future EITF meeting because each of those issues has a separate scope. Further discussion of EITF Issue No Issue Summary No. 1, p. 4

5 Issue 3 is now included in Issue The remainder of this Issue Summary focuses on Issue 4, that is, whether the milestone method is an acceptable attribution method of revenue recognition. 11. The Task Force discussed the Working Group's recommendations regarding the application of the milestone method as one type of proportional performance model of revenue recognition. As part of its discussion, the Task Force reached a tentative conclusion on the following definition of a milestone: An event that, under the terms of the arrangement, if achieved, may entitle the vendor to additional compensation based on either the vendor's performance or a specific outcome resulting from the vendor's performance. 12. Because the Task Force views the milestone payment as additional compensation that (a) becomes fixed and determinable when the milestone is reached and (b) is earned based on either the level of the vendor's performance or a specific outcome resulting from the vendor's performance, the Task Force agreed that the milestone payment may relate to past performance and may be an appropriate indicator of the value provided to the customer through the vendor's performance for that aspect of that arrangement. 13. The Task Force reached a tentative conclusion that because the objective of the milestone method is to determine whether a milestone payment amount is indicative of value transferred to a customer, the milestone method may be a valid application of the proportional performance model when the milestone is substantive. Determining whether a milestone is substantive is a matter of judgment. The Task Force tentatively concluded that the following principle should be applied to each milestone in making a determination as to whether the milestone is substantive: The amount of the payment associated with the milestone is commensurate with either the effort required to achieve the milestone or the enhancement of the value of the delivered item(s) in a unit of accounting as a result of the achievement of the milestone. The payment associated with the milestone relates solely to past performance and is reasonable when considering the deliverables and payment terms (including other potential milestone payments) within the arrangement. EITF Issue No Issue Summary No. 1, p. 5

6 14. The Task Force also tentatively concluded that a milestone shall not be considered substantive if any portion of the associated milestone payment relates to the remaining deliverables in the unit of accounting. Furthermore, in order to recognize revenue for a milestone payment in the period in which the milestone is achieved, that milestone must be substantive in its entirety. It is not appropriate to bifurcate a milestone payment into substantive and nonsubstantive components. The Task Force tentatively concluded that if an individual milestone is not considered to be substantive, the entity would not be precluded from using the milestone method for other milestones in the arrangement. 15. The Task Force also tentatively agreed that while the milestone method is an acceptable revenue attribution model, it is not necessarily the only acceptable revenue attribution model available, even when an arrangement contains substantive milestones. 16. The Task Force discussed whether the proposed guidance should include factors that would assist entities in assessing whether a milestone is substantive or whether the application of the milestone method could be illustrated through examples. The Task Force requested that the FASB staff develop examples for discussion at a future meeting that illustrate how an entity might determine when a milestone is substantive. In addition, the Task Force requested that the FASB staff seek user input on whether the proposed guidance should include additional disclosure requirements. 17. The FASB staff indicated that it would provide a draft abstract with the discussion materials for the November 13, 2008 EITF meeting for Task Force consideration. Current EITF Discussion 18. To ensure that the draft of Issue 08-9 is consistent with the recommendation of the Working Group, the draft abstract was provided to the Working Group for its consideration. Comments raised by the Working Group have been incorporated into the accounting issues for Task Force consideration. EITF Issue No Issue Summary No. 1, p. 6

7 Scope 19. Although the Working Group provided a recommendation to the Task Force to issue guidance regarding the application of the milestone method, it did not fully explore the issue of scope other than to indicate that the milestone method should not be applied in situations in which an arrangement is otherwise required to be accounted for in accordance with recognition guidance of another standard, for example SOP Consistent with the Working Group's discussion, the following scope is being proposed to the Task Force for its consideration: 9. This Issue may be applied to all contractual revenue arrangements (whether written, oral, or implied, and hereinafter referred to as "arrangements") under which a vendor satisfies its performance obligations to a customer over a period of time, when the revenue recognition convention for a given deliverable or unit of accounting is not within the scope of other authoritative literature, and when a portion or all of the arrangement consideration is contingent upon the achievement of a milestone(s). 10. For purposes of this Issue, a milestone is defined as an event for which there is substantial uncertainty at the date the arrangement is entered into that the event will be achieved when that event can only be achieved based in whole or in part on the vendor's performance or a specific outcome resulting from the vendor's performance and, if achieved, would result in additional payments being due to the vendor. 11. Because an event must be achieved based in whole or in part on the vendor's performance or a specific outcome resulting from the vendor's performance to be considered a milestone, a milestone does not include events for which the occurrence is contingent upon the passage of time or the result of a counterparty's performance. 12. The guidance in this Issue is not the only acceptable revenue attribution model for arrangement consideration contingent upon achievement of a milestone (whether or not the milestone is substantive). A vendor should apply the revenue recognition model most appropriate to the facts and circumstances. A vendor's policy for recognizing arrangement EITF Issue No Issue Summary No. 1, p. 7

8 consideration contingent upon achievement of a milestone shall be applied consistently to similar arrangements. Accounting Issues and Alternatives Issue 1: When a vendor should assess whether a milestone is substantive. 21. In drafting this Issue, the FASB staff considered the fact that a vendor's assessment of whether a milestone is substantive may change over time and questioned whether it would be appropriate for a vendor to follow the recognition guidance in this Issue for a milestone that may not be substantive at the time the milestone is achieved. For example, at the inception of an arrangement, a vendor could only estimate the amount of effort required to achieve a milestone. Some believe that the basis for revenue recognition should not be the amount of effort a vendor estimates it will expend but, rather, the actual effort expended. 22. The same general concept holds true for assessing the reasonableness of the consideration earned from achievement of a milestone compared with the enhancement of the value of the delivered item. Some believe it is inconsistent with the basic tenets of revenue recognition to recognize revenue based on the amount of enhanced value a vender expects a customer will receive upon achievement of a milestone rather than the actual enhanced value received by the customer upon achievement of the milestone. For example, at the inception of an arrangement between Pharma and Biotech, Pharma may place a significant amount of value on Biotech's ability to develop a certain drug. However, the value of that achievement may be less if a competitor of Biotech develops a similar drug first. Thus, while the consideration for achievement of the milestone may have been commensurate with the anticipated enhancement of value of the delivered item at the inception of the arrangement, it probably is not commensurate with the actual enhancement of value of the delivered item at the date the milestone is achieved. 23. Others believe that the assessment should only be performed at the inception of the arrangement because the determination of whether the consideration earned from achievement of the milestone is reasonable could change over time as market conditions change. Supporters of this view believe that events occurring subsequent to the inception of the arrangement should not impact whether a milestone is substantive. EITF Issue No Issue Summary No. 1, p. 8

9 24. Paragraph 16 of the draft abstract provides guidance requiring that as each milestone in the arrangement is achieved, an assessment be performed as to whether the consideration earned from the achievement of a milestone is not unreasonable compared with either the vendor's performance to achieve the milestone or the enhancement of the value of the delivered item(s) as a result of a specific outcome resulting from the vendor's performance to achieve the milestone. It also requires that at the inception of the arrangement, an evaluation be performed of whether the consideration earned from the achievement of a milestone relates solely to past performance and is not unreasonable in relation to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement. Issue 2: What the measurement criteria should be for determining if a milestone is substantive. 25. At the September 10, 2008, EITF meeting, the Task Force tentatively concluded that if an individual milestone is not considered to be substantive, that conclusion shall not automatically result in all other milestones in the arrangement being considered non-substantive. In addition, the Task Force tentatively concluded that for a milestone to be considered substantive, the milestone must comply with the following principle: The consideration earned from the achievement of a milestone is commensurate with either the effort required to achieve the milestone or the enhancement of the value of the delivered item(s) as a result of the achievement of the milestone. The consideration earned from the achievement of a milestone relates solely to past performance and is reasonable in relation to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement. 26. Both of the above tentative conclusions were included in the draft abstract of Issue 08-9 provided to Working Group members. In addition, the FASB staff requested that the Working Group provide feedback on the following part of the draft abstract: Paragraph 15 of the draft abstract provides guidance on when a milestone is considered substantive, including a requirement that the consideration earned from the achievement of a milestone be reasonable in relation to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement. Some have EITF Issue No Issue Summary No. 1, p. 9

10 questioned whether consideration earned from the achievement of a milestone can be considered reasonable in relation to all of the deliverables and payment terms in an arrangement if the other payment terms are not reasonable. 27. To assist with the Working Group's consideration of the above request, the draft abstract included an example of an arrangement between a biotech company (Biotech) and a pharmaceutical company (Pharma), whereby Biotech could receive consideration based on the achievement of three separate events. Furthermore, the example also indicated that the consideration for achievement of the second event was not considered to be commensurate with either the effort required to achieve the milestone or the enhancement of the value of the delivered item(s) as a result of the achievement of the milestone. 28. In response to the example, Working Group members asked how a vendor would be able to determine whether the consideration is reasonable or not. They indicated that arrangements in the biotechnology industry are highly negotiated, that each drug candidate is unique, and that the compensation is dependent on a number of factors, including remaining patent life, stage of development when agreement is executed, and potential market for a commercialized product. The Working Group indicated that, in most cases, there likely would be insufficient information available to make a positive assertion about whether the individual payments (compensation) are reasonable. 29. Upon further follow up, the FASB staff was informed that, in many cases, vendors can only assess whether the consideration received for the achievement of a milestone is not unreasonable either for the effort required to achieve the milestone or for the enhancement of the value of the delivered item(s). Furthermore, vendors use the same not unreasonable criterion in evaluating the amount of one milestone payment compared to all of the deliverables and payment terms within the arrangement. 30. As a result of the above feedback, and consistent with the FASB staff's understanding of how milestones are evaluated in practice today, the draft abstract was modified to include the following principle for assessing whether a milestone is substantive: The consideration earned from the achievement of a milestone is not unreasonable when compared with either the vendor's performance to achieve the milestone or the enhancement of the value of the delivered item(s) as a result of a specific EITF Issue No Issue Summary No. 1, p. 10

11 outcome resulting from the vendor's performance to achieve the milestone. The consideration earned from the achievement of a milestone relates solely to past performance and is not unreasonable relative to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement. 31. An alternative to the above proposal would be to provide measurement criteria in the abstract that would provide guidance on how a vendor would determine whether arrangement consideration is reasonable. However, based on the feedback received from the Working Group on the draft abstract, the staff believes it would be difficult to develop a list of factors to consider in making that assessment. 32. In addition, the FASB staff also received feedback indicating that because of the highly negotiated nature of arrangements in the Biotechnology industry, and considering the use of the not unreasonable assessment threshold, it would be extremely difficult to determine if the compensation received from one event or service related to another event or service. For example, if the overall compensation in an arrangement was considered fair but one of the milestones was considered not to be substantive, it would seem that a portion of the fee related to the non-substantive milestone must relate to some other portion of the arrangement. Determining what portion of the arrangement that fee relates to would seem highly judgmental as these types of arrangements are not comparable to other arrangements for the reasons discussed previously. As a result, the FASB staff modified the draft abstract to include the following criterion: If an individual milestone is not considered to be substantive, all milestones that have not been achieved at the date of the evaluation shall be considered nonsubstantive and no future evaluation of whether a milestone is substantive shall be performed. If a milestone is found to be non-substantive, the associated consideration should be accounted for under other revenue recognition guidance. Disclosure 33. At the September 10, 2008 EITF meeting, the Task Force requested that the staff perform research on additional disclosures, including obtaining user input on what disclosures, if any, should be required by the proposed Issue. In response, the FASB staff received input from six users of financial statements (two buy side and four sell side). In general, these users indicated a lack of significant interest in the disclosures around the application of the milestone method. EITF Issue No Issue Summary No. 1, p. 11

12 They appeared to be more interested in the receipt of cash rather than the timing of revenue recognition. However, the following is a summary of some of the disclosures these users thought might be beneficial: Achievement of revenue recognition milestones Amounts of material fees that could be received over each of the next five years Material uncertainties impacting realization of milestone fees. 34. Based on input from the Working Group and the six users, the FASB staff has included the following disclosure requirement for the Task Force's consideration: An entity shall disclose its accounting policy for the recognition of milestone payments as revenue. For those entities electing to apply the guidance of this Issue, the following information shall be disclosed in the notes to the financial statements for each arrangement that includes a material milestone payment: (a) a description of the overall arrangement, (b) a description of the individual milestones and related contingent consideration, (c) a determination as to whether the milestones are considered substantive, (d) a list of the factors considered by the entity in making its assessment of whether the milestones are substantive, and (e) the amount of milestone consideration earned during the period. Transition 35. The Working Group discussed the following transition alternatives but was unable to reach agreement on a recommendation for the Task Force. Alternative A: Retrospective Application The consensus should be applied retrospectively to all prior periods presented. The cumulative effect of the change in accounting principle on periods prior to those presented should be recognized as of the beginning of the first period presented. An offsetting adjustment should be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period, presented separately. EITF Issue No Issue Summary No. 1, p. 12

13 Alternative B: Entities should recognize the effect of the change on all revenue arrangements outstanding during the period that includes the effective date through a cumulative-effect adjustment. The consensus should be applied to all outstanding revenue arrangements as of the beginning of the fiscal year in which the consensus is initially applied. The cumulative effect of the change in accounting principle should be recognized as an adjustment to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that fiscal year, presented separately. Alternative C: Entities should recognize the effect of the change on a prospective basis to revenue arrangements entered into or modified after the effective date.. Alternative C would require entities to apply the consensus only to those revenue arrangements entered into or modified after the effective date. 36. Although the Working Group recommended that application of the milestone method be permitted but not required, it still believed that entities should be provided with the opportunity to apply the milestone method to prior transactions (retrospective application). The Working Group believed that retrospective application was the appropriate alternative for several reasons. In addition to the retrospective application generally being the preferred method of transition under Statement 154, the Working Group indicated that they did not anticipate the cost of retrospective application of the milestone method to be excessively burdensome to apply. Furthermore, they believed that because many entities believe that the Milestone Method results in revenue recognition that is reflective of the underlying arrangement, entities likely will have a desire to apply the milestone method. 37. The staff considers Alternative A to be consistent with paragraph 7 of Statement 154, which requires retrospective application to changes in accounting principles. In addition, retrospective application is the transition method that best achieves consistency of financial information between periods and facilitates comparability of accounting data. If it is impracticable to apply retrospective application, paragraph 9 of Statement 154 allows for the new accounting principle to be applied on a prospective basis. EITF Issue No Issue Summary No. 1, p. 13

14 38. Alternative B carries the benefit of consistency and comparability for the current year and future years without the burden of recasting prior years' amounts. Alternative B requires entities to evaluate only the arrangements in effect at the effective date of this Issue. The staff acknowledges that with the reduced costs and burdens of Alternative B comes less consistency and comparability for years prior to the year of adoption. 39. Alternative C would eliminate the need to reassess existing and prior arrangements. Opponents of Alternative C are concerned with the inconsistency of allowing revenue transactions entered into prior to the effective date of this Issue to be accounted for in a manner inconsistent with the consensus reached. Alternative C would allow for an entity to have multiple policies for revenue recognition for some period of time after this Issue is finalized, as arrangements entered into before its effective date would follow the entity's historic policy and arrangements entered into after the effective date would follow the guidance in this Issue. Effective date 40. Although the Working Group did not provide a specific recommendation regarding the effective date, Working Group members did support allowing entities the ability to early adopt the guidance included in this Issue. Working Group members also indicated that they understand that early adoption is normally precluded because users prefer, for consistency reasons, that all entities adopt a new standard at the beginning of a fiscal year. However, because a lack of consistency for reporting revenue among entities already exists, Working Group members did not believe that the level of consistency would be negatively impacted by allowing the guidance within this Issue to be early adopted. 41. Based on the above, the Task Force is being asked to consider whether a consensus on this Issue should be effective for fiscal years beginning after December 15, Earlier application of the consensus on this Issue is permitted. Draft Abstract 42. Attached as Appendix 08-9A is a draft abstract for this Issue. At the November 13, 2008 EITF meeting, the Task Force will be asked to discuss the issues presented below. Ultimately, the Task Force will be asked to consider the draft abstract, with or without refinements, and then EITF Issue No Issue Summary No. 1, p. 14

15 to decide whether to proceed with this Issue. The draft abstract may require additional edits based on the Task Force's tentative conclusions on Issues 1 and 2. Issue 3: Does the Task Force agree with the draft abstract as proposed? Issue 4: Does the Task Force agree with the examples included in Exhibit 08-9A of the draft abstract? International Convergence 43. No detailed guidance for multiple-deliverable revenue recognition arrangements exists under International Financial Reporting Standards. EITF Issue No Issue Summary No. 1, p. 15

16 Appendix 08-9A EITF ABSTRACTS (DRAFT) Issue No Title: Milestone Method of Revenue Recognition Dates Discussed: March 12, 2008; June 12, 2008; September 10, 2008; [November 13, 2008; January 15, 2009] References: FASB Statement No. 5, Accounting for Contingencies FASB Concepts Statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises SEC Staff Accounting Bulletin No. 104, Topic 13, Revenue Recognition EITF Issue No , "Revenue Arrangements with Multiple Deliverables" Objective 1. The objective of this Issue is to define a milestone and clarify whether a vendor may recognize arrangement consideration earned from the achievement of a milestone in its entirety in the period in which the milestone is achieved. All paragraphs in this Issue have equal authority. Paragraphs in bold set out the main principles. Background 2. Entities often enter into revenue arrangements with multiple payment streams for a single deliverable or a single unit of accounting. 4 For example, a service provider may receive an upfront payment upon signing a service contract with a customer and then receive additional payments as services are provided to that customer. Other examples can be more complex, such as in biotechnology and pharmaceutical research and development arrangements with up-front payments, payments for specific services, and payments upon achievement of specified clinical or other milestones. When delivery of a single unit of accounting spans multiple accounting periods, a vendor needs to determine how to allocate the arrangement consideration attributable to that unit of accounting to those accounting periods. The objective of attributing arrangement 4 For simplicity, the term "unit of accounting" in this Issue refers to both a single deliverable and to multiple deliverables) that are accounted for under Issue as a single unit of accounting. EITF Issue No Issue Summary No. 1, p. 16

17 consideration to a single unit of accounting is to determine when the arrangement consideration should be recognized as revenue. 3. Revenue recognition for a single unit of accounting depends on the nature of the deliverable(s) constituting that unit of accounting, the corresponding revenue recognition criteria, and whether those criteria have been met. Concepts Statement 5, paragraph 83, states that a vendor's revenue recognition "involves consideration of two factors, (a) being realized or realizable and (b) being earned, with sometimes one and sometimes the other being the more important consideration." 4. These two factors (being realized or realizable and being earned) are usually met when (a) delivery or performance has occurred and (b) the arrangement consideration is fixed or determinable. 5. Generally, delivery or performance of a deliverable is considered to have occurred when the seller has satisfied its obligations related to that deliverable and the customer has realized the value of the deliverable. Because the delivery of a unit of accounting may span multiple accounting periods, entities have adopted various accounting methods to address the issue of when delivery has occurred and, consequently, when revenue should be recognized. Recognizing revenue based on proportional performance (generally referred to as the proportional performance method) is generally accepted as one method of recognizing revenue in a pattern that reflects a vendor's satisfaction of its obligation to the customer in the arrangement. 6. In the application of a proportional performance method, the fixed or determinable fees of an arrangement generally do not include consideration contingent upon the achievement of events for which substantial uncertainty exists as to whether the event will be achieved. However, once the events are achieved, the additional consideration becomes fixed or determinable and is then recognizable, assuming all other revenue recognition criteria are met. How that additional consideration is recognized varies. 7. One method to recognize the revenue for the additional consideration is the milestone method. Under the milestone method, the additional consideration from achievement of the event (or milestone) is considered indicative of the value provided to the customer through either (a) the vendor's performance or (b) a specific outcome resulting from the vendor's performance (for example, performance of research and development services by a biotechnology company that EITF Issue No Issue Summary No. 1, p. 17

18 leads to U.S. Food and Drug Administration approval). That is, the milestone method is an approach to the application of the proportional performance method of revenue recognition. Under the milestone method, a vendor recognizes arrangement consideration received from the achievement of a milestone in its entirety in the period in which the milestone is achieved, assuming all other revenue recognition criteria are met. 8. However, some have observed that the use of the milestone method allows a vendor to recognize the full milestone payment without attributing it proportionally to the entire deliverable or components of the unit of accounting and question if this is an appropriate application of the proportional performance method. For example, in a research and development arrangement, it would not be uncommon for a biotech entity to attribute revenue based on the number of hours of research and development service performed. When recognizing the entire milestone-related consideration under the milestone method, a biotech company does not attribute that milestone consideration to all of the research and development hours that will be performed within the arrangement, but instead attributes it only to those research and development hours that have been completed. As research and development hours are not distinguishable from one another, some have questioned whether the milestone method is an acceptable application of the proportional performance method. Scope 9. This Issue may be applied to all contractual revenue arrangements (whether written, oral, or implied, and hereinafter referred to as "arrangements") under which a vendor satisfies its performance obligations to a customer over a period of time, when the revenue recognition convention for a given deliverable or unit of accounting is not within the scope of other authoritative literature, and when a portion or all of the arrangement consideration is contingent upon the achievement of a milestone(s). 10. For purposes of this Issue, a milestone is defined as an event for which there is substantial uncertainty at the date the arrangement is entered into that the event will be achieved when that event can only be achieved based in whole or in part on the vendor's performance or a specific outcome resulting from the vendor's performance and, if achieved, would result in additional payments being due to the vendor. EITF Issue No Issue Summary No. 1, p. 18

19 11. Because an event must be achieved based in whole or in part on the vendor's performance or a specific outcome resulting from the vendor's performance to be considered a milestone, a milestone does not include events for which the occurrence is contingent upon the passage of time or the result of a counterparty's performance. 12. The guidance in this Issue is not the only acceptable revenue attribution model for arrangement consideration contingent upon achievement of a milestone (whether or not the milestone is substantive). A vendor should apply the revenue recognition model most appropriate to the facts and circumstances. A vendor's policy for recognizing arrangement consideration contingent upon achievement of a milestone shall be applied consistently to similar arrangements. 13. This Issue does not address whether an arrangement comprises one or more deliverables or whether multiple deliverables within an arrangement meet the separation requirements of Issue Recognition 14. When applying the guidance in this Issue a vendor shall recognize the arrangement consideration that is contingent upon the achievement of a milestone in its entirety in the period in which the milestone is achieved, provided the milestone is substantive. 15. The determination of whether a milestone is substantive is a matter of judgment. However, the following principle shall be used in making a determination as to whether a milestone is substantive: The consideration earned from the achievement of a milestone is not unreasonable when compared with either the vendor's performance to achieve the milestone or the enhancement of the value of the delivered item(s) as a result of a specific outcome resulting from the vendor's performance to achieve the milestone. The consideration earned from the achievement of a milestone relates solely to past performance and is not unreasonable relative to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement. 16. An evaluation of whether the consideration earned from the achievement of a milestone is not unreasonable when compared with either the vendor's performance to achieve the milestone EITF Issue No Issue Summary No. 1, p. 19

20 or the enhancement of the value of the delivered item(s) as a result of a specific outcome resulting from the vendor's performance to achieve the milestone, shall be performed as each milestone in the arrangement is achieved. An evaluation of whether the consideration earned from the achievement of a milestone relates solely to past performance, and is not unreasonable relative to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement, shall be performed at the inception of the arrangement. 17. If an individual milestone is not considered to be substantive, all milestones that have not been achieved at the date of the evaluation shall be considered nonsubstantive and no future evaluation of whether a milestone is substantive shall be performed. If a milestone is found to be non-substantive, the associated consideration should be accounted for under other revenue recognition guidance. 18. A milestone shall not be considered substantive if any portion of the associated milestone consideration relates to the remaining deliverables in the unit of accounting (this is, it does not relate solely to past performance). In order to recognize the milestone consideration in its entirety as revenue in the period in which the milestone is achieved, the milestone must be substantive in its entirety. It is not appropriate to bifurcate milestone consideration into substantive and non-substantive components. For example, if the remaining arrangement consideration after the assumed achievement of a milestone is not commensurate with the estimated selling price of the remaining undelivered items in the arrangement, as determined in accordance with Issue 00-21, the consideration shall not be considered to relate solely to past performance. In addition, if a portion of the consideration earned from achieving a milestone may be refunded or adjusted based on future performance (for example, through a penalty or clawback), the contingent consideration is not considered to relate solely to past performance and thus the related milestone cannot be considered substantive. 19. Consideration received from the achievement of multiple milestones shall not be added together to determine if the contingent consideration for an individual milestone is not unreasonable when compared with either the vendor's performance to achieve the milestone or the enhancement of the value of the delivered item(s) as a result of a specific outcome resulting from the vendor's performance to achieve the milestone. EITF Issue No Issue Summary No. 1, p. 20

21 Disclosure 20. [To be discussed by the Task Force at a future meeting.] Transition 21. [To be discussed by the Task Force at a future meeting.] The provisions of this Issue need not be applied to immaterial items. Status 22. [No further EITF discussion is planned.] EITF Issue No Issue Summary No. 1, p. 21

22 Exhibit 08-9A EXAMPLES OF THE APPLICATION OF THE EITF CONSENSUS ON ISSUE 08-9 The following examples illustrate the potential application of this Issue based on the limited facts presented. The evaluations following each of the example fact patterns are for illustrative purposes only. Additional facts would most likely be required in order to fully evaluate revenue recognition for these arrangements. The purpose of these examples is to illustrate the principles of this Issue, and because the appropriate revenue recognition method for a particular arrangement is facts-and-circumstances specific, no revenue recognition guidance is provided in the examples for the contingent consideration associated with milestones that are determined not to be substantive or events that are determined not to be milestones. Illustration 1A Facts: Biotech Company (Biotech) enters into an agreement with Pharmaceutical Company (Pharma) on January 1, 20X1. The agreement includes Biotech (a) licensing certain rights to Pharma to use Technology A, and (b) providing research and development services to Pharma. Additional details on each of those aspects of the agreement follow. License: Biotech licenses certain rights on an exclusive basis to Pharma for a period of 10 years. The license gives Pharma the exclusive right to market, distribute, and manufacture any drug developed using Technology A during the licensing period. Biotech retains all ownership rights to Technology A. Biotech has not licensed Technology A to any other party. Research and development: Biotech agrees to provide research and development services on a best-efforts basis to Pharma. Biotech agrees to devote 8 to 10 full-time equivalents to the research and development activities, and Pharma expects to devote several full-time equivalents to the research and development activities as well. The objective of the research and development services is to develop a viable drug candidate using Technology A and to receive U.S. Food and Drug Administration approval of the drug candidate. Arrangement consideration is as follows: Biotech receives $5 million in licensing fees up-front upon signing the agreement EITF Issue No Issue Summary No. 1, p. 22

23 Biotech receives $250,000 per year for each full-time equivalent that performs research and development activities Milestones: 1. Biotech receives $2 million for the first drug candidate identified from the results of the research and development conducted under the arrangement 2. Biotech receives $2 million upon successful Phase II clinical trial completion 3. Biotech receives $3 million upon Food and Drug Administration approval. The license and full-time equivalent fees are comparable to rates charged by Biotech in other arrangements and are also considered comparable to rates charged by Biotech's competitors and contract research organizations. None of these payments, once received, are refundable, even if Food and Drug Administration approval is never received. In addition, while Biotech must perform on a best-efforts basis, it is not obligated to achieve the milestones. Pharma must use Biotech to perform the research and development activities necessary to develop a drug candidate using Technology A because the know-how and expertise related to Technology A is proprietary to Biotech. In other words, Biotech is the only party capable of performing the level and type of research and development services required by Pharma under the agreement. Biotech has evaluated the deliverables in this arrangement and concluded that the license deliverable does not meet the first criterion for separation under Issue in that it does not have standalone value to Pharma. Therefore, Biotech concludes that the arrangement has one unit of accounting. A high rate of failure is inherent in the research and development of new products and technologies and failure can occur at any point in the arrangement. There are many variables in Biotech's operations that may affect its ability to achieve any of the arrangement-defined milestones (events), including: domestic and international governmental regulations; trade protection measures; labor regulations; political and economic instability; diminished protection of intellectual property; and new products and technology introduced by Biotech's competitors. Any one of these factors could cause Biotech not to achieve the arrangement events. EITF Issue No Issue Summary No. 1, p. 23

24 Biotech has an accounting policy of recognizing revenue for contingent consideration earned from the achievement of a substantive milestone in its entirety in the period in which the substantive milestone is achieved. Biotech is evaluating whether it can recognize the eventrelated contingent arrangement consideration in the period in which each event is achieved. Evaluation: Before evaluating whether the events are substantive milestones, Biotech must first determine whether the events qualify as milestones and then whether the events are within the scope of this Issue. Because of the numerous variables that may affect Biotech's ability to achieve the events and the high rate of failure inherent in the research and development of new products, Biotech believes substantial uncertainty exists at the consummation date of the arrangement as to whether it will achieve the events. Accordingly, the events are considered milestones within the scope of this Issue. At the inception of the arrangement, Biotech evaluated whether the consideration earned from the achievement of each milestone relates solely to past performance, and is not unreasonable relative to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement. Based on Biotech's assessment, it was unable to find any information that would cause it to conclude that the arrangement consideration for each milestone was unreasonable when compared to the arrangement consideration for the remainder of the arrangement (license and full-time equivalent consideration as well as the other milestone contingent consideration) and the relative risk associated with each milestone. In addition, Biotech concluded that the payment relates solely to past performance because the arrangement does not include a provision for the contingent fees to be refunded and because upon the assumed achievement of each milestone, the remaining arrangement consideration would be commensurate with the estimated selling price for the remaining undelivered items. As each of the three milestones is achieved, Biotech will evaluate whether the consideration earned from the achievement of each milestone is not unreasonable when compared with either the vendor's performance to achieve the milestone or the enhancement of the value of the delivered item(s) as a result of a specific outcome resulting from the vendor's performance to achieve the milestone. The following evaluation is the same for each of the three milestones. EITF Issue No Issue Summary No. 1, p. 24