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Industry_Biotechnology_biolink_issue_12_Feb2009

Perspectives from

the Ernst & Y oung

Global Biotechnology Center

bio*link

Issue 12 February 2009

Accounting for

clinical trials

Introduction

The costs and risks of the clinical development of a drug are

ka_fa?[Yfl ^gj da^] k[a]f[]k [gehYfa]k è ]kh][aYddq af l`] dYl]j

klY_]k& O`ad] kge] [gehYfa]k `Yn] Zmadl ka_fa?[Yfl afl]jfYd [dafa[Yd% development capabilities, most look outside their organizations

af k]Yj[` g^ mfaim] lYd]flk$ lggdk Yf\ _]g_jYh`a[ j]Y[`& ;dafa[Yd% research organizations (CROs), from large multinationals to small, specialized boutiques, are serving this demand. In addition to [dafa[Yd%ljaYd egfalgjaf_ Yf\ \YlY eYfY_]e]fl$ ;JGk eYq Ydkg Z] ]f_Y_]\ lg hjgna\] Y oa\]j jYf_] g^ [dafa[Yd%\]n]dghe]fl k]jna[]k$ af[dm\af_ [gfkmdlYlagf gf klm\q \]ka_f$ afn]kla_Ylgj j][jmale]fl$ klm\q egfalgjaf_ Yf\ \YlY YfYdqkak& Da^] k[a]f[]k [gehYfa]k [geegfdq [gfljY[l oal` nYjagmk [dafa[Yd afn]kla_Ylgjk$ [gfkmdlYflk and laboratories to facilitate clinical activities.

bio *link:perspectives from the Ernst & Y oung Global Biotechnology Center

As the cost of conducting clinical trials increases, life sciences

companies should give additional consideration to (1) the potential ^gj ]jjgjk af Y[[gmflaf_ ^gj [dafa[Yd%ljaYd Y[lanala]k Yf\ *! l`] j]dYl]\ afl]jfYd [gfljgdk l`Yl eYq j]\m[] l`] jakc g^ ]jjgj &

Lqha[Yddq$ l`] [`Ydd]f_] Ykkg[aYl]\ oal` Y[[gmflaf_ ^gj [dafa[Yd ljaYdk j]dYl]k lg Y[lanala]k h]j^gje]\ Zq ;JGk Yf\ gl`]j ]pl]jfYd n]f\gjk& L`] \an]jk] fYlmj] g^ k]jna[]k l`Yl eYq Z] hjgna\]\ mf\]j ;JG Yf\ other arrangements, the different compensation arrangements that [Yf ]pakl ^gj ]Y[` lqh] g^ k]jna[] Yf\ l`] dY[c g^ lae]dq af^gjeYlagf related to certain clinical activities complicates the estimation g^ Y[[jmYdk ^gj k]jna[]k j]f\]j]\ Zq ;JGk Yf\ gl`]j n]f\gjk af connection with clinical trials.

This publication includes an overview of the relevant authoritative Y[[gmflaf_ dal]jYlmj] Yf\ YfYdqr]k af\mkljq hjY[la[] af Y[[gmflaf_ ^gj [dafa[Yd%ljaYd Y[lanala]k& O] Ydkg kmeeYjar] gmj gZk]jnYlagfk gf l`] common accounting issues related to clinical activities and provide ]pYehd]k g^ afl]jfYd [gfljgdk af mk] Yl da^] k[a]f[]k [gehYfa]k l`Yl eYq j]\m[] l`] jakc g^ ]jjgj & L`ak hmZda[Ylagf eYq Z] mk]^md lg companies wishing to benchmark their internal controls over clinical ]ph]fk]k Y_Yafkl h]]jk$ gj ^gj [gehYfa]k o`g Yj] ]ph][laf_ Yf increase in clinical activities in the near term.

Contents

Introduction...............................................1US Generally Accepted Accounting Principles (GAAP) guidance........................................3Accruing for the cost of clinical

trial activities...........................................3Fgfj]^mf\YZd] Y\nYf[] hYqe]flk ............3Supplies for clinical trials..........................3International Financial Reporting

Standards (IFRS)........................................4Observations on industry practice..............5

agreements.............................................6Clerical errors in a manual process............7Conclusion. (7)

US Generally Accepted Accounting Principles (GAAP) guidance

Accruing for the cost of clinical-trial activities

L`]j] ak _]f]jYd Y_j]]e]fl l`Yl ]ph]fk]k incurred pursuant to arrangements associated with clinical activities should

be recognized in the period that the services are rendered. Financial Accounting Standards Board Concepts Statement

No. 6, Elements of Financial Statements, provides that recognition of revenues,

]ph]fk]k$ _Yafk Yf\ dgkk]k Yf\ l`] j]dYl]\ increments or decrements in assets and daYZadala]k è af[dm\af_ eYl[`af_ g^ [gklk Yf\ j]n]fm]k$ Yddg[Ylagf Yf\ YegjlarYlagf è ak the essence of using accrual accounting to measure performance of entities. The goal of accrual accounting is to account for the effects of transactions and other events

and circumstances in the periods in which

l`]q g[[mj$ lg l`] ]pl]fl l`Yl l`gk] ?fYf[aYd effects are recognizable and measurable.

As a result, we believe that life sciences companies should make reasonable efforts to estimate accruals at each reporting period for clinical activities performed during the h]jag\$ af[dm\af_ k]jna[]k j]f\]j]\ Zq ;JGk and other vendors.Nonrefundable advance payments

=e]j_af_ Akkm]k L Ykc >gj[] Akkm] Fg& (/%+$

Accounting for Nonrefundable Advance

Payments for Goods or Services Received

for Use in Future Research and Development

Activities =AL> (/%+!$ hjgna\]k l`Yl

fgfj]^mf\YZd] Y\nYf[] hYqe]flk ^gj _gg\k

or services that will be used or rendered for

future research and development activities

should be deferred and capitalized. The

[YhalYdar]\ Yegmflk k`gmd\ Z] ]ph]fk]\

as the related goods are delivered or

l`] k]jna[]k Yj] h]j^gje]\& A^ Yf ]flalqìk

]ph][lYlagfk [`Yf_] km[` l`Yl al \g]k

fgl ]ph][l l`] _gg\k lg Z] \]dan]j]\ gj

the services to be rendered, capitalized

fgfj]^mf\YZd] Y\nYf[] hYqe]flk k`gmd\ Z]

[`Yj_]\ lg ]ph]fk]&

Supplies for clinical trials

To prepare for larger clinical trials,

companies often manufacture or purchase

larger supplies of the product candidate

being evaluated in the trial. These clinical

kmhhda]k [Yf Z] ]ph]fkan]$ Yk Zagdg_a[

product candidates are often manufactured

af dYj_] ZYl[`]k& Af gmj >]ZjmYjq *((/

bio*link article, “Accounting Considerations

^gj ;gddYZgjYlan] 9jjYf_]e]flk Yf\ Hj]%

DYmf[` Afn]flgjqê =Q? Fg& =B(((*!$

we addressed the topic of whether

éafn]flgja]kê g^ hjg\m[lk l`Yl `Yn] q]l

to receive Food and Drug Administration

Accounting for clinical trials

approval should be capitalized. Based

on informal discussions, we understand

l`Yl l`] K][mjala]k Yf\ =p[`Yf_] Commission (SEC) staff believes there emkl Z] Y `a_` dac]da`gg\ g^ j]_mdYlgjq approval to conclude that future economic Z]f]?l g^ l`] afn]flgjq ak hjgZYZd] Yf\ cost capitalization is appropriate. We understand that the SEC staff would be

n]jq kc]hla[Yd g^ Yfq [gehYfq l`Yl Ykk]jlk hjgZYZd] ^mlmj] ][gfgea[ Z]f]?l hjagj lg the completion of Phase III clinical trials.

9[[gj\af_dq$ o] Z]da]n] l`Yl [gehYfa]k _]f]jYddq k`gmd\ fgl Z] [YhalYdaraf_

hj]dYmf[` afn]flgjq hjagj lg l`] [gehd]lagf of Phase III clinical trials. As a result,

o] ]ph][l l`Yl kmhhda]k g^ mfYhhjgn]\

hjg\m[lk oadd _]f]jYddq Z] ]ph]fk]\ mhgf l`]aj eYfm^Y[lmj] gj mhgf l`] \]dan]jq from a vendor.

International Financial Reporting Standards (IFRS) L`] akkmYf[] g^ l`] K=;ìk hjghgk]\ jgY\ eYh lg Yddgo MK akkm]jk lg ?d] ?fYf[aYd statements prepared on the basis of IFRS has generated dialog about whether US

?99H oadd mdlaeYl]dq Z] j]hdY[]\& O] Z]da]n] l`Yl l`] ]n]flmYd oa\]khj]Y\ mk] g^ A>JK Zq MK akkm]jk ak dac]dq& 9k km[`$ o] Z]da]n] al ak important for US companies to now become familiar with IFRS.Oal` j]_Yj\ lg ]ph]fk] j][g_falagf ^gj [dafa[Yd%ljaYd [gklk$ o] Z]da]n] l`] A>JK

_ma\Yf[] ak af eYfq j]kh][lk [gfkakl]fl

af hjaf[ahd] oal` l`] MK ?99H klYf\Yj\k&

@go]n]j$ gf] c]q \a^^]j]f[] mf\]j A>JK ak

l`Yl afl]jfYd hjgb][l%\]n]dghe]fl [gklk Yj] capitalized when technical and economic ^]YkaZadalq g^ Y hjgb][l [Yf Z] \]egfkljYl]\ af accordance with certain criteria. The stated criteria include: demonstrating technical ^]YkaZadalq$ afl]fl lg [gehd]l] l`] Ykk]l$ Yf\ YZadalq lg k]dd l`] Ykk]l af l`] ^mlmj]$ Yk o]dd as others.

9dl`gm_` fgl _]f]jYddq k]]f af hjY[la[]$ l`]j] could be scenarios under IFRS where certain [dafa[Yd%ljaYd [gklk eYq Z] [YhalYdar]\& Mf\]j MK ?99H$ afl]jfYd hjgb][l%\]n]dghe]fl [gklk$ af[dm\af_ [dafa[Yd%ljaYd [gklk$ Yj] ]ph]fk]\

as incurred. In the development phase of

Yf afl]jfYd hjgb][l$ Yf ]flalq [Yf af kge] afklYf[]k a\]fla^q Yf aflYf_aZd] Ykk]l mf\]j IFRS and demonstrate that the asset will _]f]jYl] hjgZYZd] ^mlmj] ][gfgea[ Z]f]?lk& >gj ]pYehd]$ afl]jfYd hjgb][l%\]n]dghe]fl [gklk j]dYl]\ lg Y hgkl%eYjc]laf_ [dafa[Yd ljaYd eYq e]]l l`] [jal]jaY ^gj [YhalYdarYlagf mf\]j A>JK$ o`ad] l`]k] [gklk ogmd\ Z] ]ph]fk]\ mf\]j MK ?99H

4bio*link:perspectives from the Ernst & Y oung Global Biotechnology Center

Observations on industry practice

We reviewed the accounting practices of several life sciences companies with clinical

Y[lanala]k Yf\ a\]fla?]\ l`] e]l`g\k egkl [geegfdq mk]\ lg ]klaeYl] [dafa[Yd%ljaYd liabilities. One notable observation is that

l`]j] ak ka_fa?[Yfl \an]jkalq af hjY[la[]$ Yk

]Y[` [gehYfq `Yk lqha[Yddq \]n]dgh]\ Yf\ j]?f]\ alk [dafa[Yd%Y[[gmflaf_ hjg[]kk lg e]]l the unique needs of its business and terms

g^ alk YjjYf_]e]flk oal` ;JGk& >gj ]pYehd]$ ]Y[` [gehYfq j]na]o]\ `Y\ ]klYZdak`]\ controls to achieve differing thresholds of

j]hgjlaf_ Y[[mjY[q ^gj Yf af\ana\mYd [dafa[Yd trial, based on the magnitude of the effects

g^ ]Y[` af\ana\mYd ljaYd gf l`] [gehYfqìk

gn]jYdd ?fYf[aYd klYl]e]flk& Mf\]j l`ak

aehda]\ na]o$ l`] ?fYf[aYd%j]hgjlaf_ [gfljgdk

kmjjgmf\af_ dYj_] ljaYdk ogmd\ _]f]jYddq Z]

more robust than the controls surrounding

smaller trials.

Fgl kmjhjakaf_dq$ o] Ydkg gZk]jn]\ l`Yl

larger life sciences companies were more

dac]dq lg YmlgeYl] hgjlagfk g^ l`] Y[[jmYd

process. Automated functions include the

integration of a contract database within the

accrual process, the integration of clinical

development data within the accrual process

and the automated matching of vouchered

afnga[]k oal` l`] j]dYl]\ [dafa[Yd%ljaYd Y[[jmYd&

O`ad] o] gZk]jn]\ ka_fa?[Yfl \an]jkalq af

hjY[la[]$ o] Ydkg gZk]jn]\ eYfq [geegf

l`]e]k af l`] Y[[gmflaf_ ^gj [dafa[Yd%ljaYd

liabilities. Most companies grouped the

[gfljY[lmYd gj Zm\_]l]\ [dafa[Yd ]ph]f\almj]k

into major categories for accounting

purposes, such as the following:

KlYjl%mh h]jag\

HYla]fl%lj]Yle]fl h]jag\

OjYh%mh h]jag\

5 Accounting for clinical trials

Directly attributable costs

Af`]j]fldq$ l`] Y[[gmflaf_ ^gj [dafa[Yd ljaYdk

is an estimation process. However, some lqh]k g^ [dafa[Yd [gklk [Yf Z] egj] [d]Yjdq attributed to a period and do not need to be included in attribution methodologies, such Yk ]ph]fk] j][g_falagf gf Y kljYa_`l%daf] ZYkak& >gj ]pYehd]$ Y da^] k[a]f[]k [gehYfq eYq [gfljY[l \aj][ldq ^gj []jlYaf k]jna[]k$ such as consultants who are paid on an

`gmjdq ZYkak gj Zq dYZ [gklk& >gj l`]k] \aj][ldq attributable clinical costs, we observed companies estimating these costs on a

\ak[j]l] ZYkak$ _]f]jYddq egfl`dq&

Start-up phase

L`] klYjl%mh h`Yk] ak _]f]jYddq l`] h]jag\ before patients begin dosing under the [dafa[Yd%ljaYd klm\q& =ph]fk]k km[` Yk kal] selection and database development are

]pYehd]k g^ [gklk l`Yl eYq Z] af[dm\]\ af l`] klYjl%mh h`Yk] g^ Y [dafa[Yd klm\q& L`]k] [gklk af[mjj]\ Zq ;JGk gj gmlkgmj[]\ lg gl`]j

n]f\gjk Zq l`] ;JGk [Yf khYf Y ^]o egfl`k$ but the length of time varies depending

on the size and design of the trial. Certain [dafa[Yd hjg_jYek eYq `Yn] gfdq Y ^]o [dafa[Yd kal]k$ o`ad] kge] h`Yk] + klm\a]k eYq `Yn] numerous clinical sites around the world. We observed that most companies recognized

l`] ]klaeYl]\ klYjl%mh ]ph]f\almj]k mkaf_ Y kljYa_`l%daf] YlljaZmlagf e]l`g\gdg_q gn]j

l`] ]klaeYl]\ klYjl%mh h]jag\&Patient-treatment phase

L`] hYla]fl%lj]Yle]fl h`Yk] lqha[Yddq

j]hj]k]flk Y eYbgjalq g^ l`] [dafa[Yd%klm\q

costs. While the conduct and protocols of

]Y[` klm\q eYq nYjq oa\]dq ZYk]\ gf l`]

indication and clinical endpoints measured,

we did observe a consistent practice in that

Ydd eg\]dk ]klaeYl]\ l`] ]ph]fk]k af[mjj]\

ZYk]\ gf hYla]fl%Y[lanalq \YlY& O] gZk]jn]\

that when the treatment phase was brief,

l`] [gehYfa]k ]ph]fk]\ l`] ^mdd Yn]jY_]

treatment cost per patient when each patient

started the treatment phase. For longer

lj]Yle]fl h`Yk]k$ Y egj] \]lYad]\ YfYdqkak

oYk mk]\ lg e]Ykmj] hYla]fl%lj]Yle]fl

[gklk$ ZYk]\ gf hYla]fl Y[lanalq \YlY km[`

as the number of screening visits, patient

]fjgdde]fl$ \gkaf_ Yf\'gj egfalgjaf_ nakalk&

This kind of detailed model is dependent on

obtaining information from CROs or other

service providers. Some companies are able

to obtain this information with automated

tools, such as online databases that include

data from patients and doctors, in order to

track the progress of patients throughout

l`] klm\q&

Reporting and wrap-up phase

Occurring over the last few months of

Y [dafa[Yd klm\q$ l`] Y[lanala]k \mjaf_ l`]

ojYh%mh h`Yk] af[dm\] Y klYlakla[Yd j]na]o

g^ l`] \YlY Yf\ l`] ?fYd [dafa[Yd j]k]Yj[`

klm\q j]hgjlaf_& O] _]f]jYddq gZk]jn]\

l`Yl l`] ojYh%mh h`Yk] oYk Y[[gmfl]\ ^gj

af Y eYff]j kaeadYj lg l`] klYjl%mh h`Yk]

]ph]fk] l`] ]klaeYl]\ ojYh%mh ]ph]fk]k

mkaf_ Y kljYa_`l%daf] YlljaZmlagf e]l`g\ gn]j

l`] ]klaeYl]\ ojYh%mh h]jag\!&

What could go wrong?

Informal amendments to CRO

agreements

Most life sciences companies have an

]klYZdak`]\ [gfljgd j]dYl]\ lg l`] ?fYf[]

\]hYjle]flìk j]na]o g^ Ydd eYl]jaYd [gfljY[lk&

@go]n]j$ l`] ?fYf[] \]hYjle]fl eYq fgl

be aware of all amendments to contracts,

hYjla[mdYjdq o`]f Yf Ye]f\e]fl ak af^gjeYd&

It is not uncommon for the terms of an

agreement with a CRO to be amended during

l`] l]je g^ Y klm\q$ lg hjgna\] ^gj Y\\alagfYd

k]jna[]k& Af eYfq [Yk]k$ l`]k] Y\\alagfYd

k]jna[]k Yj] Yml`gjar]\ Zq l`] [gehYfqìk

[dafa[Yd \]n]dghe]fl klY^^ n]jZYddq$ l`jgm_`

]eYad [geemfa[Ylagfk gj Zq gl`]j af^gjeYd

methods. In addition, it is also not uncommon

^gj l`] hYjla]k lg lYc] kge] lae] lg ?fYdar]

formal change orders or amendments;

e]Yfo`ad]$ ]ph]fk]k ea_`l Z] af[mjj]\

6bio*link:perspectives from the Ernst & Y oung Global Biotechnology Center

pursuant to the less formal agreement, which [gmd\ j]kmdl af Yf égn]jjmfê afnga[] ^jge

the CRO.

L g j]\m[] l`] jakc g^ eYl]jaYd ékmjhjak]kê af CRO billing due to informal amendments, companies should consider the following internal controls:

Hmj[`Ykaf_ Yml`gjalq daealk Yj] [d]Yjdq

established regarding amendments.

9e]f\e]flk Yj] j]imaj]\ lg Z] ^gjeYddq

\g[me]fl]\ Yf\ ]p][ml]\&

L`] ?fYf[] \]hYjle]fl j]na]ok Ydd

material clinical contracts (including

Ye]f\e]flk! Yf\ h]jag\a[Yddq ]nYdmYl]k

l`] mf\]jdqaf_ [dafa[Yd Y[[jmYd ]klaeYlagf Y_Yafkl l`] ?fYf[aYd l]jek g^ l`]

contract.

9 ?fYf[]%\]hYjle]fl j]hj]k]flYlan]

h]jag\a[Yddq e]]lk oal` Y [dafa[Yd%

development representative to validate

the completeness of the agreements,

af[dm\af_ af^gjeYd gj éaf hjg[]kkê

agreements.

L`]j] ak imYjl]jdq [geemfa[Ylagf gj

é[gf?jeYlagfê oal` l`] ;JGk j]_Yj\af_

unbilled amounts.

Clerical errors in a manual process

L`] Y[[gmflaf_ ^gj [dafa[Yd ljaYdk ak lqha[Yddq

Y n]jq eYfmYd hjg[]kk& Egkl [gehYfa]k establish models in spreadsheets that require mh\Yl]k ]Y[` j]hgjlaf_ h]jag\ lg j]?][l

l`] egkl [mjj]fl ljaYd Y[lanalq Yf\ n]f\gj

invoices. These spreadsheets are often

[gehd]p Yf\ af[dm\] afhmlk ^jge nYjagmk

sources, such as the contractual costs with

l`] ;JG gj gl`]j n]f\gjk$ cfgof Y[lanalq

under the trial (such as patient enrollment)

and estimates of other activities under the

ljaYd km[` Yk j]aeZmjkYZd] ljYn]d ]ph]fk]k!&

9k oal` Yfq Y[[gmflaf_ hjg[]kk$ eYfmYd

activities have a higher risk of error than

YmlgeYl]\ Y[lanala]k&

of most clinical accrual spreadsheets, manual

]jjgjk g[[YkagfYddq `Yhh]f$ Yf\ kge]lae]k

l`]k] Yj] a\]fla?]\ gfdq Y^l]j Y eYl]jaYd

error has occurred.

T o reduce the risk of clerical errors in the

accrual process, life sciences companies

should consider the following internal controls:

;dafa[Yd%ljaYd j][gf[adaYlagfk Yf\ YfYdqk]k

are subject to a periodic detailed

review. The periodic reconciliation

process should include steps to ensure

l`Yl hj]hYa\ [dafa[Yd%ljaYd ]ph]fk]k Yj]

YhhjghjaYl]dq ]nYdmYl]\ mf\]j =AL>

(/%+$ km[` l`Yl hj]hYa\ Yegmflk Yj]

fgl afY\n]jl]fldq f]ll]\ Y_Yafkl gl`]j

accrued clinical liabilities.

K]hYjYl] hjgb][l ]ph]fk] [g\]k Yj] mk]\

^gj ]Y[` [dafa[Yd ljaYd$ Yf\'gj ngm[`]j]\

afnga[]k Yj] YmlgeYla[Yddq eYl[`]\ lg

l`] j]dYl]\ [dafa[Yd%ljaYd Y[[jmYd lg Ynga\

\gmZd] [gmflaf_ g^ l`] daYZadalq&

A robust process to create a clinical

Zm\_]l ak ^gddgo]\3 l`] [dafa[Yd ]ph]fk]k

for each program for each period are

compared to the budget, and budget

nYjaYf[]k Yj] ]phdYaf]\&

L`] ?fYf[] \]hYjle]fl j]na]ok Ydd

material clinical contracts (including

Ye]f\e]flk! Yf\ h]jag\a[Yddq ]nYdmYl]k

l`] mf\]jdqaf_ [dafa[Yd Y[[jmYd ]klaeYlagf

Y_Yafkl l`] ?fYf[aYd l]jek g^ l`]

contract.

9 ?fYf[]%\]hYjle]fl j]hj]k]flYlan]

e]]lk oal` Y [dafa[Yd%\]n]dghe]fl

j]hj]k]flYlan] h]jag\a[Yddq lg nYda\Yl]

l`] ka_fa?[Yfl Ykkmehlagfk mk]\ ^gj

accounting purposes.

L`]j] ak imYjl]jdq [geemfa[Ylagf gj

é[gf?jeYlagfê oal` l`] ;JGk j]_Yj\af_

unbilled amounts.

Conclusion

;dafa[Yd \]n]dghe]fl [Yf d]Y\ lg ka_fa?[Yfl

Zj]Ycl`jgm_`k ^gj Y [gehYfq$ Zml g^l]f

j]imaj]k q]Yjk g^ ]^^gjl Yf\ `mf\j]\k g^

millions of dollars. Even a small percentage

error in managing this spending could be

eYl]jaYd lg l`] ]ph]f\almj] lj]f\k Yf\

to investors. We encourage companies

to challenge their internal controls over

the accounting for clinical trials and to

incorporate leading practices.

Accounting for clinical trials

=jfkl Q gmf_

Assurance | L Yp | Transactions | 9\nakgjq About Ernst & Y oung

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=jfkl Q gmf_ j]^]jk lg l`] _dgZYd gj_YfarYlagf g^ e]eZ]j ^ajek g^ =jfkl Q gmf_ ?dgZYd

Daeal]\$ ]Y[` g^ o`a[` ak Y k]hYjYl] d]_Yd ]flalq& =jfkl Q gmf_ ?dgZYd Daeal]\$ Y MC [gehYfq daeal]\ Zq _mYjYfl]]$ \g]k fgl hjgna\] k]jna[]k to clients.

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material in this publication. On any specific matter , reference should be made to the appropriate advisor .