The Financial Accounting Standards Board’s (“FASB”) revenue recognition standard titled Revenue from Contracts with Customers, commonly referred to as ASC 606, has given the accounting world a five-step ‘how to’ guide on recognizing revenue:
- Identify customer contracts
- Identify performance obligations
- Calculate the transaction price
- Allocate the transaction price
- Recognize revenue
This five-step process is designed to make accounting for revenues more consistent and provide further guidance on the nuances of revenue recognition, but what does this mean for life sciences and, specifically, pharmaceutical companies which transact with the standard gross to net recognition?
Many pharmaceutical companies rely on third parties to assist with varying levels of the sales and distribution of their products to end users. In many cases, the process for invoicing to cash receipt is complicated and consists of many steps.
Gross to net is the computation of the difference between the gross revenue, which is typically the wholesaler acquisition cost (“WAC”), and the various pricing adjustments that need to be accounted for when engaging with these third parties to help market your products. These price adjustments typically consist of chargebacks to arrive at contract prices, cash discounts, rebates, and returns.
These pricing adjustments can be a significant percentage of your gross revenue depending upon the contract terms and other variables. Therefore, when should you recognize these adjustments?
Applying the FASB’s five-step guide, once the executed contract, milestones, and transaction prices are determined, the accounting standard requires that the company recognize and quantify all future pricing adjustments at the time of the initial sale of your product. This is an important distinction as the pricing adjustment estimates will need to be constantly calculated when products are sold to properly account for channel inventory, pricing changes and adjustments, and potential returns. Typically, we see that pharmaceutical companies accrue for future price adjustments at least monthly.
An accurate estimate of these pricing adjustments will help companies ensure that their net revenue is properly stated and reflected as such in the company’s income statement.
All in all, ensuring that the gross to net revenue calculation is accurate, timely calculated, and properly reflected in the appropriate area of the income statement will ensure proper compliance with the accounting standards and allow management to thoroughly understand true net revenue to ensure profitability expectations are being achieved.
If you have any questions about how your company is handling the new revenue recognition standard, gross to net accounting, or any other pharmaceutical industry matter, please contact your WilkinGuttenplan advisor.