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46
ASC 808 Collaborative Arrangements

Perspective and Issues
1. Subtopic
2. Scope
3. Overview
Definitions of Terms
Concepts, Rules, and Examples
1. Collaborative Arrangements

Perspective and Issues

Subtopic

ASC 808-10, Collaborative Arrangements, contains one subtopic:

ASC 809-10, Overall, which defines collaborative arrangements and gives reporting requirements.

Scope

ASC 808-10 applies to all collaborative arrangements, except for those addressed in other topics. See more on scope later in this chapter.

Overview

A collaborative arrangement (sometimes referred to in practice as “line-item” joint ventures or “virtual” joint ventures) is a contractual agreement between two or more parties (participants) to jointly conduct business activities for their mutual benefit without the formation of a separate entity in which to conduct the activities. These types of arrangements are commonly used for such purposes as:

producing motion pictures;
designing and developing hardware and/or software; or
developing new pharmaceutical drugs.

Determining the proper accounting treatment for the various activities included in these endeavors is the subject of Accounting Standards Codification (ASC) 808, Collaborative Arrangements.

Definitions of Terms

Source: ASC 808-10-20. Also see the Appendix A, Definition of Terms, for additional terms related to this topic: Customer, Contract, and Revenue.

Collaborative Arrangement. A contractual agreement that involves a joint operating activity. These arrangements involve two (or more) parties that meet both of the following requirements:

They are active participants in the activity.
They are exposed to significant risks and rewards dependent on the commercial success of the activity.

Endeavor. The activity upon which participants in a collaborative arrangement collaborate. For example, in a biotechnology or pharmaceutical environment the endeavor may be the development and commercialization of a drug candidate. In the entertainment industry, it may be production and distribution of a motion picture.

Concepts, Rules, and Examples

Collaborative Arrangements

Joint Operating Activities

(ASC 808-10-15-7) As previously mentioned, collaborative arrangements are used to conduct many different types of business activities. For example:

Two or more parties may agree to collaborate on joint operation of a facility, such as a hospital or long-term care nursing facility.
Two professional services firms (e.g., architects, engineers, consultants) may choose to jointly submit a proposal to obtain a new engagement that neither would have the capacity and/or capability to perform on its own.
A movie studio may collaborate with another studio because it wants to produce a film starring an actor who is under contract with another studio, or two studios may wish to spread the cost (and, of course, the risk) of producing a film.
Frequently, in the pharmaceutical industry, two companies engage in a joint operating activity to research, develop, market, manufacture, and/or distribute a drug candidate, including the process of obtaining all necessary regulatory approvals in one or more geographic markets.

A collaborative arrangement may involve various types of activities conducted or supervised by the participants, including but not limited to research, development, branding, promotion, sales, marketing, order processing, package design, manufacturing, and distribution. In some collaborative arrangements, a legal entity may be used for certain specified activities or in certain geographic jurisdictions due, for example, to legal restrictions imposed by the jurisdiction.

The participants' roles and responsibilities vary between arrangements but can be structured where certain responsibilities are shared between the participants and other responsibilities are solely the responsibility of one of the participants.

Scope

Under ASC 808, an activity (referred to as an “endeavor”) that is the subject of a joint operating arrangement is characterized as a collaborative arrangement within the scope of the pronouncement if:

The endeavor involves two or more parties.
Both (all) of the parties are:
1. Active participants in the endeavor, and
2. Exposed to significant risks and rewards that depend on the endeavor's commercial success.
The endeavor is not primarily conducted through a separate legal entity created for it.

Active involvement. (ASC 808-10-15-8). In evaluating whether a participant is active with respect to an endeavor, management is to consider the arrangement's specific facts and circumstances. Examples of involvement that could constitute active participation include, but are not limited to:

Directing and executing the activities of the endeavor,
Participating on a steering committee or other oversight or governance body,
Possessing a legal or contractual right to the intellectual property that underlies the endeavor.

Solely providing financial resources to an endeavor would not constitute an active level of involvement for the purposes of ASC 808.

Significant risks and rewards. (ASC 808-10-15-10 through 13) Management of a participant is to exercise its best judgment in evaluating whether the participant is exposed to significant risks and entitled to significant rewards. Consideration is to be given to the terms and conditions of the arrangement and the facts and circumstances surrounding it, including:

The stage of the endeavor's life cycle at which the participant is commencing its involvement
Management's expectations regarding the duration and extent of its financial participation in relation to the total expected duration and total expected value of the endeavor.

Examples of terms and conditions of an arrangement that may indicate that a participant is not exposed to significant risks or entitled to significant rewards include the following:

Market rates are paid for services provided by the participant
Ability of a participant to exit the arrangement without cause and recover all or most of its cumulative economic participation through the exit date
Limits on the rewards that a participant is entitled to receive
Allocation of initial profits from the endeavor to only one participant.

Frequently, a collaborative arrangement will involve the license of intellectual property with the participants to the arrangement exchanging consideration with respect to the license at the arrangement's inception. The existence of terms of this nature is not necessarily indicative of the participants not being exposed to significant risks or entitled to significant rewards.

Timing of determination or redetermination. A participant may become involved in a collaborative arrangement at any time during the life cycle of the endeavor. From the perspective of a participant, determination of whether an endeavor is a collaborative arrangement is to be made at the inception of the arrangement or when the participant initially becomes involved in the arrangement based on the facts and circumstances existing at that time. A participant is to reevaluate whether the arrangement continues to qualify as a collaborative arrangement any time there is a change in a participant's role in the arrangement or a change in a participant's exposure to risks or entitlement to rewards from the arrangement.

Accounting for Transactions with Unrelated Third Parties

(ASC 808-10-15-1 and 15-2) A participant in a collaborative arrangement recognizes revenue earned and costs incurred in transactions with third parties (parties that are not participants to the collaborative arrangement) in its income statement based on whether the participant is serving as a principal or an agent in the transaction under ASC 605-45.¹ The principal should record the amounts on a gross basis. See the chapter on ASC 605 for more guidance. The equity method should not be applied to collaborative arrangements. (ASC 808-10-45-1 and 45-2)

Matters for Which Guidance is not Provided

The scope of ASC 808 specifically excludes:

Arrangements for which the accounting treatment is addressed by other authoritative literature,
Guidance regarding matters such as
1. Determining the appropriate units of accounting,
2. Determining the appropriate recognition requirements for a given unit of accounting,
3. The timing of when recognition criteria are considered to have been met.

Example of a Collaborative Arrangement

Leonard Sporting Goods Company (LSG) and Maureen Metals LLC (MML) contractually agree to codevelop a new set of golf clubs using a special alloy and what they believe to be a revolutionary design. The terms of their Joint Development Agreement (JDA) are as follows:

LSG responsibilities

Conducting all necessary research and development activities associated with the design of the club faces and shafts
Developing the branding strategy, and designing the logo and product packaging
Engaging a contract manufacturer and performing or supervising all manufacturing, warehousing, logistics, and order processing functions
Carrying necessary inventories and insuring them against casualty loss
Establishing prices, and performing all invoicing, credit checks, and collection activities.

MML responsibilities

Conducting all necessary research and development on the development of the experimental alloy
Handling all press relations and conducting the advertising campaign
Filing of all patents associated with the product, its design, and materials
Marketing the product in its home state and six surrounding states; sales orders originating in those states are to be forwarded to LSG for processing, and shipment, with LSG responsible for performing all of the activities specified above. In the specified states, MML has limited discretion regarding the pricing of the product.

Other provisions of the JDA include:

All costs and operating profits are to be split by the participants 50%/50%.
The participants will co-own the intellectual property arising out of the project.
Due to legal considerations in the Grand Duchy of Leslie, all sales in that jurisdiction are required to be made by a legal entity duly established within its borders. Consequently, when orders are placed for shipment to the Duchy, LSG sells the golf clubs to Duchy Golf Sales Co. (DGS), a corporation chartered in the Duchy to enable DGS to then transact with the sporting goods retailer located in the Duchy. DGS is owned 50% each by LSG and MML, who each invested $10,000 upon its incorporation on January 2, 20X1.
On a quarterly basis each participant is to provide the other participant a full accounting for its activities with respect to the endeavor, and whichever participant has advanced a net amount in excess of its proportionate share of the operating results is entitled to receive an “equalization payment” from the other participant.

The following summarizes the transactions associated with the endeavor for calendar year 20X1, including the final activities necessary to commence production of the product and deliver it to sporting good stores in time for the 20X1 holiday selling season.

(000s omitted)	Total endeavor results (excluding JV)	50% of endeavor results	Joint venture DGS
Sales	$9,200	$4,600	$500
Cost of sales	5,000	2,500	300
Gross profit	4,200	2,100	200
Operating expenses
Advertising and promotion	500	250
Bad debts	200	100
Branding, package, and logo design	300	150
Legal and patent filing fees	600	300	50
Research and development
Alloy and metallurgy	200	100
Club faces and shafts	300	150
Shipping and delivery	600	300	20
Total operating expenses	2,700	1,350	70
Income from operations	$1,500		$130
× share of operating results allocable to each participant	× 50%
	$ 750	$ 750

The annual “equalization” payment was computed as follows, based on the transactions reported by the participants:

(000s omitted)	Initially recorded in the accounting records of
	LSG	MML
Sales	$9,200	$ –
Cost of sales	5,000	–
Gross profit	4,200	–
Operating expenses
Advertising and promotion	–	500
Bad debts	200	–
Branding, package, and logo design	300	–
Legal and patent filing fees	–	600
Research and development
Alloy and metallurgy	–	200
Club faces and shafts	300	–
Shipping and delivery	600	–
Total operating expenses	1,400	1,300
Income (loss) from operations prior to equalization	2,800	(1,300)
Share of operating results per agreement	750	750
Equalization payment (receivable) payable	$2,050	$(2,050)

Analysis

Determine applicability of ASC 808. The endeavor involves two parties that are both actively involved and that share equally in both risks and rewards. The existence of the separate entity (DGS) does not disqualify the arrangement, since the joint operating activities are not primarily conducted through the separate entity. Thus, from the perspective of the participants, the arrangement is considered a collaborative arrangement within the scope of ASC 808 for the year ended December 31, 20X1.

Determine the accounting for the transactions in the separate legal entity. DGS has no parent company that controls it via ownership as a voting interest entity or via other financial control as a variable interest entity (VIE). Thus, under ASC 323, each participant is to record its investment in DGS and apply the equity method to account for its investment in the joint venture as follows:

*1/2/20X1*
Investment in DGS	10,000
Cash		10,000
To record initial investment in Duchy Golf Sales Co. joint venture
*12/31/20X1*
Investment in DGS	65
Equity in earnings of investee (income statement)		65
To record 50% interest in the earnings of the joint venture for the year

Apply ASC 605-45² to determine which of the participants is principal and which is agent. Analysis under the provisions of ASC 605-45 yields the following results:

Indicator (G = Gross; N = Net)	LSG	MML
a. Is primary obligor	G	N
b. Has authority, within reasonable limits, to establish price	G	N^*
c. Involved in determining specifications of product or service	G	N
d. Changes the product or performs part of the service	G	N
e. Has discretion in selection of suppliers	G	N
Indicator (G = Gross; N = Net)	LSG	MML
f. Exposed to inventory risks
1. General risk before order placed; upon customer return	G	N
2. Specific risk after order placed or during shipping	G	N
g. Exposure to credit risk	G	G
h. Earnings fixed vs. variable	G	G
*In six states, MML has limited discretion with respect to sales price.

Under ASC 605-45, the party that is the primary obligor is a strong indicator of the party that serves as principal to the transactions. In addition, all of the other indicators point towards LSG being the principal. This is irrespective of the fact that MML does have limited authority in certain markets to negotiate price. Even in those limited states, LSG serves as the principal to the transaction. Both participants bear credit risk equally and are not limited to a percentage commission since they share equally in the commercial success of the endeavor, thus the applicability of indicators g and h is neutral between the parties. Based on the analysis of the above factors, management of both participants concluded that LSG is the principal to the transactions associated with the collaborative arrangement and MML functions as an agent.

Note that, in this fact situation, LSG is the principal for all sales other than those made through the joint venture. In some collaborative arrangements, this will not be the case and management will be required to analyze differing sales arrangements to determine separately for each type of arrangement, the party that is the principal. As can be discerned from the analysis above, this involves the exercise of judgment in light of the specific facts and circumstances.

Determine the applicable GAAP for the transactions and elect an appropriate accounting policy to be disclosed and followed consistently. Management of LSG and MML summarized the various activities, revenues and expenses associated with the arrangement as follows:

Functional classification						Ongoing, major central operations?
Natural classification	Particip. with primary responsibility under JDA	Directly earned or incurred as principal in transactions with third-party customers	Design and development of product, co-owned intellectual property	Development of co-owned marketing-related intangibles	Marketing	LSG	MML
Sales to sporting goods stores	LSG	x				x
R&D laboratory services; licensing	N/A						x
Advertising and promotion of product	MML				x	x
Branding, logo, package design	LSG			x		x
Credit, collections, bad debts	LSG	x				x
Filing for patents	MML		x			x	x
Manufacturing, delivery, fulfillment	LSG	x				x
R&D–Clubs	LSG		x			x
R&D–Metals	MML		x			x	x

Based on the foregoing analysis, LSG's management determines that since it is the principal under ASC 605-45, LSG is required to present in its income statement, 100% of the sales, and cost of sales, and other related operating expenses that it incurred in connection with the endeavor. It is unable to find any authoritative GAAP that directly or by analogy would address how to account for the equalization payments it is required to make or entitled to receive. It analyzes the components of the payment and reflects them in LSG's income statement as follows:

Components of Equalization Payment to MML
Presented as additional cost of sales; in effect the sharing of its gross profit with MML results in LSG realizing a reduced margin on its sales of these codeveloped products
a. MML share of gross profit	$2,100
Reimbursements to MML for LSG share of expenses:
These functions were performed under the JDA by MML; LSG elects to present these as operating expenses; none of the advertising expenses were capitalizable as direct response advertising or required to be deferred prior to the first time the advertising takes place under LSG's accounting policies it adopted under ASC 720-35, Advertising Costs
b. Advertising and promotion	250
c. Legal and patent filing fees	300
LSG records the reimbursement to MML for the metallurgical research and development as additional research and development expense analogous with outsourced contract R&D, since its laboratory did not have the experience or capability to perform such research
d. Research and development alloy and metallurgy	100
Reimbursement from MML for MML share expenses
LSG elects to present these reimbursements as reductions of its recorded expenses retaining their character; it believes its arrangement with MML to share half of the endeavor's results provides it the benefit of reduced costs and that the benefits it receives from the equalization payment should be characterized in its income statement as reductions of the expenses it would otherwise have borne on its own without MML's participation.
e. Bad debts	(100)
f. Branding, package, and logo design	(150)
g. Research and development—Club faces and shafts	(150)
h. Shipping and delivery	(300)
Net equalization payment	$2,050

Leonard Sporting Goods Company Statement of Income Ignoring income taxes and other transactions (000s omitted) Year ended 12/31/20X1
	Prior to application of ASC 808		Effects of equalization payment	Adjusted income statement
Sales	$9,200			$9,200
Cost of sales
Sales to third parties	5,000			5,000
Reimbursement to MML as agent		a	$ 2,100	2,100
Total cost of sales	5,000		2,100	7,100
Gross profit	4,200		(2,100)	2,100
Operating expenses
Advertising and promotion	–	b	250	250
Bad debts	200	e	(100)	100
Branding, package, and logo design	300	f	(150)	150
Legal and patent filing fees	–	c	300	300
Research and development
Alloy and metallurgy	–	d	100	100
Club faces and shafts	300	g	(150)	150
Shipping and delivery	600	h	(300)	300
Total operating expenses	1,400		(50)	1,350
Income (Loss) from operations	2,800		(2,050)	750
Equity interest in income of investee	65			65
Pretax income	$2,865		$(2,050)	$ 815

MML's management analyzed the facts and circumstances associated with the collaborative arrangement. As a research laboratory, performing research and development activities for other entities under contractual arrangements is part of MML's ongoing major and central operations.³ MML management reached the conclusion that, since LSG is the principal in the transactions with third parties, MML, as an agent, should not recognize revenue or the related cost of that revenue at their gross amounts, nor should it present expenses in the operating expense category in its income statement that are related to these transactions that it considers peripheral. Following this line of reasoning management classifies the activity related to the arrangement as follows:

Maureen Metals LLC Statement of Income Ignoring income taxes and other transactions (000s omitted) Year ended December 31, 20X1
*Revenues from collaborative arrangement*
MML share of gross profit			$2,100
Related expenses net of reimbursements
Advertising and promotion	$500	$(250)	250
Bad debts			100
Branding, package, and logo design			150
Shipping and delivery			300
			800
Net revenues from collaborative arrangement			1,300
*Intellectual property design and development*
Legal and patent filing fees	$600	$(300)	300
Research and development
Metallurgical	200	(100)	100
Club faces and shafts			150
			550
Income from operations			750
Equity interest in income of investee			65
Pretax income			$815

Note MML management's position that the costs of developing the intellectual property and protecting it by filing for patents are part of its “ongoing, major, or central operations.” Thus, those expenses are not considered directly related to its earnings as agent from the transactions occurring after the product was fully developed and shipments commenced. Although the details are presented for illustrative purposes, the net revenues from the collaborative arrangement could be shown as the first line in the income statement, and MML management could elect to voluntarily disclose the details in the notes to the financial statements to better inform the reader regarding the nature and results of the activities associated with the collaborative arrangement.

Notes

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Table of Contents for Chapter 46: ASC 808 Collaborative Arrangements

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Perspective and Issues

Subtopic

Scope

Overview

Definitions of Terms

Concepts, Rules, and Examples

Collaborative Arrangements

Joint Operating Activities

Scope

Accounting for Transactions with Unrelated Third Parties

Matters for Which Guidance is not Provided

Notes

Table of Contents for
Chapter 46: ASC 808 Collaborative Arrangements