ASC

ASC 730-20

Research and Development Arrangements

730 Research and Development

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In brief

IntermediateRecognitionDisclosureContingencies and guaranteesConsolidation

ASC 730-20 governs how an entity accounts for arrangements in which other parties (often a limited partnership of investors) fund the entity's research and development. The central question is the substance of the entity's obligation: whether the entity has merely contracted to perform R&D services for others, or has in substance incurred a liability to repay the funding parties. Substance governs over form, so payments labeled royalties or option/purchase prices may in fact be settlement of a borrowing, the purchase price of an asset, or true royalties.

Key points (7)
  • The provided text of the Subtopic describes R&D arrangements — typically limited partnerships in which the entity or a related party is general partner and performs the R&D on a best-efforts basis for a fixed fee or cost-plus fee (730-20-05-2 through 05-4).
  • An entity that is party to an R&D funding arrangement usually incurs an obligation when it enters the arrangement, ranging from an obligation to perform contract R&D work to an obligation to repay the funding parties with a return (730-20-05-6).
  • Accounting representations are not limited to legal requirements; future payments ostensibly for royalties or to purchase the partnership's interest may in substance be (a) settlement of a borrowing, (b) the purchase price of an asset, or (c) royalties for use of an asset (730-20-05-9).
  • Financial reporting must faithfully represent the arrangement and must not subordinate substance to form (730-20-05-9).
  • An entity accounting for its obligation as a contract to perform R&D for others must disclose the terms of significant agreements (royalty arrangements, purchase provisions, license agreements, and commitments to provide additional funding) as of each balance sheet date (730-20-50-1(a)).
  • Such an entity must also disclose compensation earned and costs incurred under those contracts for each income statement period presented (730-20-50-1(b)); related party disclosures under Topic 850 also apply (730-20-50-2).
  • Multiple arrangements need not be disclosed separately unless separate disclosure is necessary to understand the financial statement effects; aggregation of similar arrangements by type may be appropriate (730-20-50-3).

For students. Exam questions hinge on classification: if the sponsor is in substance obligated to repay the investors, the funding is a liability (borrowing), not R&D revenue or a mere service contract. The common misunderstanding is assuming the legal form — a "best-efforts" R&D services contract with a partnership — controls; ASC 730-20-05-9 expressly says substance governs.

research and development arrangementfunded research and developmentlimited partnership funding vehiclesubstance over formobligation to repay funding partiescontract to perform research and development for othersoption to purchase results of r&droyalty and purchase provisions

Machine-generated study aid for ASC 730-20. Check the source paragraphs below.

730-20-00Status

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730-20-05Overview and Background

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730-20-05-1
This Subtopic provides guidance on research and development arrangements. Research and development arrangements have been used to finance the research and development of a variety of new products, such as information processing systems, medical technology, experimental drugs, electronic devices, and aerospace equipment. Entities may enter into arrangements for any of the following reasons:
  1. a
    To transfer all or part of the uncertainty and risk involved with the research and development to others
  2. b
    To obtain the benefit of funds that are made available because of tax incentives for investors
  3. c
    To attract qualified research and development personnel who otherwise might be concerned that funding might not be assured
  4. d
    To avoid expanding the ownership of the entity and the impact on earnings per share (EPS) that would result from issuing equity securities
  5. e
    To avoid debt service expenditures and the impact on the entity's debt-to-equity ratio that would result from issuing debt securities
  6. f
    To avoid the impact on the entity's near-term earnings that would result if it incurred the related research and development expenses.
730-20-05-2
Many arrangements are formed as limited partnerships. In some, the entity or a related party is the general partner who manages the research and development activities. Sometimes, the limited partners are related to the entity. In some arrangements, the entity has the basic technology needed for the research and development and has performed preliminary research and development work to determine the attractiveness of further work. The entity might contribute the preliminary research and development work and basic technology to the partnership for a minor equity interest or might license or give the rights to the preliminary work and basic technology to the partnership.
730-20-05-3
The terms of the arrangement usually contemplate, but do not guarantee, that the funds provided by the limited partners will be sufficient to complete the intended research and development. However, some agreements permit or require the general partner to sell additional limited-partnership interests or to use its own funds if the funds provided are insufficient to complete the research and development effort. The entity sometimes provides additional funds through loans or advances to the partnership. Repayment of the loans or advances sometimes is guaranteed by the partnership although repayment sometimes is contingent on realization of future economic benefits of the research and development; for example, repayment might be made through offsets against the purchase price for the results of the project or against royalty payments.
730-20-05-4
The entity or a related party of the entity usually performs the research and development work under a contract with the partnership. The compensation under the research and development contract usually is either a fixed fee or reimbursement of direct costs plus a fixed fee or fixed percentage of those costs. The work is performed on a best-efforts basis with no guarantee of either technological or commercial success. The partnership retains legal ownership of the results of the research and development and sometimes retains legal rights to the basic technology provided by the entity.
730-20-05-5
Either as part of the partnership agreement or through contracts with the partnership, the entity usually has an option either to purchase the partnership's interest in or to obtain the exclusive rights to the entire results of the research and development in return for a lump sum payment or royalty payments to the partnership. Some arrangements contain a provision that permits the entity to acquire complete ownership of the results for a specified amount of the entity's stock or cash at some future time. In some of those purchase agreements, the partnership has the option to receive either the entity's stock or cash; in others, the entity makes the decision. Sometimes, warrants or similar instruments to purchase the entity's stock are issued in connection with the arrangement.
730-20-05-6
An entity that is a party to an arrangement through which research and development is funded by other parties usually incurs an obligation when it enters into the arrangement. The nature and extent of the entity's obligation are sometimes difficult to determine and can range from an obligation to perform contract research and development work to an obligation to repay the other parties, with a return, for the funds provided.
730-20-05-7
If the results of the research and development are determined to have sufficient future economic benefit, the entity probably will exercise its option either to purchase the partnership's interests in or to obtain the exclusive rights to the entire results. If the results do not have future economic benefit, the entity usually is not legally required to exercise its option; however, there may be valid business reasons for the entity to acquire the results even though the original objectives of the research and development are not met. For example, the entity may want to obtain ownership of results that have value to the entity even though they do not meet the original objectives.
730-20-05-8
Other reasons to acquire the results of research and development may be:
  1. a
    To maintain the ability to enter into another arrangement with the same parties or similar arrangements with other parties
  2. b
    To recover the ownership of or rights to the entity's basic technology or to prevent the partnership from providing that technology to others
  3. c
    To avoid any potential future claim against the use of the results
  4. d
    To fulfill a moral obligation (for example, the entity is the general partner and due to a conflict of interest feels compelled to exercise its option).
730-20-05-9
Although the entity's legal liabilities will be specified in the various contracts and agreements under the arrangement, accounting representations should not necessarily be limited to legal requirements. Depending on the facts and circumstances involved in a particular research and development arrangement, future payments by the entity to the other parties ostensibly for royalties or to purchase the partnership's interests in or to obtain the exclusive rights to the research and development results might actually be any of the following:
  1. a
    The settlement of a borrowing
  2. b
    The purchase price of an asset
  3. c
    The royalties for the use of an asset.
The financial reporting of an entity that is a party to a research and development arrangement should represent faithfully what it purports to represent and should not subordinate substance to form.
730-20-05-10
The legal structure of a research and development arrangement may take a variety of forms and often is influenced by federal and state income tax and securities regulations. An entity might have an equity interest in the arrangement, or its legal involvement might be only contractual (for example, a contract to provide services and an option to acquire the results of the research and development).
730-20-05-11
For guidance on consolidation of a research and development arrangement, see Subtopic 810-30. An overview can be found in Section 810-30-05.

730-20-10Objectives

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730-20-10-1
The objective of this Subtopic is to provide guidance related to research and development arrangements.

730-20-15Scope and Scope Exceptions

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Overall Guidance

730-20-15-1
This Subtopic follows the same Scope and Scope Exceptions as outlined in the Overall Subtopic, see Section 730-10-15, with specific qualifications and exceptions noted below.
730-20-15-1A
This Subtopic also applies to software-development arrangements that are fully or partially funded by a party other than the vendor that is developing the software and for which technological feasibility of the computer software product in accordance with the provisions of Subtopic 985-20 on software has not been established before entering into the arrangement. Those arrangements typically provide the funding party with some or all of the following benefits:
  1. a
    Royalties payable to the funding party based solely on future sales of the product by the software vendor (that is, reverse royalties)
  2. b
    Discounts on future purchases by the funding party of products produced under the arrangement
  3. c
    A nonexclusive sublicense to the funding party, at no additional charge, for the use of any product developed (a prepaid or paid-up nonexclusive sublicense).

Entities

730-20-15-2
This Subtopic establishes standards of financial accounting and reporting for an entity that is a party to a research and development arrangement through which it can obtain the results of research and development funded partially or entirely by others.
730-20-15-3
The guidance in this Subtopic applies whether the research and development is performed by the entity, the funding parties, or a third party. Although the limited-partnership form of arrangement is used for illustrative purposes in this Subtopic, the guidance also applies for other forms.

Transactions

730-20-15-4
The guidance in this Subtopic does not apply to the following transactions and activities:
  1. a
    Government-sponsored research and development.
  2. b
    Funded software-development arrangements in which the technological feasibility of the computer software product, in accordance with the provisions of Subtopic 985-20 on software, has been established before the arrangement has been entered into (see paragraph 985-20-25-12).

730-20-25Recognition

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730-20-25-1
This Subtopic deals with transactions in which the issue is whether, at the time an entity enters into a research and development arrangement:
  1. a
    The entity is committed to repay any of the funds provided by the other parties regardless of the outcome of the research and development.
  2. b
    Existing conditions indicate that it is likely that the entity will repay the other parties regardless of the outcome.
  3. c
    The entity is obligated only to perform research and development work for others.
730-20-25-2
An entity shall determine the nature of the obligation it incurs when it enters into an arrangement with other parties who fund its research and development. The factors discussed in paragraphs
730-20-25-3 through 25-9
and other factors that may be present and relevant to a particular arrangement shall be considered when determining the nature of the entity's obligation.

Obligation to Repay the Other Parties

730-20-25-3
If the entity is obligated to repay any of the funds provided by the other parties regardless of the outcome of the research and development, the entity shall estimate and recognize that liability. This requirement applies whether the entity may settle the liability by paying cash, by issuing securities, or by some other means.
730-20-25-4
To conclude that a liability does not exist, the transfer of the financial risk involved with research and development from the entity to the other parties must be substantive and genuine. To the extent that the entity is committed to repay any of the funds provided by the other parties regardless of the outcome of the research and development, all or part of the risk has not been transferred. The following are some examples in which the entity is committed to repay:
  1. a
    The entity guarantees, or has a contractual commitment that assures, repayment of the funds provided by the other parties regardless of the outcome of the research and development.
  2. b
    The other parties can require the entity to purchase their interest in the research and development regardless of the outcome.
  3. c
    The other parties automatically will receive debt or equity securities of the entity upon termination or completion of the research and development regardless of the outcome.
730-20-25-5
Even though the written agreements or contracts under the arrangement do not require the entity to repay any of the funds provided by the other parties, surrounding conditions might indicate that the entity is likely to bear the risk of failure of the research and development. If those conditions suggest that it is probable that the entity will repay any of the funds regardless of the outcome of the research and development, there is a presumption that the entity has an obligation to repay the other parties. That presumption can be overcome only by substantial evidence to the contrary. In this context, probable means that repayment is likely.
730-20-25-6
Examples of conditions leading to the presumption that the entity will repay the other parties include any of the following:
  1. a
    The entity has indicated an intent to repay all or a portion of the funds provided regardless of the outcome of the research and development.
  2. b
    The entity would suffer a severe economic penalty if it failed to repay any of the funds provided to it regardless of the outcome of the research and development. An economic penalty is considered severe if in the normal course of business an entity would probably choose to pay the other parties rather than incur the penalty. For example, an entity might purchase the partnership's interest in the research and development if the entity had provided the partnership with proprietary basic technology necessary for the entity's ongoing operations without retaining a way to recover that technology, or prevent it from being transferred to another party, except by purchasing the partnership's interest.
  3. c
    A significant related party relationship between the entity and the parties funding the research and development exists at the time the entity enters into the arrangement.
  4. d
    The entity has essentially completed the project before entering into the arrangement.
730-20-25-7
An entity that incurs a liability to repay the other parties shall charge the research and development costs to expense as incurred. The amount of funds provided by the other parties might exceed the entity's liability. That might be the case, for example, if license agreements or partial buy-out provisions permit the entity to use the results of the research and development or to reacquire certain basic technology or other assets for an amount that is less than the funds provided. Those agreements or provisions might limit the extent to which the entity is economically compelled to buy out the other parties regardless of the outcome. In those situations, the liability to repay the other parties might be limited to a specified price for licensing the results or for purchasing a partial interest in the results. If the entity's liability is less than the funds provided, the entity shall charge its portion of the research and development costs to expense in the same manner as the liability is incurred. For example, the liability might arise as the initial funds are expended, or the liability might arise on a pro rata basis.

Obligation to Perform Contractual Services

730-20-25-8
To the extent that the financial risk associated with the research and development has been transferred because repayment of any of the funds provided by the other parties depends solely on the results of the research and development having future economic benefit, the entity shall account for its obligation as a contract to perform research and development for others.
730-20-25-9
If the entity's obligation is to perform research and development for others and the entity subsequently decides to exercise an option to purchase the other parties' interests in the research and development arrangement or to obtain the exclusive rights to the results of the research and development, the nature of those results and their future use shall determine the accounting for the purchase transaction or business combination (or an acquisition by a not-for-profit entity).
730-20-25-10
The accounting for the cost of an item to be used in research and development is specified by paragraphs
730-10-25-1 through 25-2
. The accounting for recognized intangible assets acquired by the entity is specified in Topic 350.

Loan or Advance to Other Parties

730-20-25-11
If repayment to the entity of any loan or advance by the entity to the other parties depends solely on the results of the research and development having future economic benefit, the loan or advance shall be accounted for as costs incurred by the entity. The costs shall be charged to research and development expense unless the loan or advance to the other parties can be identified as relating to some other activity, for example, marketing or advertising, in which case the costs shall be accounted for according to their nature.

Issuance of Warrants or Similar Instruments

730-20-25-12
If warrants or similar instruments are issued in connection with the arrangement, the entity shall report a portion of the proceeds to be provided by the other parties as paid-in capital. The amount so reported shall be the fair value of the instruments at the date of the arrangement.

Certain Nonrefundable Advance Payments

730-20-25-13
Nonrefundable advance payments for goods or services that have the characteristics that will be used or rendered for future research and development activities pursuant to an executory contractual arrangement shall be deferred and capitalized. The guidance in this paragraph does not apply to refundable advance payments for future research and development activities. An entity shall not apply the guidance in this paragraph by analogy to other types of advance payments.
730-20-25-14
Paragraph 730-10-55-3 states that nonrefundable advance payments for future research and development activities for materials, equipment, facilities, and purchased intangible assets that have an alternative future use (in research and development projects or otherwise) shall be recognized in accordance with Subtopic 730-10.

730-20-35Subsequent Measurement

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Certain Nonrefundable Advance Payments

730-20-35-1
Nonrefundable advance payments capitalized under paragraph 730-20-25-13shall be recognized as an expense as the related goods are delivered or the related services are performed. An entity shall continue to evaluate whether it expects the goods to be delivered or services to be rendered. If an entity does not expect the goods to be delivered or services to be rendered, the advance payment capitalized under paragraph 730-20-25-13 shall be charged to expense. The guidance in this paragraph does not apply to refundable advance payments for future research and development activities. An entity shall not apply the guidance in this paragraph by analogy to other types of advance payments.

730-20-50Disclosure

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730-20-50-1
An entity that under the provisions of this Subtopic accounts for its obligation under a research and development arrangement as a contract to perform research and development for others shall disclose both of the following:
  1. a
    The terms of significant agreements under the research and development arrangement (including royalty arrangements, purchase provisions, license agreements, and commitments to provide additional funding) as of the date of each balance sheet presented
  2. b
    The amount of compensation earned and costs incurred under such contracts for each period for which an income statement is presented.
730-20-50-2
Topic 850 specifies additional disclosure requirements for related party transactions and certain control relationships.
730-20-50-3
An entity that is a party to more than one research and development arrangement need not separately disclose each arrangement unless separate disclosure is necessary to understand the effects on the financial statements. Aggregation of similar arrangements by type may be appropriate.

730-20-60Relationships

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Contingencies

730-20-60-1
For guidance related to loss contingencies, see Subtopic 450-20.

Consolidation

730-20-60-2
For guidance on whether and how a sponsor should consolidate a research and development arrangement, see Subtopic 810-30.

730-20-65Transition and Open Effective Date Information

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730-20-65-1
Paragraph superseded on 03/23/2010 after the end of the transition period stated in EITF Issue No. 07-3, "Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities."

730-20-S00StatusSEC

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730-20-S00-1
The following table identifies the changes made to this Subtopic.
ParagraphActionAccounting Standards UpdateDate
730-20-S99-1AmendedAccounting Standards Update No. 2012-0308/27/2012
730-20-S99-1AmendedAccounting Standards Update No. 2009-0308/24/2009

730-20-S20GlossarySEC

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730-20-S55Implementation Guidance and IllustrationsSEC

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Obligation Is a Liability to Repay the Other Parties

730-20-S55-1
See paragraph 730-20-S99-1, SAB Topic 5.O, for SEC Staff views on determining whether an entity is able to repay funds provided by other parties in a research and development arrangement.

730-20-S99SEC MaterialsSEC

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SEC Staff Guidance

730-20-S99-1
The following is the text of SAB Topic 5.O, Research and Development Arrangements.
  • Facts: FASB ASC paragraph 730-20-25-5 (Research and Development Topic) states that conditions other than a written agreement may exist which create a presumption that the enterprise will repay the funds provided by other parties under a research and development arrangement. FASB ASC subparagraph 730-20-25-6(c) lists as one of those conditions the existence of a "significant related party relationship" between the enterprise and the parties funding the research and development.
  • Question 1: What does the staff consider a "significant related party relationship" as that term is used in FASB ASC subparagraph 730-20-25-6(c)?
  • Interpretive Response: The staff believes that a significant related party relationship exists when 10 percent or more of the entity providing the funds is owned by related parties. FN14 In unusual circumstances, the staff may also question the appropriateness of treating a research and development arrangement as a contract to perform service for others at the less than 10 percent level. In reviewing these matters the staff will consider, among other factors, the percentage of the funding entity owned by the related parties in relationship to their ownership in and degree of influence or control over the enterprise receiving the funds.
    • FN14 Related parties as used herein are as defined in the FASB ASC Master Glossary.
  • Question 2: FASB ASC paragraph 730-20-25-5 states that the presumption of repayment "can be overcome only by substantial evidence to the contrary." Can the presumption be overcome by evidence that the funding parties were assuming the risk of the research and development activities since they could not reasonably expect the enterprise to have resources to repay the funds based on its current and projected future financial condition?
  • Interpretive Response: No. FASB ASC paragraph 730-20-25-3 specifically indicates that the enterprise "may settle the liability by paying cash, by issuing securities, or by some other means." While the enterprise may not be in a position to pay cash or issue debt, repayment could be accomplished through the issuance of stock or various other means. Therefore, an apparent or projected inability to repay the funds with cash (or debt which would later be paid with cash) does not necessarily demonstrate that the funding parties were accepting the entire risks of the activities.

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