Pharmaceutical

60 Pages·2015·1.05 MB·English

Accounting and
Auditing Update
Issue no. 4/2015 | Pharmaceutical
IN THIS EDITION
Revenue recognition in the pharmaceutical sector -
Key considerations p1
Potential impact of Ind AS on pharmaceutical sector p7
Survey analysis p11
Ind AS 108, Operating Segments and its impact on the
pharmaceutical sector p21
Business combinations and accounting for intangibles p27
ICDS – Potential impact on the pharmaceutical sector p31
Export benefits to pharmaceutical sector p37
GST – A sweet pill for the Indian pharmaceutical sector p41
Tax deductibility of business promotion expenses p45
Regulatory updates p47
www.kpmg.com/in
Editorial
Jamil Khatri Sai Venkateshwaran
Partner and Head Partner and Head
Assurance Accounting Advisory Services
KPMG in India KPMG in India
Continuing with our revamped series of The standard on segment reporting
the Accounting and Auditing Update, we under Ind AS focussed on enabling
focus on the pharmaceutical sector this users to understand a company’s/
month. management’s approach to the decision-
making at a segment level. In this edition
Ind AS (Indian Accounting Standards)
of the Accounting and Auditing Update,
is bringing about a paradigm shift in
we also cast our lens on the principles
financial reporting which is going to
of operating segments under Ind AS and
potentially affect many key metrics of
their likely impact on financial reporting
performance. For the pharmaceutical
on pharmaceutical companies. We also
sector, we highlight the impact on
highlight some of the areas in this sector
revenue recognition, research and
which are expected to be impacted by
development expenditure, business
the implementation of ICDS.
combinations, intangible assets and
government grants in this issue of the Apart from accounting and financial
Accounting and Auditing Update. reporting aspects, the pharmaceutical
sector faces various direct and indirect
We also carry this month the results of a
tax issues. For example, tax deductibility
survey we ran with a number of leading
of business promotion expenses, various
pharmaceutical companies on the key
policies on export benefits and impact of
regulatory changes that they face.
the proposed GST. Our articles provide
These include Ind AS, the Companies
an overview on these tax issues.
Act, 2013, Income Computation and
Disclosure Standards (ICDS) and Finally, our publication also includes our
proposed Goods and Services Tax (GST). regular round up of regulatory updates.
Some of the results are of the survey As always, we would be delighted to
provide a lot of food for thought on the receive any kind of feedback or inputs on
level of preparedness and the extent of the topics that we have covered.
challenges faced by companies in this
sector currently.
Overview
The pharmaceutical sector in India has Some of the concerns within the
‘weathered quite a few storms’ in the sector have been over the new pricing
last couple of years and has emerged regulation that significantly affected
stronger than before; being as a sector top lines of many pharmaceutical
that has stood its ground through the companies, the heightened scrutiny by
recent economic turmoil. There have international regulators consequent to
been significant changes affecting the the increasing international footprints
industry in the recent past, mostly of Indian pharmaceutical companies
progressive and some arguably so. As and the compulsory licensing and
per the India Brand Equity Foundation, patent related legal decisions that have
India1 is expected to be one of the top triggered heated discussions across the
three pharmaceutical markets in the world.
world by 2020 in terms of incremental
India Inc is currently bracing itself to deal
growth. India is the largest provider
with various changes in the regulatory
of generic drugs globally accounting
and reporting landscape including
for 20 per cent of global exports in
IFRS converged standards (Ind AS),
terms of volume. India also boasts of
Goods and Services Tax and Income tax
the largest number of Food and Drug
accounting standards among others. As
Administration (FDA) approved plants
India stands at the threshold of adopting
outside of the United States of America.
IFRS converged standards, the industry
Significant investments in the sector
has started identifying and taking stock
continue and there is also an increasing
of the key areas of financials results
trend of consolidation in the Indian
that these would have an impact on. We
pharmaceutical market. The government
take a close look at this through a series
of India unveiled the ‘Pharma
of articles in this month’s issue of the
Vision 2020’ which showcases the
Accounting and Auditing Update.
Government’s commitment to the sector
and its aim to make India a global leader
in end-to-end drug manufacturing.1
1. http://www.ibef.org/industry/pharmaceutical-
india.aspx
1
Revenue recognition
in the pharmaceutical
sector – Key
considerations
This article aims to:
– Provide an overview of the relevant framework with respect to revenue recognition
– Highlight some of the key areas that require deliberations while recognising revenue
– Discuss the accounting issues and challenges and impact of transition to Ind AS on these
areas.
2
Revenue, generally represents Accounting Standards (NACAS) has Broadly, AS 9, Revenue Recognition
the largest number in the financial made recommendations to the Ministry mainly focusses on the timing of
statements and is also amongst the of Corporate Affairs (MCA) to defer the recognition of revenue based on the
most followed performance matrices in implementation of Ind AS 115. transfer of significant risks and rewards
the analysis of financial statements. It of ownership. Uncertainties regarding
The Institute of Chartered Accountants
is also an area where there are differing the determination of the amount, or
of India (ICAI) has issued an exposure
practices under different GAAPs, and its associated costs are considered as
draft of changes proposed in Ind AS, as
there is a move towards achieving influencer in determining the timing
a consequence of deferment of Ind AS
consistency in practices across the of revenue recognition. Ind AS 18 also
115. The Exposure Draft contains Ind AS
world. echoes the same principles for timing
11, Construction Contracts, along with
of recognition but requires revenue
As a part of India’s transition to the IFRS the appendices corresponding to IFRIC
to be measured at fair value of the
converged Ind AS, India was poised 12, Service Concession Arrangements,
consideration received or receivable. Ind
to be the first, globally, to adopt the SIC- 29, Service Concession
AS 115 moves away from the concept of
new revenue recognition standard Ind Arrangements: Disclosures, and Ind AS
transfer of risk and rewards and defines
AS 115, Revenue from contracts with 18, Revenue, along with the appendices
a five step framework for revenue
Customers. However, the decisions of which form integral part of the standard,
recognition based on transfer of control
the global standard setters - International corresponding to IFRIC 13, Customer
which requires among other things
Accounting Standards Board (IASB) and Loyalty Programmes, IFRIC 18, Transfers
determination of mutual enforceability of
the U.S. Financial Accounting Standards of Assets from Customers, SIC-31
a contract, identification of performance
Board (FASB) to defer the mandatory Revenue - Barter Transactions Involving
obligations of each of the parties to the
effective date of the equivalent revenue Advertising Services and consequential
contract and allocation of the transaction
standard to 1 January 2018 further amendments to other Ind ASs, issued by
price to the performance obligations.
fuelled the discussion on whether India the Accounting Standards Board of the
should take the plunge and spearhead ICAI, for comments. As it stands today, Let us look at the key areas that have
the implementation or wait for the there does not seem to be any option for been subject to diverse practices/
global standard setters to issue the the companies required to transition as deliberations under the existing
proposed amendments including the part of phase 1 to early adopt Ind AS 115 Indian GAAP more specific to the
additional clarifications and guidance. As and skip the efforts on transitioning to pharmaceutical industry and the possible
a result of these deliberations, recently Ind AS 18 first and then to Ind AS 115. impact on these areas due to the
the National Advisory Committee on transition to IFRS converged standards.
Gross to net adjustments - Accounting under Indian GAAP and
general practices
Revenue, under the current Indian GAAP, Gross to net adjustments to revenue should be made based on past
is the gross inflow of cash, receivables or would generally include: experience. Recognition of revenue in
other consideration arising in the course such circumstances would depend on
of the ordinary activities of an enterprise I. Provision for anticipated the substance of the agreement.
from the sale of goods and from the
returns One view is that sales for the period
rendering of services. A company
should be adjusted for expected sales
reduces the revenue to account for the It is an accepted business practice for
returns in the next accounting period
impact of specific adjustments. The manufacturers in the pharmaceutical
at full sales price as per a reliable
general gross to net adjustments made industry in India to accept returns of
estimate based on past experience and
under the current Indian GAAP include products whose shelf lives have either
other relevant factors and the same
sales return accrual, turnover discounts, expired or are nearing expiry. There are
should be netted off against sales of
trade discounts and volume rebates. two types of returns. One – where the
the period at full sales price. Since the
Cash discounts, free goods offers, goods cannot be resold as their shelf
actual sales returns pertaining to the
bundled contracts, loyalty programmes life has expired or are nearing expiry
sales made during the period have been
etc. are not very common deductions that may not have resale value, and two-
netted off from sales for the period,
from gross revenue. where the goods have been returned for
the same treatment should be given to
any other reason and can be resold.
the expected sales returns pertaining
AS 9 makes a reference to guaranteed to the sales of the current period. This
sales i.e. where delivery is made would also mean an adjustment of ‘cost
giving the buyer an unlimited right of of sale’ and ‘inventories’ against sales
return wherein it may be appropriate expected to be received back (with
to recognise the sale but a suitable obsolescence/diminution in value and
provision for the anticipated returns expected incremental cost of sale of
3
the returned goods being recognised by c. an asset (and corresponding exchange for transferring the promised
the process of valuation at lower of cost adjustment to cost of sales) for goods or services to a customer. An
and net realisable value). Other view its right to recover products from amount of consideration can vary
is based on the ICAI’s Expert Advisory customers on settling the refund because of discounts, rebates, refunds,
1
Committee (EAC ) opinion, provision liability. credits, price concessions, incentives,
is to be recognised in respect of sales performance bonuses, or other similar
In a nutshell, revenue is to be recognised
returns at the best estimate of the loss items. The promised consideration
only to the extent the entity expects
expected to be incurred the entity in can also vary if an entity’s entitlement
to receive the consideration i.e. net of
respect of such returns including any to the consideration is contingent on
expected sales returns. A liability is to
estimated incremental cost that would the occurrence or non-occurrence of a
be recognised for the amount expected
be necessary to resell those goods future event. For example, an amount
to be refunded to the customers at the
as per AS 29, Provisions, Contingent of consideration would be variable if
time of the returns and a corresponding
Liabilities and Contingent Assets. In case either a product was sold with a right of
asset is to be created for the right to
of non-saleable products, this would return or a fixed amount is promised as
recover products from the customer on
be the entire amount of the sales and a performance bonus on achievement
settling the refund liability. Replacements
in case of the saleable products, this of a specified milestone’. Accordingly,
of similar products are not considered as
would be the profit element included the variable consideration is to be
returns.
in the sales and any additional expense allocated to the entire contract or to
expected to be incurred towards resale. any specific obligation based on the
Consequently, under the current Indian II. Turnover discounts, trade facts and circumstances of the contract
GAAP, this provision can be presented as discounts and volume and revenue from each performance
a separate expense item in the profit and obligation is recognised net of the
rebates
loss account without any adjustment to discounts, rebates, etc.
It is a usual practice to provide discounts
sales, cost of sales and inventories.
Each customer contract would require
to customers based on volume of sales
Under Ind AS, when the buyer has a right careful evaluation as accounting
commonly known as trade discount,
of return and there is uncertainty about would differ based on the facts and
volume rebates, etc. and for promptness
the possibility of return, revenue is not circumstances of each contract.
of payment commonly known as cash
recognised until the shipment has been
discount, etc. In practice, divergent
accepted by the customer or the goods
practices are followed by companies in III. Cash discounts
have been delivered and the time period
accounting for such discounts. Under
for rejection has elapsed. 2 Companies offer discounts for a certain
the current Indian GAAP, an EAC
percentage of the sales price, as an
issued by ICAI has clarified that trade
An entity considers historical experience
incentive for prompt payment. Under
discount is not encompassed within the
in assessing the possibility of return. If,
the current Indian GAAP, these discounts
definition of revenue since it represents
based on past experience, the entity can
are shown as a separate expense in the
a reduction of cost. Accordingly, trade
make a reliable estimate of the amount
statement of profit and loss.
discounts and volume rebates given
of goods that will be returned, then
it would be appropriate to recognise should be deducted in determining Under Ind AS, companies would be
revenue for the amount that is expected revenue. Incentives/discounts based on required to estimate the total cash
to be received for items that are not achievement of a certain turnover such discount expected to be offered to
returned (assuming that the other as foreign travel, gifts, etc. are usually customers and reduce this from
conditions for revenue recognition are provided for and disclosed as an expense revenues.
as part of sales promotion expenses. In
met). Under Ind AS 18, an adjustment
current practice several of such rebates,
would be made to revenue, cost of IV. Patient programmes
promotion scheme expenditure etc. is
revenue, and inventories for estimated
presented as part of sales promotion Patient programs are run by
sales return.
expenses. pharmaceutical companies mainly
Ind AS 115 has more specific guidance for oncology related drugs which are
As per Ind AS 18, “Revenue is measured
on recording sales with a right to return. high-priced and need to be consumed
at the fair value of the consideration
over a longer period of time. Typically,
As per Ind AS 115, in case of transfer of received or receivable taking into
these programmes comprise providing
products with a right of return, an entity account the amount of any trade
free drugs to the patient on purchase of
would recognise all of the following: discounts and volume rebates allowed
certain quantity of these drugs. There
by the entity”. Accordingly, all discounts
a. revenue for the transferred products is no specific guidance on accounting
and incentives expected to be offered on
in the amount of consideration to for such programmes under the current
the sales made during the year should be
which the entity expects to be entitled Indian GAAP. Under Indian GAAP
estimated and reduced from revenue.
(therefore, revenue would not be guidance is available under a technical
recognised for the products expected As per Ind AS 115 paragraph 50 and 51, ‘if guide on Accounting Issues in the Retail
to be returned) the consideration promised in a contract Sector (guide) relating to customer
includes a variable amount, an entity shall loyalty programmes. It mentions that
b. a refund liability and
estimate the amount of consideration currently in India, deferment model
to which the entity will be entitled in and provision model are prevalent.
1. EAC Opinion Volume XXXI Query No. 14, 2. EAC Opinion issued in the ICAI Journal, The
Accounting for sales returns Chartered Accountant, November 2014
4
Deferment model is on the lines of IFRIC Ind AS 18, however, has specific Under Ind AS 115 like under Ind AS 18,
13, Customer Loyalty Programmes. guidance on customer loyalty programs. the transaction price is to be allocated
Under the provision model, sale is Though the patient programmes may not to the goods promised to be supplied
treated as a single element transaction entirely be comparable to these loyalty free of cost and deferred to the period in
and recognise revenue for the entire programs, one can draw inference from which such goods are provided.
transaction at the time of initial sale. this guidance. Accordingly, the entity
However, since a further cost is expected should allocate the fair value of the
to be incurred in future with regard to consideration received or receivable in
the obligation to provide free/discounted respect of the initial sale between the
goods or services, a provision is free drugs and the other components
recognised towards the cost of such of the sale. The consideration allocated
free/discounted goods or services as to the free drugs should be measured
marketing expense at the time of initial by reference to their fair value, i.e. the
sale. Usually companies accrue for the amount for which these drugs could be
cost of supplying the drugs in future sold separately.
in its cost of goods sold without any
adjustment to revenue.
Timing of recognition – exports
Timing of revenue recognition is one This evaluation would require application Ind AS 115 requires evaluation through a
of the most critical factors governing of significant judgement. five step model to determine recognition
revenue recognition. of revenue
However, as per Ind AS 18, revenue from
Under the current Indian GAAP, revenue the sale of goods should be recognised
1. Identify the contract.
is to be recognised at the time of when all the following conditions have
transfer of significant risk and rewards of been satisfied: 2. Identify the performance obligations.
ownership to the buyer. An asset is transferred when (or as)
a. the entity has transferred to the buyer
the customer obtains control of that
As per AS 9, in a transaction involving the significant risks and rewards of
asset.
the sale of goods, performance should ownership of the goods
be regarded as being achieved when the 3. Determine the transaction price.
b. the entity retains neither continuing
following conditions have been fulfilled:
managerial involvement to the degree 4. Allocate the transaction price to the
i. the seller of goods has transferred to usually associated with ownership nor performance obligations and
the buyer the property in the goods effective control over the goods sold
5. Recognise revenue.
for a price or all significant risks and
c. the amount of revenue can be
rewards of ownership have been
measured reliably Under Ind AS 115, the timing of revenue
transferred to the buyer and the seller
recognition is focussed on transfer of
retains no effective control of the d. it is probable that the economic
control rather than transfer of risks and
goods transferred to a degree usually benefits associated with the
rewards. Consequently, the terms of
associated with ownership; and transaction will flow to the entity, and
the contracts with customers will need
ii. no significant uncertainty exists e. the costs incurred or to be incurred careful evaluation as to when the control
regarding the amount of the in respect of the transaction can be of the goods transfers to the customer.
consideration that will be derived from measured reliably.
the sale of the goods.
Consequently, in case of CIF export
In many cases of export sales on sales, the above criteria should be
Customs, Insurance and Freight (CIF) evaluated to analyse whether the risk
basis, we would need to evaluate and rewards of ownership of the goods
whether significant risk and rewards of passes only on delivery at the port and
ownership have being considered to be the seller has continuing managerial
transferred when the goods are handed involvement till the time the goods reach
over to the transporter based on the the destination port. Companies would
contractual terms and after considering need to understand contractual terms
facts and circumstances of each case. and exercise significant judgement while
recognising revenue.
5
Revenue from sale of dossiers/intellectual property
Many Indian pharmaceutical companies for subsequent servicing, that amount Ind AS 115 requires the revenue from a
enter in to out licensing agreements for is deferred and recognised as revenue contract to be allocated to each distinct
the purpose of selling their products in over the period during which the service good or service provided on a relative
other jurisdictions. A typical agreement is performed. Conversely, the recognition standalone selling price basis, though a
consists of two deliverables i.e. criteria are applied to two or more ‘residual’ approach is permitted in limited
preparation and sale of dossier based transactions together when they are circumstances.
on which the customer obtains ‘market linked in such a way that the commercial
Based on the discussion above, it seems
authorisation’ and commitment to effect cannot be understood without
that the intention of such contracts
supply the products for sale in the reference to the series of transactions as
is to sell the products in the defined
specific jurisdiction. In practice, a variety a whole’.
jurisdiction and the dossier by itself may
of such kind of arrangements exit, for
Under Ind AS 115,factors that indicate not represent separate standalone value
example, in some cases, the dossiers
that an entity’s promise to transfer to the customer. Accordingly, the amount
are to be returned on completion of
a good or service to a customer is attributed to such sale of dossier would
the arrangement whereas in other the
separately identifiable (in accordance need to be amortised with reference to
customer is free to retain the same.
with paragraph 27(b)) include, but are not the expected pattern of sale of products
Some agreements could stipulate refund
limited to, the following: over the contractual period (five to
of the upfront fees paid for dossier in
10 years) which represents the sole
case the marketing authorisation is not a. the entity does not provide a
performance obligation relating to the
granted. Sometimes the contracting significant service of integrating the
arrangement discussed above.
parties are free to procure the products good or service with other goods or
from other manufacturers whereas in services promised in the contract into However, considering the practical
many cases, there is a commitment to a bundle of goods or services that difficulty in anticipating revenues for
procure from the company preparing the represent the combined output for the future, another approach that can
dossier. The process of seeking approval, which the customer has contracted. be considered is amortising the dossier
typically, for change of the manufacturing In other words, the entity is not using income over the contractual period on a
facility would involve as much efforts as the good or service as an input to straight line basis provided the impact
required for obtaining a fresh approval. produce or deliver the combined of such straight line approach is not
This would hold true even for cases output specified by the customer. expected to be materially different from
when the dossier related information is the approach referred to above.
b. the good or service does not
retained by customer on termination.
significantly modify or customize While the guidance under Ind AS 115
Presently, under Indian GAAP, revenue another good or service promised in is more detailed, the requirements
from sale of dossiers is recognised the contract. under Ind AS 18 are primarily the
based on the contractual milestones same. Consequently, pharmaceutical
c. the good or service is not highly
while revenue from sale of goods companies would now need to evaluate
dependent on, or highly interrelated
is recognised separately on supply each contract carefully to determine the
with, other goods or services
of goods when risks and rewards of performance obligations and allocation of
promised in the contract. For
ownership are transferred for those the transaction price to the performance
example, the fact that a customer
goods. obligations.
could decide to not purchase the
Under IAS 18, ‘it is necessary to apply good or service without significantly
the revenue recognition criteria to the affecting the other promised goods or
separately identifiable components of services in the contract might indicate
a single transaction in order to reflect that the good or service is not highly
the substance of the transaction. For dependent on, or highly interrelated
example, when the selling price of a with, those other promised goods or
product includes an identifiable amount services.
The conversion from the current Indian GAAP to Ind AS 18 to Ind AS 115 would entail a lot of changes
not only in accounting but in other areas such as contract management, IT systems, tax compliance, etc.
The pharmaceutical industry in particular, would have to be geared to be able to meet the measurement,
recognition and disclosure requirements especially with respect to the areas discussed above. Further, as
companies prepare themselves for Ind AS, it would also be required that they keep investors, analysts and
other stake holders updated on the required changes and the anticipated impact on the financial results.