Harold,
Present accounting treats the $100MM you just spent as if you had converted it to cash and shredded it, just as RCM discussed in his post. In other words, it assumes that the resulting research has no value. (If the auditor can't touch and feel it, it can't possibly have any value). The only time the present accounting system recognizes the value of research is if someone else buys it or the company for more than its net asset value - the difference becomes an asset called goodwill. Used to be that companies would immediately try to write it down to near zero (this is the "in-process R&D"), but the SEC squawked, and now companies have to justify what they write down. When they wrote it down, they would get an earnings hit, but because it was part of the merger everyone ignored it. Under the tougher SEC standards, they get amortization expenses going forward. Now that pooling accounting is scheduled to go away, this issue becomes even more significant. (In pooling you don't get goodwill).
So what I am suggesting is that the most reasonable initial estimate of the value of what you have spent is the amount you spent on it. If it turns out to be a bust, then you write it down when this becomes apparent. If the research turns out to be enormously valuable, you still need to amortize it, but now you do it over the life of the asset that you created. In your example, in which you have created Epogen, you don't get to revalue it to its true value unless you sell it (or sell the company using purchase accounting). Revaluing it would cause a huge earnings gain in the year in which it happened, to be followed by reduced earnings in all subsequent years as the increased value got amortized).
Ultimately it is just a timing issue - do you write it off up front (present system) or only when it becomes worthless or over the life of any productive asset it creates.
Bottom line, as IJ pointed out, is that it depends what you are going to do with the numbers. If you are going to be using earnings numbers to derive the value of the company, it is vital that you correct the existing accounting numbers for the distortion inherent in it. The issue is most pressing for young biotechs with just one or two young products, but with continuing hefty R&D expenditures (companies like CELG, CEPH and GLIA).
I very much doubt the present system will ever be changed - aside from anything else my version is much harder to police effectively. But as more and more biotechs near profitability be sure to remind the next commentator you meet that the "money-losing biotechs" may only be so because of the 19th Century accounting system (actually probably earlier - I'm not up on the history of accounting <g>) they live under.
(Note also that this is a big issue with software companies as well, for many of the same reasons as with biotechs).
Peter |
