Pharmaceuticals - Assets and Liabilities

I just watched a commercial for a new R.A. drug, Cimzia.  Drug companies spend years on R&D, then $ Millions on marketing  (from TV commercials to young, attractive sales reps providing drug samples, informational pamphlets, dinner for the staff, concert tickets…) to providers.  All of these expenditure are meant to increase the value of the new drug. So, should all of these costs be capitalized and recorded as an asset on the balance sheet?  Perhaps these costs could be amortized over the life of the patent (that artificial monopoly right given to drug makers by the laws of a country that frowns upon monopoly).

To further entice arthritis sufferers, the manufacturer (UCB, Inc.) is promising a six month money-back guarantee.  So, the firm will need to record an estimated liability. I wonder how they will calculate the amount?

What about the class action law suit that is sure to follow?  At some point, someone will die of something and some attorney will get things going.  Everyone knows this will happen (it’s probable), so UCB should recognize the liability now. To determine the amount, just take the last drug class-action law suit amount and double it. 

This would be much like the accounting for land reclamation - recording the liability when the project begins...

You can’t make an omelet without breaking a few eggs and you can’t make a good drug without killing off a few people.

Advertising Addiction

I was talking to a friend that works with a direct marketing brokerage firm. Her employer helps firms place direct mail advertisement via USPS to areas covering most of the U.S. Recently, a Canadian-based pharmacy contacted the firm. The drug store is interested in implementing an $80,000 campaign in the U.S.  The direct mail advertisement provides new customers a free, three-month membership in the pharmacy’s frequent pill-popper club. (retail price, $28/month). 

 The main pecuniary benefit to club members is a 15% discount “off already low-priced” prescription medications.  If the customers choose to continue in the club after the initial 3 months, the pharmacy is offering a “money-back guarantee”. If, at any time within the fisrt 6 months, the customer wishes to discontinue their membership, the pharmacy will refund the customer all previously-paid monthly club fees. 

U.S. accounting guidance has a lot to say about these types of transactions.

However, since the pharmacy is located in Canada, they would need to use Canadian GAAP. http://www.frascanada.ca/index.aspx

A Token for your Thoughts

As I inserted the 10 dollar bill into the token machine at Chuck E. Cheese’s I had the same thought that most people have – when does CEC recognize the revenue for this transaction. J  Now that their token machine has my money does it mean that the earnings process is complete?  Maybe it’s a moot point because it did not take long for my son and I to rid ourselves of the tokens.  Within about 15 minutes the tokens were absorbed by the arcade games.  CEC could then safely claim that the earnings process was complete. So, they could book the $10 of revenue at that time.  It’s a good thing for CEC that we did not decide to leave with a few tokens in our pocket.  That type of thing could play havoc on their accounting system.

But what about all those tickets that we earned? My son did not find anything that he wanted to trade for the number of tickets that we had, so, we will just hold onto them until we come back next time. After we get another $10-$20 in tokens and toss a few more skee-balls, he should have enough tickets to get the model car that he was eyeing.  In the meantime, CEC management will have to sleep at night knowing that I already hold enough tickets to claim several small plastic toys from their gift shop.

Note: CEC annual reports provide an explanation of how they account for these transactions.

Gambling on (the) Pool

I recently heard a radio advertisement for a pool building company.  I do not recall all of the details, but the crux of the promotion was as follows.  Over the next 90 days, the company would enter all new pool clients into a contest.  If Phoenix had a record-high temperature (above 118 degrees Fahrenheit) on the upcoming July 4^th, then all new pool clients would receive $12,000 cash.  My first thought – how should the company account for this potential cost?

Likely, the firm has insured this event with some third-party.  Thus, their costs consist of the policy premium plus the cost of the coinsurance/deductible that the pool company will pay if the record-high temperature is reached. This contingent liability is where the issue arises.  Every time a pool is sold, the firm’s potential liability increases but the likelihood of the firm incurring any obligation remains at an equally unlikely level.  It is difficult to measure but considering that the average July 4^th high temperature is 107 degrees and the highest temperature ever recorded in Phoenix was 122 degrees, the chance that a record-high temperature will occur on that day is quite small. Thus, the company will likely not report any related liability on the balance sheet.

The Fair Value of Play

I went to McDonald’s today. Not for the food but for the fun.  However, I did eat there.

McDonald’s sells a significant amount of food to parents and children.  Primarily because the family wants use the play area. So, how does a McDonald’s franchise account for this highly-prized asset category (PlayPlace).

A McDonald’s franchise owner incurs a few significant costs to supply the play area. 

1) The play equipment

2) The added building space. 

Other costs include maintenance and insurance related to the play area.

The play equipment would be capitalized and depreciated. The added building space would fall into the same category.

However, if McDonald’s considered the fair value of the play area, the resulting financial reports would be significantly different.  The value of the play area could be calculated using a discounted cash flow model. The incremental future cash flows would consist of the profit from sales made to families who are at McDonald’s primarily to use the play area.   

Injurious Act of Excessively Expectorating

Why doe the PGA care about spittle on the course? This act is seen as having an inverse effect of the PGA’s value.  The value of the association, in part, consists of the cultural landscape that it fosters.  Inconsiderate acts within the confines of the tournament are seen as negatively and directly affecting the Association. Therefore, the PGA rightly expects players to comply with the cultural norms or pay for the economic damages caused by any such deviation. While Keegan Bradley’s offense was minor, he could be fined.  In theory, the “fine” should be equivalent to the decrease in total value of the PGA brand caused by this specific infraction.