Does your business provide research and development services using a milestone arrangement? The new FASB standards in ASU 2010-17 provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method. Research and development arrangements frequently include payment provisions whereby a portion or all of the consideration is contingent upon milestone events such as successful completion of phases in a drug study or achieving a specific result from a research and development effort. An entity that recognizes these milestone payments as revenue in their entirety upon achieving the related milestone is using the milestone method.
A business can recognize revenue that is contingent upon a milestone in its entirety as revenue in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive. Determining whether a milestone is substantive is a matter of judgment made at the beginning of an arrangement and must meet several criteria. First, the size of consideration earned must correspond to the company’s performance to achieve the milestone or be proportionate with the enhancement value of the item delivered. Second, the consideration earned must be based solely on past performance. Finally, the consideration must be reasonable relative to all deliverables and payment terms in the arrangement. If the consideration meets these criteria, then the milestone is considered substantive in its entirety and the milestone method can be used.
A single milestone cannot be subdivided and should be considered substantive in its entirety. An arrangement may include more than one milestone, but each milestone should be evaluated separately to determine whether the milestone is substantive. An arrangement may include both substantive and non-substantive milestones.
GAAP did not previously include guidance on when the use of the milestone method is appropriate. The amendments in this update improve financial reporting by providing a consistent framework for applying the milestone method, thus eliminating diversity in practice on its application. (ASU 2010-17) The amendments are effective on a prospective basis for milestones achieved in fiscal years beginning on or after June 15, 2010, and early adoption is permitted.