PART 4 ADDITIONAL CASES 495

distinguish between separately acquired and internally generated intangible assets. The former are usually
capitalized as the definition and recognition criteria of IAS 38 are fulfilled. Concerning internally generated
intangibles, however, IAS 38 differentiates between a research and a development phase. While costs for
research are to be expensed, costs that are incurred in the development phase are recognized as intangible
assets if an additional set of criteria is fulfilled.
With these abstract explanations in mind, Peter sought to assess the upfront payment concerning a possi-
ble capitalization. He remembered that when he first started his job, Alex Muller told him that ‘‘we expense
almost all of our R&D costs. That’s what everyone does in the pharmaceutical industry. Besides, we never
know if we will receive approval by EMA or FDA. Only if we have the authorization do we recognize the
costs for the development of the approved drug. And we only capitalize those costs that we incur after the ap-

1 Enforcing Financial Reporting Standards: The Case of White Pharmaceuticals AG

proval.’’ Still unsure about what to do Peter called his colleague at Neurocentral, Inc. and asked him to assess
the situation. Jeff Hudson, head of accounting at Neurocentral, Inc., was about to go to a meeting when his
phone rang. Jeff was surprised by the question but did not have too much time to get involved with the issue.
Thus, he simply said: ‘‘Look, Peter, I am kind of busy at the moment. But I can tell you that, here, in the
US, we don’t recognize costs that we incur when doing research for new drugs. SFAS No. 2 doesn’t allow a
capitalization. However, if we acquire R&D, that’s a different story. In that case, we follow SFAS No. 141
and SFAS No. 142 and capitalize the acquired in-process R&D. But I’m not really sure what I would do in
your situation. Besides, you’re an IFRS guy and, as far as I know, R&D accounting still differs on our conti-
nents.’’ Peter didn’t feel like his American counterpart had fully understood his problem but was still thank-
ful for Jeff’s quick assessment of the situation.
Feeling that he had to solve the issue himself, Peter considered the nature of the upfront compensation.
White Pharmaceuticals AG conducted the payment to profit from the research carried out by Neurocentral,
Inc. While White Pharmaceuticals AG received all rights to the research performed, Peter did not perceive
the five million Euros as an acquisition of an intangible asset. Instead, he felt that White only provided Neu-
rocentral with the funding for research activities that the company performed. Following this reasoning, the
payment had to be regarded as if White’s researchers were conducting the research. And, considering the sta-
tus the research was in at that time, no one could tell if the project would eventually yield a product that
White would be able to sell. Therefore, the up-front payment would fall under the definition of research ex-
penditure which IAS 38 prohibits from capitalizing. Although being skeptical of his argumentation, he
charged the five million Euros to White’s R&D expenses.
Thereafter, the project proceeded as expected and Neurocentral, Inc. started the clinical studies in 2002.
In the same year, they were able to complete the first phase of the studies which provided them with a safety
profile of the transdermal patch. Acting upon their role in the collaboration agreement, White transferred the
first milestone payment of ten million Euros as soon as they received the latest research report from their
partner. As a consequence of the payment, Peter was again confronted with the accounting for the alliance.
Considering that the project had progressed to the development phase which, according to IAS 38, meant
that incurred costs should be recognized, he wanted to discuss a possible capitalization of the payment with
his CFO. In their meeting, Peter outlined his train of thought and explained that a capitalization may be nec-
essary. He argued that White received all rights to the research performed and to the development carried out
thus far. Therefore, the ten million Euros could be considered part of the intangible asset that White acquired
in the course of the collaboration. Besides, Peter told Mr. Muller that IAS 38 required enterprises to recog-
nize expenses that they incur in the development phase. Alex Muller listened carefully to what Peter Schmidt
told him. However, he made clear that he assessed the payment differently: ‘‘I understand your reasoning,
Peter, but I don’t share your opinion. I believe that assessing the agreement is a two-step-process. First, we
have to judge whether or not the transaction is an acquisition of R&D. I don’t consider the agreement as an
acquisition, but as an outsourcing of our R&D because we just fund the research and development conducted
by Neurocentral. Thus, the second and central question that we have to ask is: Would we capitalize our
expenses if we conducted the R&D in-house? And the answer is: No, we would not. At this point in the de-
velopment process, we do not know if we will ever get a marketable product. And, if you read IAS 38, the
standard tells you that an enterprise should only capitalize R&D if it can demonstrate that the intangible asset
will yield future economic benefits. But as we don’t have approval by either FDA or EMA yet, we cannot
reasonably expect future economic benefits from the product. All this leads me to the conclusion that we
don’t have to capitalize the milestone payment.’’ Although Peter felt that he had made a valid point, Alex
Muller’s argumentation also sounded convincing. In the end, he decided to follow his CFO’s reasoning as

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