The devil, of course, is in the details. Given the industry's famously fragmented supply chain, achieving precision in revenue recognition has proved no small challenge for many pharmaceutical companies. Still, however costly and time-consuming in the short run, the effort is likely to have long-term benefits as e-pedigree tracking and other new initiatives revolutionize the flow of information upstream and down. Until these systems are up and running, a data-collection and-analysis approach developed by IMS Health can offer significantly greater insight into the supply chain, enabling pharmaceutical executives to hit higher levels of SOX compliance.
THE RIDDLE OF REVENUE RECOGNITIONA reaction to such spectacular financial meltdowns as Enron, Tyco, and WorldCom, the Sarbanes-Oxley Act demands that publicly traded corporations bolster their internal-control frameworks. The goal of the legislation is ultimately to increase the accuracy of the published financial statements upon which investors base their decisions.
However, when it comes to issues of revenue recognition, the industry's much-segmented supply chain can make answering even the most basic questions seem like a run-in with the Sphinx. Try: When is a sale really a sale, and at what price?
Many factors are responsible for this fragmentation. For example, the industry's business model features large intermediaries or consolidators, such as McKesson and Cardinal, putting increasing distance between—and wielding increasing influence over—sellers and buyers. Widespread use of discounting and rebating to shape sales contributes to the uncertainty, as do product dating and other quality controls. Overall, it is a disparate distribution system ill-suited to precision in revenue recognition.
All of this is causing much grumbling among pharmaceutical executives. A basic Internet search on the subject of revenue recognition in the industry reveals not only a whirlwind of conferences but also a spike in the number of auditors and firms hunting for executives with relevant experience. Unquestionably, this is a key challenge for the pharmaceutical industry.
BEST GUESSES NOT GOOD ENOUGH
Against this backdrop, IMS was recently approached by a client facing a number of challenges in achieving full compliance with Sarbanes-Oxley rules. In particular, this drug maker wanted to restate several years of earnings statements. Its reported revenue recognition had been based on the commonly used "sell-in" model.
In a typical sell-in scenario, revenue is recognized when the product leaves the manufacturer's factory. (Essentially, the products are assumed to have been "sold in" to the marketplace.) But in practice, companies must adjust this figure, recognizing that it does not yet account for a whole host of probable—but often very unpredictable—contingencies.
For example, seller rebates are widely deployed throughout the industry. Though useful as a means of wooing large buyers, such as managed-care organizations, precise rebate levels complicate revenue recognition because they are almost impossible to anticipate. The same can be said for the industry's frequent charge-backs, contract-based discounts, returned goods, and list-price discounts.