Our Financial Statements are prepared in accordance with IFRS as adopted by the EU (adopted IFRS) and as issued by the IASB, and the accounting policies employed are set out in the Group Accounting Policies section in the Financial Statements. In applying these policies, we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities. The actual outcome could differ from those estimates. Some of these policies require a high level of judgement because the areas are especially subjective or complex. We believe that the most critical accounting policies and significant areas of judgement and estimation are in:
- Revenue recognition
- Research and development
- Impairment testing of goodwill and intangible assets
- Litigation
- Post-retirement benefits
- Taxation
- Segmental reporting
Revenue recognition
Revenue is recorded at the invoiced amount (excluding intercompany sales and value added taxes) less movements in estimated accruals for rebates and chargebacks given to managed-care and other customers and product returns – a particular feature in the US. The impact in the rest of the world is not significant. It is the Group’s policy to offer a credit note for all returns and to destroy all returned stock in all markets. Cash discounts for prompt payment are also deducted from sales. Revenue is recognised at the point of delivery, which is usually when title passes to the customer either on shipment or on receipt of goods by the customer depending on local trading terms. Income from royalties and from disposals of intellectual property, brands and product lines is included in other operating income.
Rebates, chargebacks and returns in the US
At the time of invoicing sales in the US, rebates and chargebacks that we expect to pay, in as little time as two weeks or as much as eight months, are estimated. These rebates typically arise from sales contracts with third party managed-care organisations, hospitals, long-term care facilities, group purchasing organisations and various federal or state programmes (Medicaid ‘best price’ contracts, supplemental rebates etc) and can be classified as follows:
- Chargebacks, where we enter into arrangements under which certain parties, typically hospitals, the Department of Veterans Affairs, Public Health Service Covered Entities and the Department of Defense, are able to buy products from wholesalers at the lower prices we have contracted with them. The chargeback is the difference between the price we invoice to the wholesaler and the contracted price charged by the wholesaler. Chargebacks are paid directly to the wholesalers.
- Regulatory, including Medicaid and other federal and state programmes, where we pay rebates based on the specific terms of agreements with the US Department of Health and Human Services and with individual states, which include product usage and information on best prices and average market prices benchmarks.
- Contractual, under which entities such as third party managed-care organisations, long-term care facilities and group purchasing organisations are entitled to rebates depending on specified performance provisions, which vary from contract to contract.
The effects of these deductions on our US pharmaceuticals revenue and the movements on US pharmaceuticals revenue provisions are set out below.
Accrual assumptions are built up on a product-by-product and customer-by-customer basis, taking into account specific contract provisions coupled with expected performance, and are then aggregated into a weighted average rebate accrual rate for each of our products. Accrual rates are reviewed and adjusted on a monthly basis. There may be further adjustments when actual rebates are invoiced based on utilisation information submitted to us (in the case of contractual rebates) and claims/invoices are received (in the case of regulatory rebates and chargebacks). We believe that we have been reasonable in our estimates for future rebates using a similar methodology to that of previous years. Inevitably, however, such estimates involve judgements on aggregate future sales levels, segment mix and the customer’s contractual performance.
Gross to net sales
| 2010
$m | 2009
$m | 2008
$m |
| Gross sales | 22,909 | 22,646 | 20,029 |
| Chargebacks | (2,075) | (1,841) | (1,726) |
| Regulatory - US government and state programmes | (1,949) | (1,357) | (1,005) |
| Contractual - Managed-care and group purchasing organisation rebates | (4,755) | (4,752) | (3,658) |
| Cash and other discounts | (437) | (428) | (390) |
| Customer returns | (21) | (193) | (48) |
| Other | (265) | (196) | (167) |
| Net sales | 13,407 | 13,879 | 13,035 |
Movement in provisions
| Brought forward at
1 January 2010
$m | Provision for current year
$m | Adjustment in respect of
prior years
$m | Returns and payments
$m | Carried forward at 31 December 2010
$m |
| Chargebacks | 396 | 2,107 | (32) | (1,948) | 523 |
| Regulatory - US government and state programmes | 775 | 1,984 | (35) | (1,602) | 1,122 |
| Contractual - Managed-care and group purchasing organisation rebates | 1,447 | 4,826 | (71) | (5,008) | 1,194 |
| Cash and other discounts | 41 | 438 | (1) | (437) | 41 |
| Customer returns | 177 | 22 | (1) | (65) | 133 |
| Other | 59 | 269 | (4) | (260) | 64 |
| Total | 2,895 | 9,646 | (144) | (9,320) | 3,077 |
| Brought forward at
1 January
2009
$m | Provision for current year
$m | Adjustment in respect of
prior years
$m | Returns and payments
$m | Carried forward
at 31 December
2009
$m |
| Chargebacks | 359 | 1,947 | (106) | (1,804) | 396 |
Regulatory - US
government and state programmes | 520 | 1,373 | (16) | (1,102) | 775 |
Contractual - Managed-care and group purchasing
organisation rebates | 1,084 | 4,732 | 20 | (4,389) | 1,447 |
| Cash and other discounts | 39 | 428 | — | (426) | 41 |
| Customer returns | 77 | 194 | (1) | (93) | 177 |
| Other | 57 | 198 | (2) | (194) | 59 |
| Total | 2,136 | 8,872 | (105) | (8,008) | 2,895 |
| Brought forward at
1 January 2008
$m | Provision for current year
$m | Adjustment in respect of
prior years
$m | Returns and payments
$m | Carried
forward at
31 December 2008
$m |
| Chargebacks | 186 | 1,745 | (19) | (1,553) | 359 |
| Regulatory - US government and state programmes | 428 | 997 | 8 | (913) | 520 |
| Contractual - Managed-care and group purchasing organisation rebates | 900 | 3,622 | 36 | (3,474) | 1,084 |
| Cash and other discounts | 38 | 390 | — | (389) | 39 |
| Customer returns | 85 | 48 | — | (56) | 77 |
| Other | 53 | 167 | — | (163) | 57 |
| Total | 1,690 | 6,969 | 25 | (6,548) | 2,136 |
Cash discounts are offered to customers to encourage prompt payment. Accruals are calculated based on historical experience and are adjusted to reflect actual experience.
Industry practice in the US allows wholesalers and pharmacies to return unused stocks within six months of, and up to 12 months after, shelf-life expiry. The customer is credited for the returned product by the issuance of a credit note. Returned product is not exchanged for product from inventory and once a return claim has been determined to be valid and a credit note has been issued to the customer, the returned goods are destroyed and not resold. At the point of sale in the US, we estimate the quantity and value of goods which may ultimately be returned. Our returns accruals in the US are based on actual experience. Our estimate is based on the preceding 12 months for established products together with market-related information, such as estimated stock levels at wholesalers and competitor activity, which we receive via third party information services. For newly launched products, we use rates based on our experience with similar products or a pre-determined percentage.
For products facing generic competition (such as Arimidex and Merrem in the US) our experience is that we usually lose the ability to estimate the levels of returns from wholesalers with the same degree of precision that we can for products still subject to patent protection. This is because we have limited or no insight into a number of areas – the actual timing of the launch of a generic competitor following regulatory approval of the generic product (for example, a generic manufacturer may or may not have produced adequate pre-launch inventory), the pricing and marketing strategy of the competitor, the take-up of the generic and (in cases where a generic manufacturer has approval to launch just one dose size in a market of several dose sizes) the likely level of switching from one dose to another. Under our accounting policy, revenue is recognised only when the amount of the revenue can be measured reliably. Our approach in meeting this condition for products facing generic competition will vary from product to product depending on the specific circumstances.
The closing adjustment in respect of prior years benefited 2010 net US pharmaceuticals revenue by 1.1% (2009: increased revenue by 0.8%; 2008: decreased revenue by 0.2%). However, taking into account the adjustments affecting both the current and the prior year, 2009 revenue benefited by 0.3% and 2008 revenue decreased by 1.0%.
We have distribution service agreements with major wholesaler buyers which serve to reduce the speculative purchasing behaviour of the wholesalers and reduce short-term fluctuations in the level of inventory they hold. We do not offer any incentives to encourage wholesaler speculative buying and attempt, where possible, to restrict shipments to underlying demand when such speculation occurs.
Sales of intangible assets
A consequence of charging all internal R&D expenditure to the income statement in the year in which it is incurred (which is normal practice in the pharmaceutical industry) is that we own valuable intangible assets which are not recorded on the balance sheet. We also own acquired intangible assets which are included on the balance sheet. As a consequence of regular reviews of product strategy, from time to time we sell such assets and generate income. Sales of product lines are often accompanied by an agreement on our part to continue manufacturing the relevant product for a reasonable period (often about two years) while the purchaser constructs its own manufacturing facilities. The contracts typically involve the receipt of an upfront payment, which the contract attributes to the sale of the intangible assets, and ongoing receipts, which the contract attributes to the sale of the product we manufacture. In cases where the transaction has two or more components, we account for the delivered item (for example, the transfer of title to the intangible asset) as a separate unit of accounting and record revenue on delivery of that component provided that we can make a reasonable estimate of the fair value of the undelivered component. Where the fair market value of the undelivered component (for example, a manufacturing agreement) exceeds the contracted price for that component, we defer an appropriate element of the upfront consideration and amortise this over the performance period. However, where the fair market value of the undelivered component is equal to or lower than the contracted price for that component, we treat the whole of the upfront amount as being attributable to the delivered intangible assets and recognise that part of the revenue upon delivery. No element of the contracted revenue related to the undelivered component is allocated to the sale of the intangible asset. This is because the contracted revenue relating to the undelivered component is contingent on future events (such as sales) and so cannot be anticipated.
Research and development
Our business is underpinned by our marketed products and development portfolio. The R&D expenditure on internal activities to generate these products is generally charged to profit in the year that it is incurred. Purchases of intellectual property and product rights to supplement our R&D portfolio are capitalised as intangible assets. Further details of this policy are included in the Group Accounting Policies section of our Financial Statements. Such intangible assets are amortised from the launch of the underlying products and are tested for impairment both before and after launch. This policy is in line with practice adopted by major pharmaceutical companies.
Impairment testing of goodwill and intangible assets
We have significant investments in goodwill and intangible assets as a result of acquisitions of businesses and purchases of assets, such as product development and marketing rights.
Details of the estimates and assumptions we make in our annual impairment testing of goodwill are included in Note 8 to the Financial Statements. No impairment of goodwill was identified.
Impairment reviews have been carried out on all intangible assets that are in development (and not being amortised), all major intangible assets acquired during the year and all intangible assets that have had indications of impairment during the year. Sales forecasts and specific allocated costs (which have both been subject to appropriate senior management sign-off) are discounted using appropriate rates based on AstraZeneca’s risk-adjusted pre-tax weighted average cost of capital. In building to the range of rates used in our internal investment appraisal of future projects and capital investment decisions, we adjust our weighted average cost of capital for other factors, which reflect, without limitation, local matters such as risk on a case by case basis.
Intangible asset impairment charges recorded in 2010 included $445 million following our decision to withdraw our FDA biological license application for motavizumab as detailed on page 156 and $128 million related to our decision to discontinue further development of lesogaberan (AZD3355).
The majority of our investments in intangible assets and goodwill arose from the restructuring of the joint venture with Merck in 1998, the acquisition of MedImmune in 2007 and the payments to partially retire Merck’s interests in our products in the US in 2008 and 2010, and we are satisfied that the carrying values at 31 December 2010 are fully justified by estimated future cash flows. The accounting for our arrangements with Merck is fully explained in Note 25 to the Financial Statements.
Further details of the estimates and assumptions we make in impairment testing of intangible assets are included in Note 9 to the Financial Statements.
Litigation
In the normal course of business, contingent liabilities may arise from product-specific and general legal proceedings, from guarantees or from environmental liabilities connected with our current or former sites. Where we believe that potential liabilities have a less than 50% probability of crystallising or where we are unable to make a reasonable estimate of the liability, we treat them as contingent liabilities. These are not provided for but are disclosed in Note 25 to the Financial Statements.
In cases that have been settled or adjudicated, or where quantifiable fines and penalties have been assessed and which are not subject to appeal (or other similar forms of relief), or where a loss is probable (more than 50% assessed probability) and we are able to make a reasonable estimate of the loss, we indicate the loss absorbed or the amount of the provision accrued.
AstraZeneca is defending its interests in various federal and state investigations and civil litigation matters relating to product liability and to drug marketing and pricing practices and in respect of which AstraZeneca has made an aggregate provision of $612 million in the year. $592 million of this provision has been made in respect of the ongoing Seroquel product liability litigation and state attorney general investigations into sales and marketing practices in aggregate. The current status of these matters is described more fully in Note 25 to the Financial Statements, including our position on recovery of legal defence costs on page 190. This provision constitutes our best estimate at this time of the losses expected for these matters.
Where it is considered that the Group is more likely than not to prevail, or in the rare circumstances where the amount of the legal liability cannot be estimated reliably, legal costs involved in defending the claim are charged to profit as they are incurred. Where it is considered that the Group has a valid contract which provides the right to reimbursement (from insurance or otherwise) of legal costs and/or all or part of any loss incurred or for which a provision has been established and we consider recovery to be virtually certain, then the best estimate of the amount expected to be received is recognised as an asset.
Assessments as to whether or not to recognise provisions or assets and of the amounts concerned usually involve a series of complex judgements about future events and can rely heavily on estimates and assumptions. AstraZeneca believes that the provisions recorded are adequate based on currently available information and that the insurance recoveries recorded will be received. However, given the inherent uncertainties involved in assessing the outcomes of these cases and in estimating the amount of the potential losses and the associated insurance recoveries, we could in future periods incur judgments or insurance settlements that could have a material adverse effect on our results in any particular period.
The position could change over time, and there can, therefore, be no assurance that any losses that result from the outcome of any legal proceedings will not exceed the amount of the provisions that have been booked in the accounts. Although there can be no assurance regarding the outcome of legal proceedings, we do not currently expect them to have a material adverse effect on our financial position, but they could significantly affect our financial results in any particular period.
Post-retirement benefits
We offer post-retirement benefit plans which cover many of our employees around the world. In keeping with local terms and conditions, most of these plans are ‘defined contribution’ in nature, where the resulting income statement charge is fixed at a set level or is a set percentage of employees’ pay. However, several plans, mainly in the UK (which has by far the largest single scheme), the US and Sweden, are defined benefit plans where benefits are based on employees’ length of service and final salary (typically averaged over one, three or five years). The UK and US defined benefit schemes were closed to new entrants in 2000. All new employees in these countries are offered defined contribution schemes. The benefits provided by the UK pension plan were modified during 2010. As detailed above and Note 18 to the Financial Statements from page 162, in accordance with IAS 19 ‘Employee Benefits’, we recognised a gain of $791 million in the year arising from changes made to benefits under certain of the Group’s post-retirement plans, chiefly the freezing of future pensionable pay at 30 June 2010 levels under the Group’s UK pension plan.
In applying IAS 19, we recognise all actuarial gains and losses immediately through reserves. This methodology results in a less volatile income statement charge than under the alternative approach of recognising actuarial gains and losses over time. Investment decisions in respect of defined benefit schemes are based on underlying actuarial and economic circumstances with the intention of ensuring that the schemes have sufficient assets to meet liabilities as they fall due, rather than meeting accounting requirements. The trustees follow a strategy of awarding mandates to specialist, active investment managers, which results in a broad diversification of investment styles and asset classes. The investment approach is intended to produce less volatility in the plan asset returns.
In assessing the discount rate applied to the obligations, we have used rates on AA corporate bonds with durations corresponding to the maturities of those obligations except in Sweden where we have used rates on government bonds as the market in high quality bonds is insufficiently deep.
In all cases, the pension costs recorded in the Financial Statements are assessed in accordance with the advice of independent qualified actuaries but require the exercise of significant judgement in relation to assumptions for future salary and pension increases, long-term price inflation and investment returns.
Taxation
Accruals for tax contingencies require management to make judgements and estimates in relation to tax audit issues and exposures. Amounts accrued are based on management’s interpretation of country-specific tax law and the likelihood of settlement. Tax benefits are not recognised unless the tax positions are probable of being sustained. Once considered to be probable, management reviews each material tax benefit to assess whether a provision should be taken against full recognition of the benefit on the basis of potential settlement through negotiation and/or litigation. All such provisions are included in creditors due within one year. Any recorded exposure to interest on tax liabilities is provided for in the tax charge.
AstraZeneca faces a number of transfer pricing audits in jurisdictions around the world and, in some cases, is in dispute with the tax authorities. These disputes usually result in taxable profits being increased in one territory and correspondingly decreased in another. Our balance sheet positions for these matters reflect appropriate corresponding relief in the territories affected.
Further details of the estimates and assumptions we make in determining our recorded liability for transfer pricing audits and other tax contingencies are included in the tax section of Note 25 of the Financial Statements on page 195.
Segmental reporting
In 2009, AstraZeneca adopted IFRS 8 ‘Operating Segments’. IFRS 8 requires an entity to report financial and descriptive information about its reportable segments. Reportable segments are operating segments or aggregations of operating segments that meet specified criteria. In addressing these criteria, it was determined that AstraZeneca is engaged in a single business activity of pharmaceuticals and that the Group does not have multiple operating segments. Further details of our consideration of IFRS 8 are given in our Group Accounting Policies from page 145.