HONG KONG – South Korean pharmaceutical and biotech companies have been given new guidelines on how to treat research and development spending in their accounting, a move expected to remove uncertainties related to R&D's impacts on companies' return on assets and return on invested capital.

South Korea's Financial Services Commission, the top financial regulator, published guidelines stating that for different pharmaceutical products, R&D spending can be capitalized as assets rather than incurred as expenditures, if the products are technically viable.

Under the new rules, R&D expenses can be deemed assets when new drugs enter phase III trials; when biosimilars pass phase I studies; when generic drugs obtain approval for bioequivalence testing; and when diagnostic reagents have entered the government approval or third-party verification process.

Park Seon-mi, director of the public relations and marketing communications division at the Korea Biotechnology Industry Organization, told BioWorld there have been problems with companies treating their R&D spending in an arbitrary way. "The criteria for treating R&D spending in the biotechnology industry have not been clear," said Park.

Previously, the industry treated R&D spending as assets if the spending was incurred on a technology or a new drug that would generate profits after further development and commercialization. However, there are no clear rules to justify whether the technology or the drug candidate could do so.

Companies also treat their R&D spending as assets in different situations – when the drug candidates enter clinical stage, or when they are granted marketing approval. It largely depends on the company's own accounting practice.

According to U.S. generally accepted accounting principles, R&D costs are required to be treated as expenses in the same fiscal year that the spending is incurred, as it is uncertain whether R&D activities, which aim to create a product or improve an existing one, could be successful eventually.

Capitalizing R&D spending as assets generally improves the company's financial position as it raises net income in its financial reports, whereas treating it as an expense affects the company's profitability on paper, as the costs are now incurred as expenses on the profit and loss statement, thereby lowering net income.

Earlier this year, South Korea financial watchdog the Financial Supervisory Service (FSS) revealed that 21 out of 43 KOSPI-listed biotech companies treated their R&D spending as assets.

On the Kosdaq market, where small- and medium-sized companies are listed, 54 out of 90 biopharma companies followed suit.

Upon the release of the new guidelines, 22 biotech companies were asked to make voluntary changes, with no actions to be taken against them.

The financial authorities said it is questionable how those companies could list their R&D spending as assets when developing new drugs involves high risk and uncertainty. Such uncertainty in accounting regulations could potentially generate misleading information regarding companies' financial health.

The biotech sector also wanted clearer accounting rules from the authorities. That view was reflected by 84 percent of 26 biotech companies surveyed in May by the Korea Biotechnology Industry Organization.

Their call came as the FSS launched a special investigation into 10 biotech companies regarding how they categorized their R&D spending, involving big names such as Celltrion Inc. and Cha Biotech Co. Ltd. "For the industry's growth, Korea needs to consider adopting not a unilateral, but flexible accounting standard to account for the special nature of the biotech sector," said Lee Seung-gyu, vice president of the Korea Biotechnology Industry Organization.

Rules clearer but not helpful

While the new guidelines mark the beginning of defining clearly when R&D spending should be treated as assets, Park said they do not fully address concerns raised by companies.

"The guidelines are not reasonable for all the biotech companies," she said. In particular, companies that develop new drugs would be hit hard.

"They will find it more difficult to attract investment at preclinical and early clinical stages, as investors look at the proportion of the company's assets," she said.

"If the R&D spending can no longer be listed as assets, it will hamper these companies' bargaining power in seeking investment."

Park noted that Korean drug companies' technology is often exported overseas before the phase III trials. According to the accounting guideline, however, revenues obtained that way must be treated as R&D expenses rather than assets.

As the guidelines are still fresh, her organization, Korea Bio, is soliciting opinions from member companies.

"We hope that the guidelines will be modified appropriately to take into consideration the realistic aspects of biotech companies in South Korea," Park said.

Ongoing financial overhaul

This is not the first time that South Korea's financial authorities have rolled out measures specific to the biotech industry.

On Aug. 17, the FSS issued stricter disclosure requirements for biotech companies, starting with their third-quarter earnings reports, as the watchdog claims there are "unique investment risks" in the industry.

The new rules require drugmakers to present R&D data for new drug development and disclose details of licensing deals in their reports.

The FSS said that is intended to address doubts, especially among minority investors, amid biotech stock volatility.

In April, the Korea Exchange said biotech shares accounted for eight out of 10 stocks that saw the highest growth this year. Local media and market watchers were calling it a biotech bubble.

Feelux Co., for example, saw its share price surge as much as 555 percent, while Inscobee Inc., Bionics Co. and Samil Pharmaceutical Co. had risen more than 400 percent.