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Microsoft Word - C-2264 UV0731 This case was prepared by Lisa Evans (MBA ’07) under the supervision of Professor Mark Haskins. It was written as a basis for class discussion rather than to illustrate...

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Microsoft Word - C-2264
UV0731



This case was prepared by Lisa Evans (MBA ’07) under the supervision of Professor Mark Haskins. It was written
as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation.
Copyright © 2007 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved.
To order copies, send an e-mail to XXXXXXXXXX. No part of this publication may be
eproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—
electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School
Foundation.



ADENOSINE THERAPEUTICS LLC:
ACCOUNTING FOR A DIFFERENT COMPENSATION METHOD


To lead the world in discovering, developing, and commercializing novel
therapeutic compounds acting on the adenosine receptor subtypes in order to
save and improve the lives of our patients.
—Company Mission Statement


It was a beautiful, early spring afternoon. As Bill Stilley, chief financial officer (CFO) for
Adenosine Therapeutics (AT) walked his firm’s outside auditors to the door, Stilley wondered
how their earlier discussion might affect the young biotechnology company. The accounting
firm’s auditors had asked some hard questions about the accounting method Stilley used for the
creative compensation method in place at AT. The auditing team had concluded its audit and
wanted to be sure that any salary-related liabilities were accurately and fully reported. Stilley
wondered how any changes in AT’s accounting approach would affect the company’s financial
picture, which was a key marketing tool used in attracting private funding.


Company Background

Founded in 1999, Adenosine Therapeutics was a world leader in adenosine research
focused on the discovery and development of novel therapeutic products that targeted adenosine
eceptor subtypes. Adenosine is a naturally occu
ing molecule that plays an important role in
numerous human biochemical processes. For example, adenosine triphosphate (ATP) supplies
the energy to contract a muscle or to send a message between nerve cells. Adenosine also
egulates certain cell functions and physiological responses, such as heart rhythm, blood flow,
vessel tone, wakefulness, and urine production.

Adenosine mediates its effects by activating receptors in a cell’s mem
ane. Scientists
had identified four such adenosine receptor subtypes: A1, A2A, A2B, and A3. Depending on the
location and distribution of the receptor subtype, adenosine could modulate a variety of
physiological responses by affecting the cells su
ounding the site of its release. However, the
This document is authorized for use only by Jennifer Robinson in ACCT-6140-1,Cu
ent Trends Acct Standards.2020 Summer Sem 05/04-08/23-PT2 at Laureate Education - Walden University,
2020.
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usefulness of adenosine as a therapeutic agent had been limited because there had not been a
convenient way to deliver adenosine to specific sites or to prevent it from activating untargeted
eceptors, which could produce adverse or undesired effects.

Adenosine Therapeutics developed a process for creating small molecules that acted as
selective agonists (receptor activators) or antagonists (receptor blockers) for specific adenosine
eceptor subtypes.1 These molecules can activate physiological responses or block the activation
of receptor subtypes by endogenously produced adenosine. AT’s goal was to develop products
that evoked a subtype-specific pharmacodynamic effect without producing undesired outcomes
that could result from interactions with other subtypes of adenosine receptors.

The firm was cofounded in 1999 by a University of Virginia professor, Joel Linden, and a
successful entrepreneur, Robert Capon. Linden was one of the world’s leaders in understanding
the adenosine receptor. He devoted over 25 years to the study of the pharmacology, physiology,
and molecular biology of adenosine and its receptor subtypes, and co-authored over 120 papers
and 15 book chapters on the subject. Robert Capon was an entrepreneur who had been at the
helm of four successful companies, including having founded a public biotechnology company.
Through a licensing agreement with the University of Virginia Patent Foundation, AT had
exclusive, worldwide rights to the university’s adenosine-related patent2 portfolio.

The company employed 22 people and maintained a chemistry laboratory at a location a
few miles from its main office in Charlottesville, Virginia. AT’s intellectual property portfolio
consisted of over 50 patents issued or pending in the adenosine field. The company’s potent and
selective adenosine A2A agonists, A2A antagonists, and A2B antagonists offered potential
commercialization opportunities across a range of therapeutic areas, several of which represented
multibillion dollar markets. Cu
ent program areas included cardiac imaging, acute
inflammation, asthma, diabetes, arthritis, and cancer. Led by an experienced management team,
AT had its lead drug, Apadenoson, in Phase III clinical3 trials as a cardiac imaging agent with
approval projected for 2009. Additionally, Apadenoson, a potent and selective A2A agonist, has
successfully completed human safety testing for use as an anti-inflammation drug, and the
cu
ent focus of clinical development resources is on the development of Apadenoson as an
infused anti-inflammatory agent, targeting sickle cell disease as the first therapeutic indication.
Sickle cell disease is an inflammatory disease in which patients experience damaging and painful

1 An agonist promotes certain kinds of cellular activity by binding to a cell’s receptor. An antagonist prevents
certain types of cellular reactions by blocking other substances from binding to the cell’s receptor.
2 A patent was a property right granted by the U.S. Patent and Trademark Office to an inventor to exclude
others from making, using, offering for sale, or selling the invention for a limited time in exchange for public
disclosure of the invention when the patent was granted. A “composition of matter” patent protected a company’s
ownership of a drug’s chemical or biological properties; a “use” patent allowed the holder to manufacture and
market the drug for a specific therapeutic purpose. AT had patents that fell under both classifications. Under rules
established by the World Trade Organization, new pharmaceutical patents extended for 20 years from their
application date.
3 The word “clinic” or “clinical” meant human testing or use, whereas “nonclinical” or “preclinical” meant
testing in animals.
This document is authorized for use only by Jennifer Robinson in ACCT-6140-1,Cu
ent Trends Acct Standards.2020 Summer Sem 05/04-08/23-PT2 at Laureate Education - Walden University,
2020.
UV0731

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inflammatory overactivation or “crisis.” The company had shown that activation of the A2A
eceptor produced potent inhibition of the inflammatory response and the resulting damage in
many nonclinical models, including nonclinical models of sickle cell crisis. Management
elieved that its A2A agonists could eventually be targeted against a host of inflammatory
diseases, such as organ rejection, serious infection, and arthritis. The company also had a
promising pipeline of preclinical drugs to drive growth well into the future, including oral A2B
antagonist drugs for the treatment of asthma and diabetes.


Bill Stilley

Bill Stilley served as the chief operating officer (COO) and CFO of Adenosine, having
joined the company in 2002. His background was as an experienced operational and finance
entrepreneur, including an interim CFO position at a public company and as the COO and CFO
of a number of private companies. He also had experience advising both public and private
companies on financing and merger and acquisition (M&A) transactions. Before entering the
usiness community, Stilley served as an officer in the U.S. Marine Corps. He received his MBA
degree from the Darden Graduate School of Business Administration and had a BS in
Commerce/Marketing from the McIntire School of Commerce, both at the University of
Virginia.


Financing and Compensation

Like many small, biotech, start-up firms, AT’s operations were supported by private
investments, grants, and partnership a
angements. Grants and partnerships enabled the company
to make substantial progress in its scientific, clinical, and patenting programs without significant
dilution of its equity. Because the company experienced large gaps in the time between grant and
equity infusions, it was frequently concerned with cash flow. This led the company to develop a
creative compensation package so that it did not dilute equity, but also so that it did not have to
use its constrained cash. To reward and provide incentives to employees, AT used an accrued
payroll system whereby salary raises were accrued and not paid until a specific company
“milestone event,” such as private equity financing or a large partnership deal was consummated.
Stilley, and the executive team, felt that this method was fair and provided a creative solution to
their continuously tight cash position.

The accrued payroll system worked in the following way. When an employee got a salary
aise (typically during an annual or bi-annual review), the increased portion of the salary was
proportionately accrued on a monthly basis, but not paid at each pay period going forward. When
a milestone event occu
ed, the employee received a one-time check for the full amount accrued
since the raise was announced. Additionally, the employee’s increased salary level was then set
This document is authorized for use only by Jennifer Robinson in ACCT-6140-1,Cu
ent Trends Acct Standards.2020 Summer Sem 05/04-08/23-PT2 at Laureate Education - Walden University,
2020.
UV0731

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as the baseline amount going forward. As an example (ignoring taxes),4 assume an employee
earned $60,000 per year. In her yearly review, she was awarded a $15,000 raise, which was to be
accrued until a milestone event occu
ed. If the event occu
ed exactly two years after her raise,
she would receive a one-time payment of $30,000 (amount accrued) on the day of the
transaction. Going forward, she would be paid a salary of $75,000 ($60,000 + $15,000) per year.
If the employee left AT for any reason before the event, she forfeited her accrued salary in full.
In the history of AT, only three employees had ever left, and they left for reasons unrelated to
compensation. In fact, Stilley had never heard anyone openly complain
Answered Same Day May 31, 2021

Solution

Pallavi answered on May 31 2021
131 Votes
A4.1 The basic accounting research question that Adenosine Therapeutics’ accountant required to answered about the firm’s compensation method are how does the organisation accrued payroll system operates and what is the motive of implementation of such system during the payment of salary. The cash flow was affected because of the grant and equity infusions leads to which the company has generated different compensation package whereby the procedure has been stated about the payment of the salary to the employee. From such scheme the company would be able to retain its equity. Further, employee’s incentives calculation process is also different. The organisation uses accrued payroll system in which the accrued salary not paid unless the organisation has achieved their milestone event that can be described either private equity financing or successful giant partnership deal. Further, if an employee receives incentive than such increased potion of salary are paid through one check with the full and final amount rather than paying on monthly basis. If the employees leaves the organisation, the payment of salary has being done at that time only and do not wait for any occu
ence of any milestone event.
A4.2 While answering the question the accountant should understand the requirements and application of the accounting standard associated with the organisation. Every transaction of the accounts has two affects;...
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