Biotech founders' practical guide to accounting for failed milestone payments under ASC 606/IFRS 15

Why a Missed Milestone is a Revenue Recognition Problem

A collaboration agreement is signed, and a significant payment lands in your biotech startup’s bank account, tied to a future preclinical research milestone. That cash extends your runway and feels like a win. But now, months later, the results are not what you hoped for, and the milestone has been missed. The cash is still there, but the board meeting is next week. The immediate question becomes a major source of stress: is that cash still revenue? For early-stage biotech companies, understanding how to account for missed milestone payments is crucial for maintaining credibility with investors and auditors. The distinction between cash in the bank and revenue on the income statement is where many startups get into trouble, but a clear process can resolve the uncertainty.

The core of the issue lies in a simple principle: revenue is recognized when it is *earned*, not simply when cash is received. Modern revenue recognition is governed by ASC 606 for US GAAP and IFRS 15 for international standards. These frameworks are largely converged on this topic and require a company to identify its “performance obligations,” which are the specific promises made to a customer.

In a biotech collaboration, a performance obligation is not just about performing research activities. It is typically tied to achieving a specific outcome, such as completing a research phase with a certain result, delivering a successful data package, or providing access to a discovery platform. When you receive cash for a milestone that has not been achieved, you have not yet fulfilled the related promise. Therefore, you have not technically earned the money, even if your collaboration partner paid you upfront.

Step 1: Review the Contract to Determine Your Legal Position

Before you open QuickBooks, open the collaboration agreement. Your first step is to determine the contractual reality of the missed milestone. Does the agreement explicitly state that the milestone payment is non-refundable, even if the target is not met? Or does it include a clawback clause requiring you to return the funds? This is a legal question, not an accounting one.

If the cash is contractually refundable, your path is clear. You have a legal obligation to return it and must record a refund liability on your balance sheet. However, most biotech collaboration agreements are structured so that these upfront or milestone-contingent payments are non-refundable. Be careful with this point, as non-refundable does not automatically equal recognized revenue. It simply means you have a legal right to retain the cash. The accounting treatment is a separate conversation, guided by ASC 606 and IFRS 15, not just the contract’s refund clause.

Step 2: Apply the Correct Accounting Treatment for the Missed Milestone

Once you have confirmed the cash is non-refundable, the next step is to apply the correct accounting rules. Under both US GAAP and IFRS, this situation is governed by the guidance on “variable consideration.”

Understanding Variable Consideration in Biotech

Milestone payment accounting is a classic example of variable consideration because the final amount of revenue you earn depends on a future event. The payment is contingent on an outcome, which introduces uncertainty. The accounting standards are very specific about how to handle this. Revenue from variable consideration can only be recognized *before* a milestone is met if it is "highly probable" that a significant revenue reversal will not occur later under ASC 606.

When a milestone is definitively missed, that uncertainty is resolved, but not in your favor. The condition required for you to earn the payment has failed. Therefore, any revenue you might have hoped to book from that payment cannot be recognized. Instead, the cash you hold becomes a liability on your balance sheet, typically labeled “Deferred Revenue” or “Unearned Revenue.”

The Journal Entry to Defer Revenue

Consider a biotech startup developing a new compound. A pharma partner pays $500,000 upfront, contingent on the compound achieving a specific efficacy target in a preclinical study. If the study fails to meet that target, the performance obligation tied to the milestone is not met. The $500,000, even if non-refundable, must sit as Deferred Revenue on the balance sheet.

In your accounting software, the journal entry is straightforward. If you initially recorded the cash as income, you now need to reverse it. In QuickBooks or Xero, you would debit the Revenue account and credit the Deferred Revenue liability account. This action removes the income from your Profit and Loss (P&L) statement and parks the corresponding amount on your balance sheet as a liability. For specific steps in Xero, you can see the Xero guide.

Step 3: Communicate the Revenue Change to Stakeholders

For a founder, explaining a sudden drop in reported revenue can be daunting, especially when investor expectations or performance covenants are on the line. The key is proactive and transparent communication. This is not about a loss of cash; it is an accounting reclassification based on strict rules. What founders find actually works is framing the conversation correctly from the start.

Your job is to separate the story of your P&L from the story of your cash and runway. Explain to your board and investors: “We did not meet the XYZ clinical milestone. Per ASC 606 guidance, we cannot recognize the associated $500,000 payment as revenue at this time. We have reclassified it as deferred revenue on our balance sheet. Importantly, this does not affect our cash position or our operational runway. The funds are secure and remain in our bank account.”

This approach achieves two goals. First, it addresses the issue head-on, leaving no room for misinterpretation. Second, it demonstrates financial discipline and a sophisticated understanding of proper accounting. It shows you are managing the company's finances professionally, which builds credibility with your board and investors rather than eroding it.

Step 4: Create a Clear and Simple Audit Trail

You do not need an in-house technical accounting team to create audit-ready documentation for this change. The reality for most Pre-Seed to Series B startups is more pragmatic: you need a simple, clear record that explains why you made the accounting adjustment. Your future auditors and due diligence teams will appreciate it.

Create a short internal memo that documents your decision. This memo should include four key items:

1. The Contract: Reference the specific section of the collaboration agreement related to the milestone payment and its non-refundable nature.
2. The Event: Briefly describe the milestone and the date it was confirmed as not being met. Include a reference to the internal data or report that confirmed the outcome.
3. The Accounting Rationale: State that under ASC 606/IFRS 15, the failed milestone means the variable consideration cannot be recognized as revenue. Note that the cash has been reclassified as deferred revenue on the balance sheet.
4. The Journal Entry: Include a screenshot or a PDF copy of the journal entry you created in QuickBooks or Xero to move the amount from the revenue account to the deferred revenue liability account.

Save this memo with the contract file and your financial records. This simple document provides a clear, contemporaneous audit trail that explains your decision-making and demonstrates compliance with accounting standards.

Conclusion: Managing Biotech Revenue with Discipline

Navigating how to account for missed milestone payments in biotech collaborations comes down to a few core principles. First, remember that cash in the bank is not revenue until it is earned by fulfilling a specific performance obligation. Second, your contract determines if a payment is refundable, but accounting standards determine when you can recognize it as revenue. When a milestone is missed, you must reclassify the associated non-refundable cash from revenue to a Deferred Revenue liability on your balance sheet. Communicate this change to stakeholders by emphasizing that it is an accounting requirement, not a change in your cash position. Finally, document your decision in a simple memo to create a clear audit trail. This disciplined approach ensures your financial reporting remains accurate and credible. See the IP Licensing & Collaboration Revenue hub for related guides.

Frequently Asked Questions

Q: What is the difference between deferred revenue and a refund liability?

A: A refund liability means you have a legal obligation under the contract to return the cash. Deferred revenue (or unearned revenue) applies when the cash is non-refundable, but you have not yet met the accounting requirements (a performance obligation) to recognize it as earned income on your P&L.

Q: Can we ever recognize revenue from a failed milestone payment?

A: Generally, no. Once the condition for the milestone fails, the performance obligation tied to it cannot be met. The cash remains as deferred revenue. However, if the collaboration agreement is later modified to assign that cash to a new or different performance obligation, you might recognize it as that new promise is fulfilled.

Q: How does reclassifying cash to deferred revenue impact our company's valuation?

A: It has a mixed impact. While it reduces your short-term reported revenue, which could affect revenue-multiple valuations, it does not change your cash position. Sophisticated investors understand GAAP/IFRS rules and focus on cash flow, runway, and scientific progress. Demonstrating proper financial controls can actually enhance credibility and support your valuation in the long run.