Question

Case 2: Noven Pharmaceuticals, Inc.

Noven Pharmaceuticals, Inc., headquartered in Miami, Florida, describes itself in a recent annual report as follows.

Noven Pharmaceuticals, Inc.

Noven is a place of ideas—a company where scientific excellence and state-of-the-art manufacturing combine to create new answers to human needs. Our transdermal delivery systems speed drugs painlessly and effortlessly into the bloodstream by means of a simple skin patch. This technology has proven application sinestrogen replacement, but at Noven we are developing a variety of systems incorporating best selling drugs that fight everything from asthma, anxiety and dental pain to cancer, heart disease and neurological illness. Our research portfolio also includes new technologies, such as iontophoresis, in which drugs are delivered through the skin by means of electrical currents, as well as products that could satisfy broad consumer needs, such as our anti-microbial mouth rinse.

Noven also reported in its annual report that its activities to date have consisted of product development efforts, some of which have been independent and some of which have been completed in conjunction with Rhone-Poulenc Rorer (RPR) and Ciba-Geigy. The revenues so far have consisted of money received from licensing fees, “milestone” payments (payments made under licensing agreements when certain stages of the development of a certain product have been completed), and interest on its investments. The company expects that it will have significant revenue in the upcoming fiscal year from the launch of its first product, a transdermal estrogen delivery system.

The current assets portion of Noven’s balance sheet follows.

Cash and cash equivalents \(12,070,272

Securities held to maturity 23,445,070

Inventory of supplies 1,264,553

Prepaid and other current assets 825,159

Total current assets \)37,605,054

Inventory of supplies is recorded at the lower-of-cost (first-in, first-out)-or-net realizable value and consists mainly of supplies for research and development.

Instructions

(a) What would you expect the physical flow of goods for a pharmaceutical manufacturer to be most like: FIFO, LIFO, or random (flow of goods does not follow a set pattern)? Explain.

(b) What are some of the factors that Noven should consider as it selects an inventory measurement method?

(c) Suppose that Noven had $49,000 in an inventory of transdermal estrogen delivery patches. These patches are from an initial production run and will be sold during the coming year. Why do you think that this amount is not shown in a separate inventory account? In which of the accounts shown is the inventory likely to be? At what point will the inventory be transferred to a separate inventory account?

Short answer

a) FIFO system

b) Nature of product, cost, taxation, suitability, and simplicity

c) Still pending to be approved as a final product or finished inventory.

Step-by-step solution

Physical flow of goods for pharmaceutical manufacturer .

In pharmaceutical industries, drugs used for making different medicines have limited life. Thus the earliest acquired drugs need to be utilized first. So, in the given case, Noven pharmaceuticals must be using theFIFO systemfor the physical flow of goods. This method is most suitable for the company as it matches the cost with the actual inventory used and prevents the obsoleteness of inventory.

Factors for selecting inventory measurement method

Following are the factors that should be considered before selecting an inventory measurement method -

a) Nature of the product– The nature of the product is the first factor that should be given priority in selecting the inventory valuation method. In the given case, the inventory is drugs, medicine, or some drug delivery system. So this is a kind of perishable inventory and must be utilized based on first-in-first-out.

b) Cost – The cost of inventory is the second factor in this regard. Some inventories like medicine have a rising price trend. So the inventories acquired first must be used on a priority basis. On the other hand, some inventories have flexible costs, so the average method would be appropriate in this case.

c) Taxation – taxation is another issue with inventory valuation. Under the LIFO method, COGS would be high. So, as a result, income before tax would be lower, and thus tax would be below. On the other hand, the FIFO method causes more tax to pay.

d) Suitability and simplicity – Suitability and simplicity is the important aspect of implementing the valuation method. Some methods may be more accurate in valuing inventory but are the most complex in implanting. So the valuation method must be simple and suitable to have better control over cost.

Unrepresented inventory

The amount of $49,000 has not been shown on the balance sheet. The possible reason for this is that this product is still pending to be approved for launch. As given in the case, the transdermal delivery system painlessly delivers drugs into the blood system. So this product seems to be like a piece of equipment or medical application for providing medical service. Currently, this inventory may have been shown in the inventory of supplies. This inventory would be transferred to a separate inventory account once the patches are ready to be launched.