Summary of Significant Accounting Policies

3 Months Ended

Mar. 31, 2018

Summary of Significant Accounting Policies

2.	Summary of Significant Accounting Policies

Summary of Accounting Policies

The significant accounting policies and estimates used in preparation of the unaudited condensed consolidated financial statements are described in the Company’s audited consolidated financial statements as of and for the year ended December 31, 2017, and the notes thereto, which are included in the Company’s Annual Report on Form 10-K. Material changes to the significant accounting policies previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 are reflected below.

Revenue Recognition

The Company derives revenue from the provision of molecular information services provided to its ordering physicians and biopharmaceutical customers, as well as from pharma research and development services provided to its biopharmaceutical customers. Molecular information services include molecular profiling and the delivery of other molecular information derived from the Company’s platform. Pharma research and development services include the development of new platforms and information solutions, including companion diagnostic development. The Company currently receives payments from commercial third-party payors, Medicare, certain hospitals and cancer centers with which it has direct-bill relationships, individual patients, and its biopharmaceutical customers. All amounts are due to be paid in accordance with the customers agreed upon payment terms and we have not identified the existence of any significant financing components.

Effective January 1, 2018, the Company began recognizing revenue in accordance with FASB ASC Topic 606, Revenue from Contracts with Customers (“ASC 606”). The Company adopted ASC 606 utilizing the modified retrospective method, meaning the cumulative effect of applying the standard was recognized to opening retained earnings as of January 1, 2018. ASC 606 provides for a five-step model that includes identifying the contract with a customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction price to the performance obligations, and recognizing revenue when, or as, an entity satisfies a performance obligation.

Performance Obligations

Molecular Information Services

Clinical

Our clinical contracts included within molecular information services typically have a single performance obligation to transfer molecular profiling services to either a patient or a facility. In certain limited contracted scenarios, such as arrangements with academic medical centers, the transaction price is stated within the contract and is therefore fixed consideration. For most of our clinical volume, we identified the patient as the customer in Step 1 of the model and have determined an implied contract exists with the patient in Step 1. As such, a stated contract price does not exist and the transaction price for each contract represents variable consideration. In developing the estimate of variable consideration, we utilize the expected value method under a portfolio approach. Our estimate requires significant judgment and is developed using historical reimbursement data from payors and patients, as well as known current reimbursement trends not reflected in the historical data. As these contracts typically have a single performance obligation, no allocation of the transaction price is required in Step 4 of the model. Control over molecular information services is transferred to our ordering physicians at a point in time. Specifically, we determined the customer obtains control of the promised service upon our delivery of the test results. Certain incremental costs, such as commissions, are incurred in obtaining clinical contracts. We have elected to utilize the practical expedient to expense incremental costs of obtaining a contract that meet the capitalization criteria, as the amortization period of any contract acquisition asset would be one year or less due to the short-term nature of our clinical contracts.

Biopharma

Our biopharma contracts included within molecular information services may include single or multiple performance obligations depending on the contract, and may include different molecular information service offerings, such as molecular profiling, provision of data through either database queries or subscription access to our platform, and clinical trial enrollment assistance, as separately identifiable from other promises in the contracts and therefore distinct performance obligations.

The transaction price in biopharma molecular information service contracts is typically fixed consideration. In certain instances, contracts may include variable consideration. In these contracts, variable consideration is estimated utilizing the expected value method. The primary method used to determine standalone selling price for the biopharma molecular information services is observable standalone selling price. When standalone selling price is not directly observable, the primary method used to estimate standalone selling price for molecular information services is the adjusted market assessment approach, under which we evaluate the market in which we sell the services and estimate the price that a customer in that market would be willing to pay for those services.

Control over biopharma molecular information services from molecular profiling and database queries is transferred to customers at a point in time. We determined the customer obtains control of the promised service upon delivery of the test results or the delivery of responses to database queries to the biopharma partner. Control over biopharma molecular information services from subscription access to our data platform is transferred to customers ratably over time. We determined that the customer obtains control of the promised service as we host the content throughout the contract term. Control over biopharma molecular information services from clinical trial enrollment assistance is transferred to customers ratably over time. We determined that the customer obtains control of the promised service as we stand ready to perform such services throughout the contract term.

Pharma Research and Development Services

Our biopharma contracts included within pharma research and development services may include single or multiple performance obligations depending on the contract. Research and development (“R&D”) services typically represent a single performance obligation as the Company performs a significant integration service for the individual goods or services in the R&D workstream, such as analytical validation and regulatory submissions. The individual promises are not separately identifiable from other promises in the contracts and, therefore, are not distinct. However, in certain contracts, a partner may engage the Company for multiple distinct R&D workstreams which are both capable of being distinct and separately identifiable from other promises in the contracts and, therefore, distinct performance obligations. Additionally, for regulatory contracts in pursuit of approval of a companion diagnostic assay, the Company identifies a performance obligation for commercial availability of the assay subsequent to obtaining regulatory approval.

The transaction price can consist of a combination of an upfront fee, performance-based development milestones, cost reimbursement, fixed per sample fees, commercial royalties, and commercial milestones. With the exception of upfront and fixed per sample fees, the other forms of compensation represent variable consideration. Variable consideration in the form of cost reimbursement and commercial royalties is estimated using the expected value method. Variable consideration in the form of development and commercial milestones is estimated using the most likely amount method. All variable consideration is constrained such that it is probable a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. Application of the constraint for variable consideration to milestone payments is an area that requires significant judgment. In making this assessment, the Company evaluates factors such as the scientific, clinical, regulatory, commercial, and other risks that must be managed to achieve the respective milestone and the level of effort and investment required to achieve the respective milestone.

The primary method used to estimate standalone selling price for the R&D service performance obligations is the expected cost plus a margin approach, under which we forecast our expected costs of satisfying each performance obligation and then add an appropriate margin for that distinct good or service. The primary method used to estimate standalone selling price for a commercial availability performance obligation is the adjusted market assessment approach, under which we evaluate the market in which we sell the services and estimate the price that a customer in that market would be willing to pay for those services. The estimation of standalone selling price is an area that requires significant judgment, as it impacts the allocation objective in Step 4 of the model. Revenue will be recognized over time for R&D services and commercial availability services. Specifically, for R&D services we will recognize revenue using an input method to measure progress, utilizing costs incurred to-date relative to total expected costs as our measure of progress. For commercial availability services, we will recognize revenue using an input method to measure progress, resulting in a time-elapsed measure of progress.

The Company performs R&D services as part of its normal activities. The Company records payments for these services as Pharma research and development services revenue in the Consolidated Statements of Operations and Comprehensive Loss. The R&D costs incurred by the Company under these arrangements are included as Research and development expenses in the Company’s Consolidated Statements of Operations and Comprehensive Loss given these costs are related to the development of new services to be owned and offered by the Company to its customers.

Significant Judgments and Contract Estimates

Molecular Information Services

For our clinical molecular information services, we have concluded that an implied contract exists with the patient. This is a significant judgment as contract existence is a requirement to applying the general five-step model of ASC 606.

Accounting for clinical revenue contracts includes estimation of the transaction price, defined as the amount we expect to be entitled to receive in exchange for providing the services under the contract. Due to our out-of-network status with the majority of payors, estimation of the transaction price represents variable consideration. In order to estimate variable consideration, we utilize a portfolio approach in which payors with similar reimbursement experience are grouped into portfolios. Our estimates of variable consideration are based primarily on historical reimbursement data. Certain assumptions will also be adjusted based on known and anticipated factors not reflected in the historical reimbursement data. We monitor these accrual estimates at each reporting period based on actual cash collections in order to assess whether a revision to the estimate is required. Both the initial accrual estimate and any subsequent revision to the estimate contain uncertainty and require the use of judgment in the estimation of the transaction price and application of the constraint for variable consideration.

Pharma Research and Development Services

Accounting for biopharma revenue contracts includes several judgments and estimates which impact the timing and pattern of revenue recognition. Specifically, biopharma contracts require evaluation of separability of promised services, estimation of the transaction price, allocation of the transaction price to performance obligations, and estimation of measure of progress toward complete satisfaction for those performance obligations satisfied over time.

Certain biopharma contracts, typically those for pharma R&D services, contain promises to deliver multiple services. The process for evaluating contracts for material promises, in contrast to immaterial promises or administrative tasks, requires judgment. Once material promises have been identified, we then evaluate whether these promises are both capable of being distinct and distinct within the context of the contract. If both of these criteria are satisfied, a separate performance obligation will be identified. If both criteria are not satisfied, certain promises will be combined in the identification of a combined performance obligation. In assessing whether a promised service is capable of being distinct, the Company considers whether the customer could benefit from the service either on its own or together with other resources that are readily available to the customer, including factors such as the research, development, and commercialization capabilities of a third party and the availability of the associated expertise in the general marketplace. In assessing whether a promised service is distinct within the context of the contract, the Company considers whether we provide a significant integration of the services, whether the services significantly modify or customize one another, or whether the services are highly interdependent or interrelated.

The nature of certain biopharma contracts, primarily contracts for pharma R&D services, requires that the transaction price must be estimated, including application of the constraint to performance-based milestones. The Company evaluates factors such as the scientific, clinical, regulatory, commercial, and other risks that must be managed to achieve the respective milestone and the level of effort and investment required to achieve the respective milestone in making this assessment. Application of the constraint is based on our historical experience with similar milestones, the degree of complexity and uncertainty associated with each milestone, and whether achievement of the milestone is dependent on parties other than the Company. The constraint for variable consideration is applied such that it is probable a significant reversal of revenue will not occur when the uncertainty associated with the contingency is resolved. Application of the constraint for variable consideration is updated at each reporting period as a revision to the estimated transaction price.

Once the transaction price has been estimated, the standalone selling price for each identified performance obligation must be determined in order to allocate the transaction price to performance obligations. Observable standalone selling price is used when available. When an observable price is not available, standalone selling price is estimated using either the adjusted market assessment approach or the expected cost plus a margin approach, utilizing the approach which maximizes the use of observable inputs. Under the adjusted market assessment approach, we utilize pricing on historical similar transactions as well as competitor pricing as relevant inputs. Under the expected cost plus a margin approach, we utilize internal cost models for required personnel and sample resources as the relevant inputs.

Lastly, once the transaction price has been allocated to the identified performance obligations, we must determine the timing and pattern of revenue recognition. For certain biopharma services, particularly pharma R&D services satisfied over time, this requires estimation of the total cost pool in order to determine our measure of progress under the input method. This cost pool is the same cost model utilized to estimate standalone selling price under the expected cost plus a margin approach. At the end of each reporting period, we track actual costs incurred in order to measure progress under the input method and recognize revenue accordingly.

For further discussion on the Company’s revenue recognition, refer to Note 4: Revenue and Note 7: Contract Balances.

Reclassifications

Certain reclassifications have been made to the revenue captions of the Condensed Consolidated Statements of Operations and Comprehensive Loss to conform to the current classifications. These reclassifications had no net effect on the Company’s consolidated results.

Recent Accounting Pronouncements

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) or other standard setting bodies and adopted by the Company as of the specified effective date. Unless otherwise discussed, the Company believes that the impact of recently issued standards that are not yet effective will not have a material impact on its financial position or results of operations upon adoption.

The Company adopted ASU 2014-09 Revenue from Contracts with Customers and all related amendments (collectively codified as ASC 606) on January 1, 2018 utilizing the modified retrospective method, meaning the cumulative effect of applying the standard to all contracts that were not completed as of the date of initial application was recognized to opening retained earnings as of January 1, 2018. The Company identified certain differences in accounting for revenue recognition as a result of adoption of ASC 606 which are expected to have a material impact on its financial position or results of operations. These differences are discussed below and any other identified policy differences are not expected to have a material impact on the Company’s financial position or results of operations.

For molecular information services revenue, the Company identified a difference in accounting for certain revenue arrangements from the application of the new revenue accounting standard as compared to the previous revenue accounting standards. Historically, for certain clinical customers, the Company deferred revenue recognition until cash receipt when the price pursuant to the underlying customer arrangement was not fixed and determinable and collectability was not reasonably assured. Under the new standard, this is considered variable consideration. For these arrangements, the Company will record an estimate of the transaction price, subject to the constraint in the new standard for variable consideration, as revenue at the time of delivery. This estimate will be monitored in subsequent periods and adjusted as necessary based on actual collection experience. This will result in earlier revenue recognition as compared to previous revenue recognition.

For pharma research and development services revenue, the Company identified a difference in accounting for certain contracts from the application of the new revenue accounting standard as compared to previous revenue accounting standards. Historically, for arrangements with regulatory and other developmental milestone payments, the Company limited revenue recognition based on the right to invoice the customer. Under the new standard, for these arrangements, the Company will constrain revenue such that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. Based on the facts and circumstances associated with each milestone, this could result in a change to the timing and pattern of revenue recognition as compared to previous accounting policy.

Effective January 1, 2018, the Company recognizes revenue in accordance with ASC 606. Comparative information from prior periods has not been restated and continues to be reported under the accounting standards in effect for those periods.

The cumulative effect of changes made to the Condensed Consolidated Balance Sheet at January 1, 2018 for the adoption of ASC 606 were as follows (in thousands):

	Balance at December 31, 2017			Adjustments Due to ASC 606		Balance at January 1, 2018
Assets:
Accounts receivable	$	19,967		$	17,243	$	37,210
Prepaid expenses and other current assets		9,118			710		9,828
Other assets		1,760			573		2,333

	Balance at December 31, 2017			Adjustments Due to ASC 606		Balance at January 1, 2018
Liabilities:
Deferred revenue	$	2,212		$	156	$	2,368
Roche related-party deferred revenue		3,742			78		3,820

	Balance at December 31, 2017			Adjustments Due to ASC 606		Balance at January 1, 2018
Equity:
Accumulated deficit	$	(506,349	)	$	18,292	$	(488,057	)

In accordance with ASC 606 requirements under the modified retrospective method of adoption, the disclosure of the impact of adoption on our Condensed Consolidated Statement of Operations and Condensed Consolidated Balance Sheet was as follows (in thousands):

	For the three months ended March 31, 2018
Revenue:	As Reported Under ASC 606		Effect of Change Higher/(Lower)			Balances Without Adoption of ASC 606
Molecular information services	$	31,943	$	3,212		$	35,155
Related-party molecular information services from Roche		14,648		(374	)		14,274
Pharma research and development services		4,782		(3,923	)		859
Related-party pharma research and development services from Roche		1,467	—				1,467

	March 31, 2018
Assets:	As Reported Under ASC 606			Effect of Change Higher/(Lower)			Balances Without Adoption of ASC 606
Accounts receivable	$	32,222		$	(14,008	)	$	18,214
Prepaid expenses and other current assets		13,003			(4,771	)		8,232
Other assets		2,225			(491	)		1,734

Liabilities:	As Reported Under ASC 606			Effect of Change Higher/(Lower)			Balances Without Adoption of ASC 606
Deferred revenue	$	2,867		$	(179	)	$	2,688
Roche related-party deferred revenue		4,801			286			5,087

Equity:	As Reported Under ASC 606			Effect of Change Higher/(Lower)			Balances Without Adoption of ASC 606
Accumulated deficit	$	(525,472	)	$	(19,377	)	$	(544,849	)

ASC 606 did not have an aggregate impact on the Company’s net cash used in operating activities, but resulted in offsetting changes in certain assets and liabilities presented within net cash used in operating activities in the Company’s Condensed Consolidated Statement of Cash Flows, as reflected in the above tables.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). ASU 2016-01 provides guidance about how to recognize, measure, present and make disclosures about certain financial assets and financial liabilities under Topic 825. ASU 2016-01 became effective for fiscal years beginning after December 15, 2017. The adoption of ASU 2016-01 did not have a material effect on the Company’s consolidated financial statements or disclosures.

In February 2016, the FASB issued ASU 2016-02, Leases (“ASU 2016-02”), to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities, including for operating leases, on the balance sheet and disclosing key information about leasing arrangements. ASU 2016-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is still performing its assessment of ASU 2016-02, however expects that substantially all of its operating lease commitments will be subject to the new guidance.

In November 2016, the FASB issued ASU 2016-18, Restricted Cash (“ASU 2016-18”). ASU 2016-18 provides guidance on the classification of restricted cash and cash equivalents in the statement of cash flows. Although it does not provide a definition of restricted cash or restricted cash equivalents, it states that amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of period total amounts shown on the statement of cash flows. ASU 2016-18 became effective for fiscal years beginning after December 15, 2017. The adoption of ASU 2016-18 did not have a material effect on the Company’s consolidated financial statements or disclosures.

In May 2017, the FASB issued ASU 2017-09, Scope of Modification Accounting (“ASU 2017-09”). ASU 2017-09 provides guidance about which terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. ASU 2017-09 became effective for fiscal years beginning after December 15, 2017. The adoption of ASU 2017-09 did not have an effect on the Company’s consolidated financial statements or disclosures.

Foundation Medicine, Inc. 10-Q