Klancet, a public limited company, is a pharmaceutical company and is seeking advice on several financial reporting issues. (a) Klancet produces and sells its range of drugs through three separate divisions. In addition, there are two laboratories which carry out research and development activities. In the first of these laboratories, the research and development activity is funded internally and centrally for each of the three sales divisions. It does not carry out research and development activities for other entities. Each of the three divisions is given a budget allocation which it uses to purchase research and development activities from the laboratory. The laboratory is directly accountable to the division heads for this expenditure. The second laboratory performs contract investigation activities for other laboratories and pharmaceutical companies. This laboratory earns 75% of its revenues from external customers and these external revenues represent 18% of the organisation’s total revenues. The performance of the second laboratory’s activities and of the three separate divisions is regularly reviewed by the chief operating decision maker (CODM). In addition to the heads of divisions, there is a head of the second laboratory. The head of the second laboratory is directly accountable to the CODM and they discuss the operating activities, allocation of resources and financial results of the laboratory. Klancet is uncertain as to whether the research and development laboratories should be reported as two separate segments under IFRS 8 Operating Segments, and would like advice on this issue. (8 marks) (b) Klancet has agreed to sell a patent right to another pharmaceutical group, Jancy. Jancy would like to use the patent to develop a more complex drug. Klancet will receive publicly listed shares of the Jancy group in exchange for the right. The value of the listed shares represents the fair value of the patent. If Jancy is successful in developing a drug and bringing it to the market, Klancet will also receive a 5% royalty on all sales. Additionally, Klancet won a competitive bidding arrangement to acquire a patent. The purchase price was settled by Klancet issuing new publicly listed shares of its own. Klancet’s management would like advice on how to account for the above transactions. (7 marks) (c) Klancet is collaborating with Retto Laboratories (Retto), a third party, to develop two existing drugs owned by Klancet. In the case of the first drug, Retto is simply developing the drug for Klancet without taking any risks during the development phase and will have no further involvement if regulatory approval is given. Regulatory approval has been refused for this drug in the past. Klancet will retain ownership of patent rights attached to the drug. Retto is not involved in the marketing and production of the drug. Klancet has agreed to make two non-refundable payments to Retto of $4 million on the signing of the agreement and $6 million on successful completion of the development. Klancet and Retto have entered into a second collaboration agreement in which Klancet will pay Retto for developing and manufacturing an existing drug. The existing drug already has regulatory approval. The new drug being developed by Retto for Klancet will not differ substantially from the existing drug. Klancet will have exclusive marketing rights to the drug if the regulatory authorities approve it. Historically, in this jurisdiction, new drugs receive approval if they do not differ substantially from an existing approved drug. The contract terms require Klancet to pay an upfront payment on signing of the contract, a payment on securing final regulatory approval, and a unit payment of $10 per unit, which equals the estimated cost plus a profit margin, once commercial production begins. The cost-plus profit margin is consistent with Klancet’s other recently negotiated supply arrangements for similar drugs. Klancet would like to know how to deal with the above contracts with Retto. (8 marks) Required: Advise Klancet on how the above transactions should be dealt with in its financial statements with reference to relevant International Financial Reporting Standards. Note: The mark allocation is shown against each of the three issues above. Professional marks will be awarded in question 3 for clarity and quality of presentation. (2 marks)