REQUIREMENTS
Part 1 - The Situation, Consolidation, and Interpretation

This is an unusual type of corporate relationship. The first set of questions will reinforce your understanding of the relationship and provide evidence on the pros and cons of consolidation.

1. Carefully reread the information provided about the corporate headquarters and the Development Agreement. Which company is actually performing the research and development activities?
Pharmco

2. Justify your response.
Disco is obligated, via a “Development Agreement,” to engage Pharmco to perform all of Disco’s research, development, & clinical testing activities related to products under development.

2. Using the financial statements provided in Teaching
- Definition of control: the direct or indirect ability to determine the direction of management & policies through ownership, contracts, or otherwise.
Evaluate whether Pharmco controls disco after the LPO & evidence pointing toward control
- Disco’s board of directors is composed of five members: Two members are upper management employees of Pharmco: the Chairman of the Board is President & Chief Executive Officer of Pharmco, & the other member is the Senior Vice President of Pharmco.
- Pharmco has the sole right to purchase Disco’s common stock at specified prices.
- Disco cannot issue additional common stock, pay dividends, borrow more than $2 million in the aggregate, or merge, liquidate, or sell all or substantially all of its assets without Pharmco’s approval.
Evidence pointing away from control
- Pharmco currently doesn’t own any equity in Disco because it has not exercised its option to purchase Disco’s callable stock.
What additional information would help in your decision process? - Regarding the 2 board members that are also board members of a company similar to Disco that has almost identical arrangements with Pharmco, how did that company get started? Did it also have an unusual limited private offering where Pharmco could exercise options to purchase their stock?
2. Assume that authoritative guidance under GAAP is not clear as to whether consolidation is required or not. How does this uncertainty affect the “reasonable