Case – Yeah, Science!

Case 19-3 Yeah, Science!
Pinkman Inc. (“Pinkman”) is a wholly owned subsidiary of an SEC registrant. Pinkman
has a contract (the “Contract”) with the Heisenberg Institute (“Heisenberg”), which is a
privately funded research institute with the stated mission of developing a cure for
narcolepsy and other wide-spread sleep disorders.
Under the Contract (which has a term of ten years), Pinkman serves as the administrator
of the “Lab,” which is a multiple-unit campus consisting of recreational vehicles that
Heisenberg uses to conduct research. As administrator of the Lab, Pinkman provides
Heisenberg a single, distinct combined bundle of services (the “Lab Administration”) that
comprises all the activities necessary to administer the Lab and conduct research therein.
To provide the Lab Administration, Pinkman employs approximately 15,000 personnel
(including administrators, scientists, researchers, technicians, etc.) that administer and
maintain the Lab infrastructure and conduct the research performed therein. Research is
conducted via multiple individual “Research Programs.”
Pinkman is compensated by Heisenberg under the Contract on a cost-plus-fixed-fee basis.
In accordance with this payment structure, Heisenberg reimburses Pinkman (via a
prefunded bank account) for all expenses incurred by Pinkman in its provision of the Lab
Administration (including all labor-related costs associated with Pinkman’s employees,
such as salaries, benefits, and severance, etc.), and Heinsenberg additionally pays
Pinkman a predetermined annual fixed fee (as established within the Contract terms). The
annual fixed fee does not fluctuate with changes in the costs incurred by Pinkman. In
other words, regardless of the costs incurred by Pinkman in its provision of the Lab
Administration (all of which are reimbursed by Heisenberg), the fixed fee that Pinkman
receives does not change.
Additional information related to Pinkman’s operations and the Contract is as follows:
• Pinkman is the legal employer of all the personnel that it employs. In its role as
employer, Pinkman is responsible for all activities normally associated with a
legal employer, including (but not limited to) the following:
o Pinkman is responsible for hiring all employees, and it is the legal
counterparty to the employee in each individual’s employment contract.
o Pinkman is responsible for evaluating employee performance, and it has
the discretion to terminate employees who are not performing well.
o Pinkman is responsible for handling and resolving employee complaints,
including any potential lawsuits that may arise during the course of
employment.
o Pinkman is legally obligated to pay its employees, even if it does not
receive reimbursement from Heisenberg. (However, Pinkman has never
Case 07c: Yeah, Science! Page 2
Copyright © 2019 Deloitte Development LLC
All Rights Reserved.
failed to receive adequate prefunded reimbursement from Heisenberg for
all of its allowable expenses.)
Pinkman also manages employee compensation, including decisions regarding
salary, benefits, and merit/equity adjustments. However, because the Contract
involves the use of personnel for the benefit of a private entity, the Contract sets
certain restrictions and minimum requirements regarding the manner in which
Pinkman must manage its employee workforce, including the following relevant
terms:
o Heisenberg determines a maximum employee salary, which is
commensurate with certain established rates Heisenberg offers its
employees. Although Pinkman has the ability to pay its employees more
than this established rate, any salary in excess of this established rate is not
reimbursable by Heisenberg. In practice, Pinkman does not employ any
personnel to which it pays more than the maximum rate established by
Heisenberg.
o Heisenberg determines the minimum level of annual paid vacation days
and annual paid holidays that must be provided to Pinkman’s employees.
o Heisenberg must approve all changes in the fringe benefits offered to
Pinkman’s employees, such as new types of insurance coverage, changes
in premium levels and eligibility for coverage, revisions to retirement
plans, and bonus programs.
• Pinkman cannot use its employees for any tasks other than the Lab Administration
and cannot transfer its employees to other of its corporate parent’s subsidiaries. In
addition, Pinkman does not employ any personnel other than those who perform
the Lab Administration under the Contract.
• The Contract specifies the overall number of employees that Pinkman must
employ each year during the Contract’s term. Pinkman must employ between
85 percent and 115 percent of this number to be contractually compliant.
• Heisenberg establishes specific job skill requirements that it requires Pinkman’s
employees to have, but Heisenberg does not review and approve the individual
employees hired by Pinkman.
• In the event that the Contract is terminated and Heisenberg appoints a new vendor
to administer the Lab, the employees of Pinkman must be transferred to
employment with the new vendor. The validity of this transfer provision is
demonstrated by the fact that Pinkman inherited its employees from Heisenberg’s
previous vendor when Pinkman initially secured the Contract to be the
administrator for the Lab.
Case 07c: Yeah, Science! Page 3
Copyright © 2019 Deloitte Development LLC
All Rights Reserved.
• The Contract contains a detailed statement of work (SOW) that lists and describes
all the activities that are required to be performed by Pinkman’s employees.
Heisenberg must approve all changes, additions, or deletions to the SOW.
o The SOW includes detailed descriptions of each of the specific Research
Programs that are to be undertaken at the Lab by Pinkman’s employees.
The Research Programs have been developed, planned, and approved by
Heisenberg.
o The SOW also describes the administrative tasks (e.g., janitorial,
maintenance) to be performed by Pinkman’s employees to maintain the
Lab infrastructure.
• All costs incurred by Pinkman must be in accordance with an established
“Budget.” The Budget contains detailed funding information for all of the
individual Research Programs and administrative tasks at the Lab.
• The Budget is formally updated and approved by Heisenberg annually, but it is a
fluid document that is continuously reviewed and updated by Heisenberg
throughout the year to respond to its shifting priorities. For example, if
Heisenberg believes that “Research Program X” has a need for a specific
employee skill set that is currently working on “Research Program Y,”
Heisenberg can adjust the Budget to move that employee skill set and the related
labor costs from “Research Program Y” to “Research Program X.”
• Heisenberg has the sole and unilateral ability to adjust the Budget as it deems
necessary.
• The work of Pinkman’s employees is overseen by Heisenberg Representatives
(HRs). The HRs are Heisenberg employees that work at the Lab, and they are
responsible for ensuring that the work of Pinkman’s employees (including the
Research Programs) is in accordance with the SOW and the Budget.
• Heisenberg holds title to all resources, systems, furniture, etc. used by Pinkman to
deliver the Lab Administration.
Required:
Using the guidance in ASC 606, Revenue From Contracts With Customers, determine
whether Pinkman is a principal or an agent in the Contract to provide Lab Administration
to Heisenberg, and therefore whether Pinkman should recognize revenue on a gross or net
basis.