Annual report pursuant to Section 13 and 15(d)

Summary of Significant Accounting Policies

Summary of Significant Accounting Policies
12 Months Ended
Dec. 31, 2022
Accounting Policies [Abstract]  
Summary of Significant Accounting Policies Summary of Significant Accounting Policies
Basis of presentation: The Company follows accounting standards established by the Financial Accounting Standards Board (FASB) to ensure consistent reporting of financial condition, results of operations, and cash flows. References to generally accepted accounting principles (GAAP) or U.S. GAAP in these footnotes are to the FASB Accounting Standards Codification (ASC or the Codification). At the end of the second quarter of 2020, the Company determined that it no longer qualified as a Foreign Private Issuer under the SEC rules. As a result, beginning January 1, 2021 the Company is required to report with the SEC on domestic forms and comply with domestic company rules in the United States.
Certain prior year amounts and notes to the consolidated financial statements have been reclassified to conform with the current year presentation. Other current assets and deferred revenue which were previously included in prepaid expenses and other current liabilities respectively, has been separately presented on the consolidated balance sheets as of December 31, 2022. Inventory reserves which was previously included in other, net on the consolidated statements of cash flows, has been separately presented for the years ended December 31, 2022 and December 31, 2021. Additionally, amortization of intangible assets which was presented separately on the statements of operations, has been included in SG&A and is included with depreciation on the consolidated statements of cash flows. Accounts payable and accrued liabilities and cash, cash equivalents and restricted cash and short-term investments balances have been reclassified in the notes to the consolidated financial statements. These reclassifications have no impact on previous reported total assets, total liabilities, net loss, stockholders’ equity or operating cash flows.
Principles of consolidation: These financial statements present the consolidated financial position of the Company and its wholly owned subsidiaries, Aurinia Pharma U.S., Inc. (Delaware incorporated) and Aurinia Pharma Limited (UK incorporated) as of December 31, 2022 and 2021, and the results of operations and cash flows for the three years ended December 31, 2022, 2021 and 2020. All intercompany accounts and transactions have been eliminated in consolidation.
Use of estimates: The preparation of the accompanying financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure
of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from those estimates.
Segment information: The Company operates in one operating segment engaged in the research, development and commercialization of therapeutic drugs in which revenues are derived from product, license, and contract revenues. Operating segments are defined as components of an enterprise where separate financial information is evaluated regularly by the chief operating decision maker (CODM), the chief executive officer, in deciding how to allocate resources and assessing performance. The Company's CODM allocates resources and assesses performance based upon discrete financial information at the consolidated level.

Functional currency: The functional currency for the Company and all of its foreign subsidiaries is determined to be the U.S. dollar, therefore there is no currency translation adjustment upon consolidation as the remeasurement of gains or losses are recorded in the consolidated statement of operations. All monetary assets and liabilities denominated in a foreign currency are remeasured into U.S. dollars at the exchange rate on the balance sheet date. Non-monetary assets and liabilities (along with their related expenses) are translated at the rate of exchange in effect on the date assets were acquired. Monetary income and expense items are translated at the average foreign currency period. Foreign exchange gains and losses arising on translation or settlement of a foreign currency denominated monetary item are included in the consolidated statements of operations.

COVID-19: U.S. GAAP requires management to make estimates and assumptions that affect amounts reported in the annual consolidated financial statements and accompanying notes. The annual consolidated financial statements reflect all adjustments of a normal, recurring nature that are, in the opinion of management, necessary for a fair presentation of results for these interim periods. The full extent to which the novel coronavirus (COVID-19) pandemic will directly or indirectly impact the Company’s financial statements related to our estimates and assumptions or results of operations will depend on future developments that are uncertain at this time. As events continue to evolve and additional information becomes available, the Company’s estimates may change materially in future periods.
Fair value measurements: The Company's financial instruments consist primarily of cash and cash equivalents, short-term investments, accounts receivable, accounts payable and accrued liabilities. The Company has determined the carrying values of these financial instruments approximate their fair value because of the relatively short period to maturity of the instruments.
Financial assets and liabilities are categorized based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels.
Concentration of credit risk: Financial instruments, which potentially subject the Company to significant concentrations of credit risk, consist primarily of cash, cash equivalents and restricted cash, short term investments and accounts receivable, net. The Company attempts to minimize the risks related to cash and cash equivalents and restricted cash and investments by investing in a range of financial instruments. The Company established guidelines related to credit ratings and maturities intended to safeguard principal balances, earn a return on investments and to maintain liquidity. The Company's investment portfolio is maintained in accordance with its investment policy, which defines allowable investments, specifies credit quality standards and limits the credit exposure of any single issuer. The Company does not enter into any investment transaction for trading or speculative purposes.
The Company’s investment policy limits investments to certain types of instruments such as certificates of deposit, money market instruments, obligations issued by the U.S. government and U.S. government agencies as well as high quality corporate debt securities, and places restrictions on maturities and concentration by type and issuer. The Company maintains cash balances in excess of amounts insured by the Federal Deposit Insurance Corporation and Canada Deposit Insurance Corporation and concentrated within a limited number of financial institutions. The accounts are monitored by management to mitigate the risk.
The Company is exposed to financial risk related to the fluctuation of foreign currency exchange rates which could have a material effect on its future operating results or cash flows. Foreign currency risk is the risk that variations in exchange rates between the U.S. dollar and foreign currencies, primarily with the Canadian dollar, Swiss Franc and Great British Pound will
affect the Company's operating and financial results. The Company holds the majority of its cash and cash equivalents in U.S. dollars and the majority of its expenses, including commercial and clinical trial costs are also denominated in U.S. dollars, which mitigates the risk of material foreign exchange fluctuations.
Major customers: The Company currently has two main customers for U.S. commercial sales of LUPKYNIS and a collaboration partner for sales of LUPKYNIS in the Otsuka Territories. Revenues from the Company's two main customers in the U.S. accounted for approximately 45% and 35%, respectively, of the Company's total revenues for the year ended December 31, 2022. The two main customers accounted for 100% of the Company’s accounts receivable, net balance as of December 31, 2022. Otsuka, the Company's collaboration partner for sales outside the U.S. accounted for approximately 20% of the Company's total revenue for the year ended December 31, 2022.
In late March 2022, the Company provided a nominal additional discount to both of its two main U.S. customers, applicable for the 2022 calendar year, in connection with holding additional amounts of LUPKYNIS on hand due to supply chain concerns. In December 2022, the Company extended the nominal discount to the end of 2023. Such discounts, or any future discounts, may result in reduced sales to these customers in subsequent periods and substantial fluctuations in our revenues from period to period. The Company monitors economic conditions, the creditworthiness of customers and government regulations and funding, both domestically and abroad. The Company regularly communicates with its customers regarding the status of receivable balances. Global economic conditions and customer specific factors may require the Company to periodically re-evaluate the collectability of its receivables and based on this evaluation the Company could potentially incur credit losses. The Company has had no historical write-offs related to our customers or receivables.
Accounts receivable, net: Accounts receivables are stated at their net realizable value. The Company's accounts receivable represents amounts due to the Company from product sales and from its Otsuka collaboration agreement (Note 10). Sales and services that have not been invoiced as of the balance sheet date are recorded as unbilled accounts receivable. As of December 31, 2022 and December 31, 2021, accounts receivable, net are $13.5 million and $15.4 million, respectively. The timing between the recognition of revenue for product sales and the receipt of payment is not significant. The Company's standard credit terms range from 30 to 45 days. The Company does not assess whether a contract has a significant financing component if the expectation at contract inception is such that the period between the transfer of the promised good to the customer and receipt of payment will be one year or less.
The Company's estimates the allowance for doubtful accounts using the current expected credit loss (CECL) model. Under the CECL model, the allowance for doubtful accounts reflects the net amount expected to be collected from the account receivables. The Company evaluates the collectability of these cash flows based on the asset’s amortized cost, the risk of loss even when that risk is remote, losses over an asset’s contractual life, and other relevant information available to us. Accounts receivable balances are written off against the allowance when it is probable that the receivable will not be collected. Given the nature of the Company's accounts receivable, it determined that an allowance for doubtful accounts was nil at December 31, 2022 and December 31, 2021.

Accounts receivables are recorded net of estimates of variable consideration for which reserves are established and which result from discounts that are offered within contracts between us and two specialty pharmacies and one specialty distributor in the United States. These reserves are recorded as a reduction of accounts receivable.
Cash and cash equivalents: The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. Cash and cash equivalents consist primarily of operating accounts, money market funds and bank money market accounts which are recorded at fair value. Cash and cash equivalents totaled $94.2 million as of December 31, 2022. The Company has invested its cash reserves in short term U.S. dollar denominated, fixed rate, highly liquid and highly rated financial instruments such as treasury notes, banker acceptances, bank bonds, and term deposits.
Restricted cash: Restricted cash consists of the 2021 Employee Share Purchase Plan (ESPP) deposits of $0.1 million and $0.3 million as of December 31, 2022 and December 31, 2021, respectively.
Investments: The Company classifies its debt securities as either held to maturity or available-for-sale in accordance with the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 320, Investments — Debt Securities. Investments classified as held to maturity are carried at amortized cost when management has the positive intent and ability to hold them to maturity. Investments classified as available-for-sale are carried at fair value with unrealized losses
reported in other comprehensive loss within shareholders’ equity. Realized losses on available-for-sale securities are recorded in other income (expense), net. Interest income (expense) is recorded separately on the consolidated statements of operations. The cost of securities sold is based on the specific-identification method.
Intangible assets: Intangible assets are amortized over their useful lives using methods that correlate to the pattern in which the economic benefits are expected to be realized. All intangible assets are amortized on a straight-line basis. The Company evaluates the estimated remaining useful life of its intangible assets and whether events or changes in circumstances warrant a revision to the remaining period of amortization. The carrying amounts of these assets are periodically reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable. Refer to the long-lived assets section below for impairment considerations.
Acquired intellectual property and patents
External patent costs specifically associated with preparing, filing, obtaining and protecting patents are capitalized and amortized straight-line over the shorter of the estimated useful life and the patent life, commencing in the year of the grant of the patent. Other intellectual property expenditures are recorded as R&D expenses on the consolidated statements of operations as incurred. Patents do not contain the option to extend or renew. External legal costs incurred to defend a patent are capitalized when it is believed that the future economic benefit of the patent will be increased and a successful defense is probable.
Separately acquired intellectual property is shown at historical cost. The initial recognition of a reacquired right is recognized as an intangible asset measured on the basis of the remaining contractual term of the related contract. If the terms of the contract giving rise to a reacquired right are favorable relative to the terms of current market transactions for the same or similar items, the difference is recognized as a gain or loss in the consolidated statements of operations and comprehensive loss. Purchased intellectual property and reacquired rights are capitalized and amortized on a straight-line basis in the consolidated statements of operations and comprehensive loss over periods ranging from 10 to 20 years.
Property, plant and equipment: Property, plant and equipment are recorded at cost and are depreciated using the straight-line method. Expenditures for additions are capitalized and leasehold improvements are amortized over the lesser of the expected lease term or the estimated useful life of the improvement. Expenditures for maintenance and repairs are charged to expense as incurred; however, maintenance and repairs that improve or extend the life of existing assets are capitalized. The carrying amount of assets disposed of and the related accumulated depreciation are eliminated from the accounts in the year of disposal. Gains or losses from property and equipment disposals are recognized in the year of disposal.
Recoverability and impairment of long-lived assets: ASC Topic 360 requires long-lived assets, including definite-lived intangible assets, to be evaluated for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The judgments made related to the expected useful lives of long-lived assets, definitions of lease terms and the Company’s ability to realize undiscounted cash flows in excess of the carrying amounts of these assets are affected by factors such as the ongoing maintenance and improvements of the assets, changes in economic conditions, changes in usage or operating performance and other factors. If indicators are present, assets are grouped to the lowest level for which identifiable cash flows are largely independent of other asset groups and cash flows are estimated for each asset group over the remaining estimated life of each asset group. If the undiscounted cash flows estimated to be generated by the asset group are less than the asset’s carrying amount, impairment is recognized in the amount of excess of the carrying value over the fair value. The Company recorded no asset impairment charges during the years ended December 31, 2022, 2021 and 2020.
Leases: The Company assesses all contracts at inception to determine whether a lease exists. The Company’s leases are all classified either as operating or finance leases per ASC 842. The Company leases office space under operating leases that typically provide for the payment of minimum annual rentals and may include scheduled rent increases. The Company also entered into a manufacturing agreement that contained an embedded lease of a dedicated manufacturing facility that will be accounted for as a finance lease once lease commencement begins (see Note 15).
The Company made an accounting policy election, the practical expedient that allows lessees to treat the lease and non-lease components of leases as a single lease component. Leases with an initial term of 12 months or less are not recorded on the Company's consolidated balance sheets and to recognize those lease payments on a straight-line basis in its consolidated statements of operations. Fixed costs associated with these arrangements are disclosed in Note 15 of the financial statements.
Operating lease ROU assets and lease liabilities are recognized at commencement date based on the present value of lease payments over the lease term. The Company used the incremental borrowing rate for all of its leases, as the implicit interest rate was not readily determinable. In determining the Company’s incremental borrowing rate of each lease, the Company considered recent rates on secured borrowings, observable risk-free interest rates and credit spreads correlating to the Company's creditworthiness, the impact of collateralization and the term of each of the Company's lease agreements. The lease terms range from 12 to 128 months.
Deferred Compensation Arrangements: The Company has recorded deferred compensation arrangements in liabilities for estimated future employee benefits relating to applicable historical employment arrangements. The deferred compensation arrangements are part of the resolution of the board of directors of the company dated March 8, 2012. Pursuant to ASC Topic 710, the Company recognizes future benefits provided by employee retention arrangements, as deferred compensation, which is recognized when the Company determines that it is probable to make future payments. The deferred compensation is based on an income approach for the estimated future net revenues of voclosporin using an internal risk-adjusted net present value of the future payments to be made to the individuals.
The Company is required to use judgment to determine the most appropriate model to use to measure the deferred compensation liability and is required to use significant judgment and estimates in determining the inputs into the model. The royalty rates applied to the net revenue are dependent on the type of net revenue earned, which includes product sales and royalty revenue. There are multiple unobservable and inherently uncertain inputs. The determination of this deferred compensation is subject to significant judgments and estimates in determining the assumptions related to future net revenues and the determination of the discount rate for the net present value calculation. The net revenue estimate for the United States includes assumptions related to the number of patients being treated (including patients who initially start taking the product but subsequently discontinue), dosing adjustments, duration of treatment, timing of generics and competitors entering the market, market penetration and potential future use in new indications. Additional variables for ex-U.S. geographies include timing of approval in ex-U.S. territories, escalating royalty rates, net pricing, government payor coverage of the product, and market penetration. In determining the estimate for ex-U.S. revenues, the Company relies on forecasts provided by its collaboration partner.
Management developed the model and inputs in conjunction with their internal scientific team and utilized third party scientific studies, information provided by third party consultants engaged by the Company, information from medical and pharmacy claims databases and research papers as sources to develop their inputs; application and usage of these inputs is also informed by product sales and distribution data, ongoing market research fielded by the company and third parties, and our continually evolving understanding of the market as the U.S. launch progresses. Management believes the liability is based on reasonable assumptions; however, these assumptions may be incomplete or inaccurate and unanticipated events and circumstances may occur. There are numerous significant inputs into the model all of which individually or in combination may result in a material change to the obligation.
Initially, these obligations are measured at the present value of expected future payments to be made in respect of services provided by employees up to the end of the reporting periods. Subsequent re-measurements as a result of performance obligations met by the Company or changes in assumptions are recognized in the consolidated statement of operations.
Contingencies: In the normal course of business, the Company may be subject to loss contingencies, such as legal proceedings, amounts arising from contractual arrangements and claims arising out of the Company’s business that cover a wide range of matters, including, among others, government investigations, shareholder lawsuits, product and environmental liability, and tax
matters. In accordance with ASC Topic 450, Accounting for Contingencies, (ASC 450), the Company records accruals for such loss contingencies when it is probable that a liability will be incurred, and the amount of loss can be reasonably estimated. The Company, in accordance with this guidance, does not recognize gain contingencies until realized or realizable.
Common Shares: The Company’s shares have no par value and therefore, upon issuance of shares, all amounts related to the shares are credited to common shares on the balance sheet. The value of common shares includes cash amounts received or paid for the shares and the fair value of equity awards and warrants. Amounts for common shares are offset by share issue costs associated with equity offerings.
Inventories: Inventories are valued under a standard costing methodology on a first-in, first-out basis and are stated at the lower of cost or net realizable value. The Company capitalizes inventory costs related to products to be sold in the ordinary course of business. The Company makes a determination of capitalizing inventory costs for a product based on, among other factors, status of regulatory approval, information regarding safety, efficacy and expectations relating to commercial sales and recoverability of costs. Capitalized costs of inventories mainly include third party manufacturing costs, transportation, storage, insurance and allocated internal labor. The Company assesses recoverability of inventory each reporting period to determine any write down to net realizable value resulting from excess or obsolete inventories.
Revenue Recognition: Pursuant to Accounting Standards Codification Topic 606, Revenue from Contracts with Customers (ASC 606), the Company recognizes revenue when a customer obtains control of promised goods or services. The Company records the amount of revenue that reflects the consideration that it expects to receive in exchange for those goods or services. Revenue is recognized through a five-step process: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) a performance obligation is satisfied. The Company only applies the five-step model to contracts when it is probable that the Company will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer. At contract inception, the Company assesses the goods or services promised within each contract and determines those that are performance obligations. Revenue is recognized for the applicable performance element when each distinct performance obligation is satisfied.
Product Revenues
In the United States (and territories), the Company sells LUPKYNIS primarily to a limited number of specialty pharmacies and specialty distributors. These customers subsequently resell the Company's products to health care providers and patients. Revenues from product sales are recognized when the customer obtains control of the Company's product, which typically occurs upon delivery to the customer.
Reserves for discounts and allowances: Product sales are recorded at the net sales price (transaction price), which includes estimates of variable consideration for which reserves are established. These reserves are based on estimates of the amounts earned or to be claimed on the related sales and are classified as reductions of accounts receivable (if the amount is payable to our customer) or a liability (if the amount is payable to a party other than our customer).
The Company's estimates of reserves established for variable consideration are calculated based upon utilizing the expected value method. The transaction price, which includes variable consideration reflecting the impact of discounts and allowances, may be subject to constraint and is included in the net sales price only to the extent that it is probable that a significant reversal of the amount of the cumulative revenues recognized will not occur in a future period. Amounts related to such items are estimated at contract inception and updated at the end of each reporting period as addition information becomes available.
Significant judgment is required in estimating variable consideration. In making these estimates, the Company considers historical data, including patient mix and inventory sold to our customers that has not yet been dispensed. The Company uses a data aggregator and historical claims to estimate variable consideration for inventory sold to our customers, including specialty pharmacies and specialty distributors, that has not yet been dispensed. Actual amounts may ultimately differ from the Company's estimates. If actual results vary, the Company adjusts these estimates, which could have an effect on earnings in the period of adjustment. As of December 31, 2022, the Company did not have any material adjustments to variable consideration estimates based on actual results.
More specifically, these adjustments include the following:
Prompt Pay Discounts: The Company generally provides invoice discounts on product sales to its customers for prompt payment. The Company estimates that its customers will earn these discounts and fees, and deducts the full amount of these discounts and fees from its gross product revenues and accounts receivable at the time such revenues are recognized.
Customer Fees: The Company pays certain customer fees, such as fees for certain data that customers provide to the Company. The Company records fees paid to its customers as a reduction of revenue, unless the payment is for a distinct good or service from the customer and the Company can reasonably estimate the fair value of the goods or services received. If both conditions are met, the Company records the consideration paid to the customer as SG&A expense.
Government Rebates: The Company estimates its government rebates, primarily Medicaid and Medicare rebates based upon a range of possible outcomes that are probability-weighted for the estimated payor mix. These reserves are recorded in the same period the related revenue is recognized, resulting in a reduction of product revenue and the establishment of a current liability that is included in accrued expenses on the consolidated balance sheet.
Medicaid rebates relate to the Company's estimated obligations to states under established reimbursement arrangements. Rebate accruals are recorded in the same period that the related revenue is recognized, resulting in a reduction of product revenue and the establishment of a liability, which is included in other current liabilities. The Company's liability for Medicaid rebates consists of estimates for claims that a state will make for the current quarter, claims for prior quarters that have been estimated for which an invoice has not been received, invoices received for claims from the prior quarters that have not been paid and an estimate of potential claims that will be made for inventory that exists in the distribution channel at period end.
For Medicare, the Company also estimates the number of patients in the prescription drug coverage gap for whom the Company will owe an additional liability under the Medicare Part D program. The Company’s liability for these rebates consists of invoices received for claims from prior quarters that have not been paid or for which an invoice has not yet been received, estimates of claims for the current quarter, and estimated future claims that will be made for product that has been recognized as revenue, but remains in the distribution channel inventories at the end of each reporting period.
Co-payment Assistance: Co-payment assistance represents financial assistance to qualified patients, assisting them with prescription drug co-payments required by insurance. The program is administered by the specialty pharmacies. The calculation of the accrual for co-payment assistance is based on the co-payments administered on the Company's behalf by the specialty pharmacies.

Payor Rebates and Administration Fees: Payor rebates and administration fees represent our estimated obligations to third parties, primarily benefit managers. Accruals are recorded in the same period the related revenue is recognized, resulting in a reduction of product revenue and the establishment of a liability. These rebates and fees result from formulary position and price increase limit allowances (price protection) and administration fees. The calculation of the accrual for these items are based on the estimated payors buying patterns and the resulting applicable contractual rebate rate(s) to be earned over a contractual period.
Manufacturing Supply Services: The Company also has agreements with its partners that include a promise for future supply of drug substance or drug product for either clinical development or commercial supply at the licensee’s discretion are generally considered as options. The Company assesses if these options provide a material right to the licensee and if so, they are accounted for as separate performance obligations. If the Company is entitled to additional payments when the licensee exercises these options, any additional payments are recorded as product sales when the licensee obtains control of the goods, which is typically upon delivery. Certain agreements include terms where the Company can partially bill for drug substance used before the manufacturing cycle is complete, resulting in a deferred revenue which is to be recognized once delivery occurs.
License and Collaboration Revenue
The Company enters into out-licensing agreements that are within the scope of ASC 606, under which it licenses certain rights to its product candidates to third parties. The terms of these arrangements typically include payment to the Company of one or more of the following: non-refundable, up-front license fees; development, regulatory and commercial milestone payments, payments for manufacturing supply services the Company provides through its contract manufacturers, and royalties on net sales of licensed products. Each of these payments results in license, collaboration and other revenues, except for revenues from royalties on net sales of licensed products, which are classified as royalty revenues.
In determining the appropriate amount of revenue to be recognized as it fulfills its obligations under each of its agreements, the Company performs the following steps: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when (or as) the Company satisfies each performance obligation. As part of the accounting for these arrangements, the Company must develop assumptions that require judgment to determine the stand-alone selling price for each performance obligation identified in the contract. The Company uses key assumptions to determine the stand-alone selling price, which may include forecasted revenues, development timelines, reimbursement rates for personnel costs, discount rates and probabilities of technical and regulatory success.
Licenses of Intellectual Property: If the license to the Company’s intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, the Company recognizes revenues from non-refundable, up-front fees allocated to the license when the license is transferred to the licensee and the licensee is able to use and benefit from the license. For licenses that are bundled with other promises, the Company utilizes judgment to assess the nature of the combined performance obligation to determine whether the combined performance obligation is satisfied over time or at a point in time and, if over time, the appropriate method of measuring progress for purposes of recognizing revenue from non-refundable, up-front fees. The Company evaluates the measure of progress each reporting period and, if necessary, adjusts the measure of performance and related revenue recognition.
Milestone Payments: At the inception of each arrangement that includes development or commercial sales milestone payments, the Company evaluates whether the milestones are considered probable of being reached and estimates the amount to be included in the transaction price using the most likely amount method. If it is probable that a significant revenue reversal would not occur, the associated milestone value is included in the transaction price. The transaction price is then allocated to each performance obligation on a relative stand-alone selling price basis, for which the Company recognizes revenue as or when the performance obligations under the contract are satisfied. At the end of each subsequent reporting period, the Company re-evaluates the probability of achievement of such development milestones and any related constraint, and if necessary, adjusts its estimate of the overall transaction price. Any such adjustments are recorded on a cumulative catch-up basis, which would affect license, collaboration and other revenues and earnings in the period of adjustment.
Other Services Revenue: The Company’s agreements may include R&D, manufacturing or other services to be performed by the Company on behalf of the counterparty. If these services are determined to be distinct from the other promises or performance obligations identified in the arrangement, the Company recognizes the transaction price allocated to these services as revenue either over time based on an appropriate measure of progress when the performance by the Company does not create an asset with an alternative use and the Company has an enforceable right to payment for the performance completed to date or at a point in time as the related performance obligations are satisfied.
Royalty Revenue
For arrangements that include sales-based royalties, revenue is recognized when the underlying product sales have occurred. Revenue is recorded based on estimated quarterly net sales reports provided by our partner. Differences between actual results and estimated amounts are adjusted in the period in which they become known, which typically follows the quarterly period in which the estimate is made. Sales based milestone payments are recognized in the period once the milestone objectives have been achieved.
Costs to obtain a contract
As the majority of our contracts are short-term in nature, sales commissions are generally expensed when incurred as the amortization period would have been less than one year. The costs are recorded within SG&A.
Cost of sales: Cost of sales consist primarily of cost of inventories for LUPKYNIS and semi-finished product, which mainly includes third party manufacturing costs, transportation, storage, insurance and allocated internal labor. Cost of sales also includes costs related to collaboration revenues.
Research and development costs: R&D costs are accounted for in accordance with ASC Topic 730, Research and Development, (ASC 730) and are expensed as incurred. R&D costs consist primarily of the cost of salaries, share-based
compensation expenses, payroll taxes and other employee benefits, subcontractors and materials used for R&D activities, including nonclinical studies, clinical trials, manufacturing costs and professional services. The costs of services performed by others in connection with the R&D activities of the Company, including R&D conducted by others on behalf of the Company, shall be included in R&D costs and expensed as the contracted work is performed.
We accrue the costs incurred under our agreements with these third parties based on actual work completed in accordance with agreements established with these third parties. We determine the accruals for R&D costs through monitoring invoices received and discussions with internal personnel and external service providers as to the progress or stage of completion of the clinical studies and the agreed-upon fee to be paid for such services. Where contingent milestone payments are due to third parties under R&D arrangements or license agreements, the milestone payment obligations are expensed when the milestone results are probable to be achieved.
R&D expenses for the years ended December 31, 2022, 2021 and 2020, were $45.0 million, $51.1 million and $50.3 million, respectively, and are included in total cost of sales and operating expenses on the accompanying consolidated statements of operations.
Selling, general and administrative expenses: The Company's SG&A expenses include commercial and allocated administrative personnel, corporate facility and external costs required to support the marketing and sales of LUPKYNIS. These
SG&A costs include corporate facility operating expenses and allocated depreciation; commercial, marketing, advertising, pharmacovigilance, publications, tradeshows, advisory boards, samples and operations in support of LUPKYNIS; patient assistance program costs; human resources; finance, legal, information technology and support personnel expenses; and other corporate costs such as telecommunications, insurance, audit and government affairs. We expense SG&A expenses as they are incurred.

The Company uses a third-party logistics provider to perform a full order to cash service, which includes warehousing and shipping directly to two specialty pharmacies and receiving orders from a specialty distributor for shipping to hospitals, on our behalf. As such, since these costs are not integral to bringing the inventories to a salable condition, we elected not to treat shipping and handling costs as a fulfillment activity. Shipping and handling costs related to order fulfillment are recorded in SG&A expenses.

Advertising and marketing costs are expensed as incurred and included in SG&A. For the years ended December 31, 2022, 2021 and 2020, advertising and marketing costs totaled $16.3 million, $15.4 million and $10.0 million, respectively.

SG&A expenses for the years ended December 31, 2022, 2021 and 2020 were $196.4 million, $173.5 million and $97.3 million, respectively, and are included in total cost of sales and operating expenses on the accompanying consolidated statements of operations.
Shared-based compensation: The Company follows ASC Topic 718, Compensation - Stock Compensation (ASC 718), which requires the measurement and recognition of compensation expense, based on estimated fair values, for all share-based awards made to employees and directors. The Company records compensation expense based on the fair value on the grant date using the graded accelerated vesting method for all share-based payments related to stock options, performance awards (PAs), restricted stock units (RSUs) and purchases under the Company's 2021 ESPP. The estimated fair value of performance-based awards is measured on the grant date and is recognized when it is determined that it is probable that the performance condition will be achieved. The Company has elected a policy for all share-based awards to estimate forfeitures based on historical forfeiture experience at the time of grant and revise in subsequent periods if actual forfeitures differ from those estimates.
Income taxes: The Company accounts for income taxes under the asset and liability method in accordance with ASC Topic 740, Income Taxes (ASC 740). Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income in the period that such tax rate changes are enacted. The portion of any deferred tax asset for which it is more likely than not that a tax benefit will not be realized must then be offset by recording a valuation allowance. Financial statement recognition of a tax position taken or expected to be taken in a tax return is determined based on a more-likely-than-not threshold of that position being sustained. If the tax position meets this threshold, the benefit to be recognized is measured
as the largest amount that is more likely than not to be realized upon ultimate settlement. The Company’s policy is to record interest and penalties on uncertain tax positions as a component of income tax expense.
Recently adopted accounting pronouncements
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The standard requires that credit losses be reported using an expected losses model rather than the incurred losses model that is currently used, and establishes additional disclosures related to credit risks. For available-for-sale debt securities with unrealized losses, these standards now require allowances to be recorded instead of reducing the amortized cost of the investment. These standards limit the amount of credit losses to be recognized for available-for-sale debt securities to the amount by which carrying value exceeds fair value and requires the reversal of previously recognized credit losses if fair value increases. The adoption of the standard as of January 1, 2020 did not have a material impact on the Company’s consolidated financial statements.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirement for Fair Value Measurement. Topic 820 requires to disclose transfers into and out of Level 3 of the fair value hierarchy and purchases and issues of Level 3 assets and liabilities. For investments in certain entities that calculate net asset value, an entity is required to disclose the timing of liquidation of an investee’s assets and the date when the restrictions from redemptions might lapse only if the investee has communicated the timing to the entity or announced the timing publicly. The new standard also amends that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date. The new standard is effective for fiscal years beginning after December 15, 2019. The standard should be applied retrospectively to the date of initial application of ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The Company elected to adopt the amendment as of January 1, 2020, which did not have a material impact on the consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40)-Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which aligns the accounting for implementation costs incurred in a hosting arrangement that is a service contract with the accounting for implementation costs incurred to develop or obtain internal-use software under ASC 350-40, in order to determine which costs to capitalize and recognize as an asset and which costs to expense. ASU 2018-15 is effective for annual reporting periods, and interim periods within those years, beginning after December 15, 2019, and can be applied either prospectively to implementation costs incurred after the date of adoption or retrospectively to all arrangements. The Company adopted ASU 2018-15 effective January 1, 2020 and applied the standard prospectively to implementation costs incurred in its cloud computing arrangements.
In November 2018, the FASB issued ASU No. 2018-18, Collaborative Arrangement (Topic 808): Clarifying the Integration between Topic 808 and Topic 606. The new standard clarifies that certain transactions between collaborative arrangement participants should be accounted for as revenue under Topic 606 when the collaborative arrangement participant is a customer in the context of a unit of account. Further, the new standard adds unit-of-account guidance to Topic 808 to align with the guidance in Topic 606 when an entity is assessing whether the collaborative arrangement or part of the arrangement is within the scope of Topic 606. The new standard requires that in transactions with a collaborative arrangement participant that is not directly related to sales to third parties, presenting under Topic 606 is precluded if the collaborative arrangement participant is not a customer. The new standard is effective for fiscal years beginning after December 15, 2019. The standard should be applied retrospectively to the date of initial application of ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). The Company elected to adopt the amendment as of January 1, 2020, which did not have a material impact on the consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which clarifies and simplifies certain aspects of the accounting for income taxes. The standard is effective for years beginning after December 15, 2020, and interim periods within annual periods beginning after December 15, 2020. The Company adopted the ASU effective January 1, 2021 with no material impact on the consolidated financial statements.
In November 2021, the FASB issued ASU No. 2021-10, Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance, which requires business entities to make annual disclosures about transactions with a government (including government assistance) by analogizing to a grant or contribution accounting model. The required
disclosures include the nature of the transaction, the entity's related accounting policy, the financial statement line items affected and the amounts reflected in the current period financial statements, as well as any significant terms and conditions. The guidance is effective for financial statements issued for annual periods beginning after December 15, 2021. The Company adopted the ASU effective January 1, 2022, with no material impact on the consolidated financial statements.