C.11 Licensing (Chapter 12 of the Roadmap)
C.11.1 Licenses of IP — TRG Agenda Papers 8 and 11
Because of the impact of a licensor’s ongoing activities on the determination of whether a license of IP is a right-to-use or right-to-access license, the TRG discussed how entities should evaluate such ongoing activities. Issues noted by stakeholders include whether:
- An entity is required to identify the nature of a license when the license is not distinct (i.e., determine whether the license is satisfied over time or at a point in time when it is not a separate performance obligation).
- A license may be classified as a right to access:
- Only if the licensor’s contractual or expected activities change the form or functionality of the underlying IP.
- If there are significant changes in the value of the IP (because such changes alone would constitute a change to the IP).
- In the case of a license that does not require the customer to use the most recent version of the underlying IP, the licensor’s activities directly expose the customer to positive or negative effects of the IP.
- Activities transferring a good or service that is not separable from a license of IP should be considered to determine the nature of the license.
- Restrictions in a contract for a license of IP affect the determination of the number of performance obligations in the contract (i.e., the number of distinct licenses).
TRG members did not reach general agreement on these topics and believed that clarifications to the guidance would be helpful.
In April 2016, as noted in Section C.4.1, the FASB issued ASU 2016-10, which amends certain
aspects of the revenue standard, including the implementation guidance on
licensing. The ASU revises the guidance in ASC 606 to distinguish between two
types of licenses: (1) functional IP and (2) symbolic IP, which are classified
according to whether the underlying IP has significant stand-alone functionality
(e.g., the ability to process a transaction, perform a function or task, or be
played or aired). For additional information, see Chapter 12.
C.11.2 Licenses (Restrictions and Renewals) — TRG Agenda Papers 45 and 49
The TRG discussed the following issues related to point-in-time licenses:
- Renewals of time-based right-to-use (point-in-time) licenses — Whether a term extension represents a change in an attribute of a license that has already been transferred to a customer.
- Distinct rights in a current contract versus those added through a contract modification —Whether the removal of restrictions on the use of the underlying IP in a multiyear license (e.g., geographic and product-class restrictions) conveys additional rights to the customer and thus represents distinct licenses. In addition, there are questions regarding how an entity would account for such releases affected through a contract modification (i.e., whether an entity would follow the revenue standard’s modification guidance).
- Accounting for a customer’s option to purchase or use additional copies of software — Whether options to acquire additional software rights should be accounted for (1) in accordance with the royalty constraint guidance because they are related to licenses of IP or (2) in a manner similar to the accounting for options to purchase additional goods because control is transferred at a point in time.
TRG members generally agreed that:
- The evaluation of whether an entity has provided a single license of IP or multiple licenses to a customer (either in a single contract or through contract modifications) would depend on whether it has granted the customer additional rights (i.e., new or expanded rights).
- The modification of a license arrangement should be treated no differently from the modification of a contract for goods or services. Therefore, an entity should apply the contract modification guidance in the revenue standard.
However, the TRG did not reach general agreement about:
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Why a time-based restriction would be treated differently from a geographic or product-based restriction. That is, many TRG members viewed the extension of time (i.e., through the contract renewal) as granting a customer an additional right rather than the continued use of the same rights under a license that the entity already delivered to the customer and from which the customer is currently benefiting.
- Whether additional copies of software would be accounted for as a customer option or as a usage-based royalty.
ASU 2016-10 includes additional illustrative examples to clarify that
restrictions of time, geographic region, or use affect the scope of the
customer’s right to use or right to access the entity’s IP (i.e., they are
attributes of a license) and do not define the nature of the license (i.e.,
functional vs. symbolic). However, restrictions should be distinguished from
contractual provisions that, explicitly or implicitly, require the entity to
transfer additional goods or services (including additional licenses) to the
customer.
In addition, ASU 2016-10 clarifies that revenue should not be recognized for renewals or extensions of licenses to use IP until the renewal period begins.
For additional information on restrictions and renewals, see Chapter 12.
C.11.3 Options to Purchase or Use Additional Copies of Software — Implementation Q&A 58 (Compiled From TRG Agenda Papers 45 and 49)
Stakeholders have questioned whether options to acquire additional software users
or usage of the software should be (1) subject to the sales- or usage-based
royalty constraint because the variability is related to licenses of IP already
transferred to the customer or (2) treated in a manner similar to the accounting
for options to purchase additional goods that will be transferred at a point in
time (if and when the options are exercised). If the guidance on sales- or
usage-based royalties is applied, revenue would be recognized when the
additional usage occurs. If the additional consideration is due as a result of
an option to purchase additional goods, the entity should perform an assessment
to determine whether a material right exists at contract inception. Depending on
the entity’s determination, a portion of the transaction price may need to be
allocated to a material right.
The application of one of the above methods is not a choice; rather, it is a
determination that requires judgment based on a consideration of the relevant
facts and circumstances. Entities should assess whether the additional
consideration is due (1) as a result of additional usage of rights already
transferred to the customer or (2) only once a customer exercises an option to
acquire additional rights not already transferred.
The requirement to provide additional copies of software is not determinative.
Entities will need to assess whether (1) the availability of additional copies
of the software is provided as a convenience to the customer and therefore
represents variable consideration for rights already delivered or (2) the facts
and circumstances indicate that the additional use of the software (e.g., added
users) represents additional rights that the customer can obtain, which should
be accounted for as an option.
C.11.4 Sales- and Usage-Based Royalties — TRG Agenda Papers 3 and 5
The TRG discussed issues regarding how the royalty constraint
would apply when a license of IP is offered with other goods or services in a
contract (e.g., software licenses with postcontract customer support, franchise
licenses with training services, biotechnology and pharmaceutical licenses sold
with R&D services or a promise to manufacture a drug for the customer).
Views differ on whether the royalty constraint should apply to circumstances in
which a royalty is related to (1) both a distinct license and nonlicense goods
or services that are distinct from the license and (2) a license combined with
other nonlicense goods or services in the contract (i.e., the license is not
distinct).
TRG members did not reach general agreement and noted their
belief that stakeholders would benefit from additional clarifications to the
revenue standard.
ASU 2016-10 clarifies that the sales- or usage-based royalty exception applies
whenever the royalty is predominantly related to a license of IP, regardless of
whether the license is distinct. The ASU therefore indicates that an “entity
should not split a sales-based or usage-based royalty into a portion subject to
the recognition guidance on sales-based and usage-based royalties and a portion
that is not subject to that guidance.”
C.11.4.1 Sales- or Usage-Based Royalties With a Minimum Guarantee for a License of Functional IP — Implementation Q&A 60 (Compiled From TRG Agenda Papers 58 and 60)
For licenses of functional IP, a minimum guarantee should be recognized as
revenue at the point in time when the entity transfers control of the
license to the customer. Any royalties that exceed the minimum guarantee
should be recognized as the subsequent sales or usage occurs in accordance
with ASC 606-10-55-65.
C.11.4.2 Sales- or Usage-Based Royalties With a Minimum Guarantee for a License of Symbolic IP — Implementation Q&A 59 (Compiled From TRG Agenda Papers 58 and 60)
For licenses of symbolic IP, the FASB staff articulated three views:
- View A — Recognize revenue as the subsequent sales or usage occurs in accordance with ASC 606-10-55-65 if the entity expects that the total royalties will exceed the minimum guarantee.
- View B — Estimate the transaction price (as fixed consideration plus expected royalties to be earned over the license term) and recognize revenue over time by using an appropriate measure of progress, subject to the royalty constraint.
- View C — Recognize the minimum guarantee over time by using an appropriate measure of progress. Once the minimum guarantee has been met, recognize the incremental royalties as the subsequent sales or usage occurs.
The revenue standard does not require application of a
single approach in all situations in which a sales- or usage-based royalty
contract with a customer includes a minimum guaranteed amount of
consideration and the entity expects that the royalties will exceed the
guaranteed minimum. An entity should evaluate its facts and circumstances to
determine which method under the standard best depicts its progress toward
completion.
The three views could be reasonable interpretations of the
revenue standard, subject to the following “guard rails”:
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In the application of View A or View B, the estimated sales- or usage-based royalties must exceed the minimum guarantee.
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If View B is applied, the entity will need to periodically revisit its estimate of the total consideration (fixed and variable) and update its measure of progress accordingly, which may result in a cumulative adjustment to revenue.