12.1 Overview

Under the revenue standard, the framework used to account for licensing of intellectual property (IP) is essentially the same as the framework used to account for a sale of goods or services. That is, the five-step model is generally applied to licensing transactions as well. However, licensing of IP can take many forms, and the economics and substance of such transactions can often be difficult to identify. Determining how to account for licensing transactions will often depend on the specific facts and circumstances and will require professional judgment. To help preparers exercise such judgment, the revenue standard provides supplemental guidance on recognizing revenue from contracts related to the licensing of IP to customers. The scope of the guidance includes all licenses that provide a customer with rights to IP, except for certain software hosting arrangements that are accounted for as a service (see Section 12.2.1).

In the evaluation of how to account for a licensing transaction under the revenue standard, it is important for an entity to consider each of the five steps in the model (although, as discussed below, certain exceptions are provided for licensing transactions). Specifically, an entity will need to do each of the following:

Step 1: Identify the contract with the customer — This step includes identifying the counterparty that is the customer, evaluating the enforceable rights and obligations (including implicit rights) of each party to the contract, and determining whether amounts under the contract are collectible.1
Step 2: Identify the performance obligations under the contract — This includes determining whether the entity’s obligation to transfer a license to a customer results in (1) a single promise that will be satisfied (i.e., a single performance obligation) or (2) multiple performance obligations. This step could also involve determining whether the license of IP is the predominant element in the arrangement.
Step 3: Determine the transaction price — This includes identifying and, potentially, measuring and constraining variable consideration.
Step 4: Allocate the transaction price— This includes considering whether the residual approach could be used for determining the stand-alone selling price of one (or a bundle) of the performance obligations.2
Step 5: Determining when control of the license is transferred to the customer — This includes determining whether the license is transferred at a point in time (for a right to use IP) or over time (for a right to access IP).

Some of the key judgments an entity will need to make are likely to be in connection with step 2 (identify the performance obligations), step 4 (allocate the transaction price), and step 5 (recognize revenue) of the model. As part of step 2, an entity will need to evaluate license restrictions (and changes in any such restrictions) when determining whether the restrictions merely define the licenses (which may be the case when the restrictions are related to time or geography) or, in effect, give rise to multiple performance obligations (which may be the case when the restrictions change over the license period and require the entity to transfer additional rights to the customer).

As part of step 5, when an entity is determining whether it has granted a customer a right to use or a right to access its IP, it will need to assess the nature of the promised license to determine whether the license has significant stand-alone functionality. For licenses with significant stand-alone functionality, ongoing activities3 of the entity providing the license do not significantly affect the license’s functionality (i.e., its utility). However, certain licenses do not have significant stand-alone functionality and require ongoing activities from the entity to support or maintain the license’s utility to the customer. The nature of an entity’s license of IP will determine the pattern of transfer of control to the customer, which is either at a point in time (if the customer is granted a right to use the IP) or over time (if the customer is granted a right to access the IP).

For licensing transactions in which consideration is tied to the subsequent sale or usage of IP, the revenue standard provides an exception to the recognition principle that is part of step 5 (i.e., recognize revenue when or as control of the goods or services is transferred to the customer). Under this sales- or usage-based royalty exception, an entity would generally not be required to estimate the variable consideration from sales- or usage-based royalties. Instead, the entity would wait until the subsequent sale or usage occurs to determine the amount of revenue to recognize.

As a result of implementation concerns raised by various stakeholders after the issuance of ASU 2014-09, the TRG discussed several licensing issues. After debating these issues, the TRG requested that the FASB issue clarifying guidance to help stakeholders apply the revenue standard to licensing arrangements. In April 2016, the FASB issued ASU 2016-10, which was intended to improve the operability and understandability of the standard’s licensing guidance on (1) determining the nature of the arrangement, (2) applying the sales- or usage-based royalty constraint, and (3) clarifying how contractual provisions affect licenses of IP.

Footnotes

Refer to Section 4.4.1 for (1) guidance on determining the contract term for certain licensing arrangements and (2) a discussion of challenges associated with applying the revenue standard to licensing arrangements that involve termination rights.

Refer to Section 7.3.3.7 for more information about estimating stand-alone selling prices for term licenses and postcontract customer support and Section 7.3.3.2 for more information about the residual approach to estimating stand-alone selling prices and allocating the transaction price when a value relationship exists.

These do not include activities that transfer one or more goods or services to the customer (e.g., maintenance activities), which an entity must assess to determine whether they constitute separate performance obligations.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.