12.5 Transfer of Control and Recognition

ASC 606-10

55-58C Notwithstanding paragraphs 606-10-55-58A through 55-58B, revenue cannot be recognized from a license of intellectual property before both:

An entity provides (or otherwise makes available) a copy of the intellectual property to the customer.
The beginning of the period during which the customer is able to use and benefit from its right to access or its right to use the intellectual property. That is, an entity would not recognize revenue before the beginning of the license period even if the entity provides (or otherwise makes available) a copy of the intellectual property before the start of the license period or the customer has a copy of the intellectual property from another transaction. For example, an entity would recognize revenue from a license renewal no earlier than the beginning of the renewal period

Determining when control has been transferred to a customer may be difficult in certain arrangements related to the licensing of IP, especially those related to software that is delivered electronically.

12.5.1 Electronic Delivery of Software

The examples below discuss the transfer of control in arrangements involving electronically delivered software.

Example 12-15

Assessing When Control Is Transferred to the Customer for a Suite of Software Licenses

Entity X enters into a five-year license agreement with Customer B under which B purchases licenses to a suite of software products consisting of five modules. At the inception of the arrangement, B is required to make a nonrefundable payment of $5 million to X for the licenses to all five modules, and the license term for the suite of licenses begins on January 1, 20X5. Customer B has previewed all five modules and accepted the software as of January 1, 20X5, but has only obtained the access codes for, and downloaded, four of the five modules. Customer B installs the modules itself and expects that it will take three months to install the four modules. Customer B does not download the fifth module immediately because of system limitations but plans to obtain the access code and install the fifth module once installation of the first four modules is complete. The access code for the fifth module is available to B on demand.

In this scenario:

Customer B is required to pay the nonrefundable license fee at the inception of the arrangement and has accepted the software.
The license terms have begun.
The access code for the fifth module is available to B at any time on demand.

Assuming that no other indicators of control are present, X can reasonably conclude that control of the licenses for all five modules is transferred to B on January 1, 20X5.

Example 12-16

Assessing When Control Is Transferred to the Customer When the License Requires an Access Code or Product Key

Entity X sells software licenses to customers that represent right-to-use licenses (for which revenue is recognized at a point in time) and give customers access to the software via X’s Web site. Customers need either an access code to download the software or a product key to activate the software once downloaded. The software cannot be used on the customer’s hardware without the access code or the product key.

Entity X may not need to deliver the access code or product key to the customer to conclude that control of the software license has been transferred to the customer. ASC 606-10-55-58B and 55-58C state, in part:

An entity’s promise to provide a customer with the right to use its intellectual property is satisfied at a point in time. The entity should apply paragraph 606-10-25-30 to determine the point in time at which the license transfers to the customer.

Notwithstanding paragraphs 606-10-55-58A through 55-58B, revenue cannot be recognized from a license of intellectual property before both:

An entity provides (or otherwise makes available) a copy of the intellectual property to the customer.
The beginning of the period during which the customer is able to use and benefit from its right to access or its right to use the intellectual property. That is, an entity would not recognize revenue before the beginning of the license period even if the entity provides (or otherwise makes available) a copy of the intellectual property before the start of the license period or the customer has a copy of the intellectual property from another transaction. [Emphasis added]

Entity X should consider the guidance on control in ASC 606-10-25-23 through 25-26 and the indicators in ASC 606-10-25-30 related to determining when a customer obtains control of the software license.

In some circumstances, control of the software license may be transferred to the customer before the access code or product key is delivered. In particular, there may be situations in which the access code or product key has not been delivered but is nonetheless made available to the customer at any time on demand. In such circumstances, it will be necessary to consider whether control has passed to the customer by focusing on the indicators in ASC 606-10-25-30. For example, if the customer has accepted the software, nonrefundable payment has been received, the license term has begun, and the customer has a current right to request and receive the access code or product key, X may conclude that control of the software license has been transferred even though the access code or product key has not been provided to the customer. These situations may be viewed as analogous to bill-and-hold arrangements, as discussed in ASC 606-10-55-81 through 55-84.

However, if payment terms or acceptance depends on delivery of the software access code or product key, or if X is not yet in a position to make the code or key available, it would be unlikely that X could conclude that control of a software license has been transferred until the access code or product key has been provided to the customer.

Example 12-17

Assessing When Control Is Transferred to the Customer in a Hosting Arrangement

Entity Y enters into a license and hosting software arrangement with Customer X that allows X to access via the Internet and use software that Y physically hosts on its servers. Customer X is required to pay a nonrefundable license fee of $1,000 at the inception of the arrangement. Customer X accepts the software, and the license term begins once the hosting service commences.

As part of the arrangement, X has the right to take possession of the software at any time during the contract period without incurring additional costs or diminution of the software’s utility or value. That is, there are no contractual or practical barriers to X’s exercising its right to take possession of the software, and X is able to benefit from the software on its own or with readily available resources.

Entity Y concludes that the software license and hosting service are each distinct and that the software license gives X a right to use Y’s IP. If X exercises its right to take possession of the software, Y will immediately provide an access code that will enable X to download the software.

In this scenario:

X is required to pay the nonrefundable license fee at the inception of the arrangement.
X has accepted the software, and the license term begins once the hosting service commences.
Y has made the access code available to X at any time on demand.

Therefore, assuming that no other indicators affecting the transfer of control are present, Y can reasonably conclude that control of the software license is transferred to X when the license term and hosting service begin. As a result, (1) the transaction price allocated to the license is recognized at inception of the arrangement (corresponding to its transfer of control at that point in time) and (2) the transaction price allocated to the hosting service is recognized over time.

12.5.2 When Control Is Transferred in Reseller Arrangements

Reseller arrangements in which a reseller purchases software from a software provider (the vendor) and then resells the software to end users are common in the software industry. In these situations, the reseller is often the vendor’s customer (rather than the end user). ASC 606-10-55-58C provides that revenue cannot be recognized from a license of IP before both (1) an entity provides a copy of the IP to a customer and (2) the period during which the customer can use and benefit from the IP has begun. Questions arise about when revenue can be recognized when sales of IP are made to resellers (e.g., distributors) rather than end users.

Example 12-18

On March 15, 20X0, Vendor A enters into a reseller arrangement with Reseller B that immediately permits B to resell 1,000 licenses of A’s software (a form of functional IP) for a nonrefundable up-front fee of $200,000. Reseller B plans to resell the functional IP to end users and will provide all set-up and maintenance services directly to the end users. There is no expectation that A will undertake activities to substantively change the functionality of the IP, and there are no promised goods or services in the contract other than the license to the functional IP. Also on March 15, 20X0, A ships to B a master copy of the software; B receives the master copy on April 1, 20X0, and can use it to replicate the software for resale. Vendor A also makes the software available for download on March 15, 20X0; however, B intends to use the master copy rather than the downloaded version to replicate the software for resale.

Vendor A should recognize revenue on March 15, 20X0. As noted in ASC 606-10-55-58C, control of IP cannot be transferred (and revenue cannot be recognized) before (1) the “entity provides (or otherwise makes available) a copy of the [IP] to the customer” and (2) the “beginning of the period during which the customer is able to use and benefit from its right to access or its right to use” the IP. In a reseller arrangement, the customer is not using the functionality of the software; rather, the customer will benefit from the software through the ability to resell the software. Although B intends to use the master copy to replicate the software, the software is made available to B on March 15, 20X0, which is also when B could begin reselling the software. Therefore, on March 15, 20X0, it would be appropriate for A to recognize the nonrefundable fee of $200,000 as revenue. However, even if A does not make the software available for download and only ships B a master copy of the software, A could recognize the nonrefundable fee of $200,000 as revenue when it ships the master copy of the software to B on March 15, 20X0, if control of the master copy is transferred to B upon shipment (e.g., FOB shipping point).

12.5.3 Recognition When a License Is Not Distinct From Other Goods or Services

If an entity determines that a license is not distinct and should therefore be combined with other goods or services in a contract, the entity will need to evaluate the nature of the combined goods and services to determine (1) when the performance obligation is satisfied (i.e., at a point in time or over time) and (2) the appropriate method of measuring progress for revenue recognition over time, if applicable. This requirement is intended to ensure that the arrangement is accounted for in a manner that is consistent with the objective of the revenue standard. That is, revenue is recognized when (or as) control of the good or service is transferred to the customer.

For example, assume the following:

A contract contains a five-year license for the right to access IP and a two-year service agreement, both of which meet the requirements for recognizing revenue over time.
The license is not distinct and is therefore combined with the service agreement as a single performance obligation.
The license is the predominant part of that combined single performance obligation.

In this example, it would not be appropriate to recognize revenue related to the five-year license over a two-year period. Rather, the transaction price would be recognized as revenue as the combined performance obligation (five-year license plus two-year service agreement) is satisfied. In this case, the timing of revenue recognition would be determined on the basis of the promised good or service that is transferred over the longer period (i.e., the five-year license).

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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.