12.7 Sales- or Usage-Based Royalties
An entity may license its IP to a customer and in exchange receive
consideration that may include fixed and variable amounts. Certain licensing
arrangements require the customer to pay the entity a variable amount based on the
underlying sales or usage of the IP (a “sales- or usage-based royalty”). As
discussed in Chapter 6, the
revenue standard requires an entity to estimate and constrain variable consideration
in a contract with a customer. The FASB and IASB decided to create an exception to
the general model for consideration in the form of a sales- or usage-based royalty
related to licenses of IP.
ASC
606-10
55-65 Notwithstanding the
guidance in paragraphs 606-10-32-11 through 32-14, an entity
should recognize revenue for a sales-based or usage-based
royalty promised in exchange for a license of intellectual
property only when (or as) the later of the following events
occurs:
-
The subsequent sale or usage occurs.
-
The performance obligation to which some or all of the sales-based or usage-based royalty has been allocated has been satisfied (or partially satisfied).
Under the sales- or usage-based royalty exception to the revenue
standard’s general rule requiring an entity to include variable consideration in the
transaction price, if an entity is entitled to consideration in the form of a sales- or
usage-based royalty, revenue is not recognized until (1) the underlying sales or usage
has occurred and (2) the related performance obligation has been satisfied (or partially
satisfied). That is, an entity is generally not required to estimate the amount of a
sales- or usage-based royalty at contract inception; rather, revenue would be recognized
as the subsequent sales or usage occurs (under the assumption that the associated
performance obligation has been satisfied or partially satisfied).
ASC
606-10
55-65A The guidance
for a sales-based or usage-based royalty in paragraph
606-10-55-65 applies when the royalty relates only to a license
of intellectual property or when a license of intellectual
property is the predominant item to which the royalty relates
(for example, the license of intellectual property may be the
predominant item to which the royalty relates when the entity
has a reasonable expectation that the customer would ascribe
significantly more value to the license than to the other goods
or services to which the royalty relates).
55-65B When the
guidance in paragraph 606-10-55-65A is met, revenue from a
sales-based or usage-based royalty should be recognized wholly
in accordance with the guidance in paragraph 606-10-55-65. When
the guidance in paragraph 606-10-55-65A is not met, the guidance
on variable consideration in paragraphs 606-10- 32-5 through
32-14 applies to the sales-based or usage-based
royalty.
The sales- or usage-based royalty exception only applies if the royalty
is associated with a license of IP that, as described in ASC 606-10-55-65A, is “the
predominant item to which the royalty relates.” For example, if the royalty is
associated with a franchise license and other services provided to a franchisee, the
exception would apply if the customer can reasonably expect the franchise license to
have significantly more value than the services. Example 60 in ASC 606, which is
reproduced below, illustrates a situation in which a license of IP would be considered
the predominant item to which a contract’s sales-based royalty is related.
ASC 606-10
Example 60 — Sales-Based Royalty Promised in
Exchange for a License of Intellectual Property and Other Goods
and Services
55-393 An entity, a movie
distribution company, licenses Movie XYZ to a customer. The
customer, an operator of cinemas, has the right to show the
movie in its cinemas for six weeks. Additionally, the entity has
agreed to provide memorabilia from the filming to the customer
for display at the customer’s cinemas before the beginning of
the six-week airing period and to sponsor radio advertisements
for Movie XYZ on popular radio stations in the customer’s
geographical area throughout the six-week airing period. In
exchange for providing the license and the additional
promotional goods and services, the entity will receive a
portion of the operator’s ticket sales for Movie XYZ (that is,
variable consideration in the form of a sales-based
royalty).
55-394 The entity concludes
that the license to show Movie XYZ is the predominant item to
which the sales-based royalty relates because the entity has a
reasonable expectation that the customer would ascribe
significantly more value to the license than to the related
promotional goods or services. The entity will recognize revenue
from the sales-based royalty, the only fees to which the entity
is entitled under the contract, wholly in accordance with
paragraph 606-10-55-65. If the license, the memorabilia, and the
advertising activities were separate performance obligations,
the entity would allocate the sales-based royalties to each
performance obligation.
12.7.1 Whether to Apply the Sales- or Usage-Based Royalty Exception to Only Part of the Royalties
In some contracts, a single sales- or usage-based royalty may be
related to both a license of IP and another good or service (i.e., not a
license). After the revenue standard was issued, stakeholders communicated that
it is unclear whether a sales- or usage-based royalty should ever be split into
a portion to which the sales- or usage-based royalty exception would apply and a
portion to which the general constraint on variable consideration in step 3
would apply.
The FASB clarified in ASU 2016-10 that an entity should not
split a royalty into a portion that is subject to the sales- or usage-based
royalty exception and a portion that is subject to the general constraint on
variable consideration in step 3. However, as explained in paragraph BC75(a) of
the ASU, “this amendment does not affect the requirement to allocate fees due
from a sales-based or usage-based royalty to the performance obligations (or
distinct goods or services) in the contract to which the royalty relates,
regardless of the constraint model the entity is required to apply.” For an
illustration of how an entity would comply with the allocation requirement, see
Example 35, Case B, in ASC 606-10-55-275 through 55-279, which is reproduced in
Section
7.5.1.
In ASU 2016-10, the FASB also clarified that the sales- or usage-based royalty
exception applies when the license is the predominant item (regardless of
whether the license is distinct or combined with other goods or services as a
single performance obligation) in relation to other nonlicense goods or
services. That is, an entity either applies the sales- or usage-based royalty
exception in its entirety (if the license to IP is predominant) or applies the
general variable consideration guidance (if the license to IP is not
predominant). Further, the FASB clarified in paragraph BC75(b) of the ASU that
the sales- or usage-based royalty exception would also apply in “situations in
which no single license is the predominant item to which the royalty relates but
the royalty predominantly relates to two or more licenses promised in the
contract.” However, ASC 606 does not define the term “predominant.” As a result,
an entity will need to exercise judgment when determining whether the license to
IP is predominant.
12.7.2 Interaction of Sales- or Usage-Based Royalty Exception With Measuring Progress Toward Satisfaction of a Performance Obligation
When applying the sales- or usage-based royalty exception, an entity typically
would recognize revenue when (or as) the customer’s subsequent sales or usage
occurs. However, if the sales- or usage-based royalties accelerate revenue
recognition as compared with the entity’s satisfaction (or partial satisfaction)
of the associated performance obligation, the entity may be precluded from
recognizing some or all of the revenue as the subsequent sales or usage
occurs.
ASC 606-10-55-65 specifies that revenue from a sales- or usage-based royalty
promised in exchange for a license of IP is recognized only when (or as) the
later of the following events occurs:
- The subsequent sale or usage occurs.
- The performance obligation to which some or all of the sales-based or usage-based royalty has been allocated has been satisfied (or partially satisfied).
Accordingly, revenue should be deferred if, and to the extent that, recognition
based on subsequent sales or usage (i.e., criterion (a)) is judged to be in
advance of satisfaction of a performance obligation (i.e., criterion (b)).
Royalty arrangements can differ greatly between entities and between contracts.
Further, the timing of the recognition of royalties can depend on the nature of
the underlying IP (i.e., right to access or right to use) as well as the
structure of the royalty payments. Therefore, the determination of whether
revenue from royalties should be deferred will depend on an analysis of the
specific facts and circumstances. For example, if the performance obligation to
which the royalties are related is a right-to-access license of IP, it will
often be helpful to consider whether the structure of the royalty payments
appropriately depicts progress toward satisfying the performance obligation of
providing access to the entity’s IP throughout the license period. If the
structure of the royalty payments does appropriately depict such progress, the
criteria in ASC 606-10-55-65(a) and (b) will coincide, and no deferral of
revenue will be necessary.
Whereas the amount determined under criterion (a) will be essentially a matter of
fact (actual sales or usage multiplied by the applicable royalty rate), an
entity will typically need to use judgment to determine the amount under
criterion (b). In particular, it will be important for an entity to identify an
appropriate measure of progress toward complete satisfaction of its obligation
(e.g., providing access to the entity’s IP) in accordance with ASC 606-10-25-31.
The entity should then apply the guidance in ASC 606-10-55-65 to determine
whether any revenue from royalties that have become payable on the basis of
sales or usage exceeds the amount of revenue that the entity determined by
applying the identified measure of progress. If so, the entity should defer that
excess and recognize it as a contract liability.
Note that ASC 606-10-55-65 requires an entity to recognize revenue upon the
occurrence of the later of the events described in ASC 606-10-55-65(a)
and (b). Consequently, it is never possible to recognize revenue in advance of
the amount payable under criterion (a) (actual sales or usage multiplied by the
applicable royalty rate), even if royalty rates have been back-end loaded in
such a way that royalties lag behind the measure of progress identified.
The example below illustrates the accounting for royalties
related to a right-to-access license under various scenarios.
Example 12-28
Entity S, a sports team, enters into a noncancelable
license agreement with Entity C, a clothing
manufacturer, under which C can use the sports team’s
logo on the shirts it manufactures and sells. The
license is a right to access S’s IP and is transferred
to C over time.
Consider the following scenarios:
-
Scenario 1 — The license is for a five-year period in exchange for a flat-rate royalty payable to S for every shirt sold. During the first year of the contract, a sporting competition is held. As a result of the sporting competition, the clothing manufacturer sells a much larger than normal number of shirts.
-
Scenario 2 — The license arrangement is such that the first shirt sold triggers a royalty payment of $1 million to S and the next 999,999 units sold do not trigger any further royalty payments. Each sale in excess of 1 million items triggers a $1 royalty.
Scenario 1
In Scenario 1, S concludes that it is reasonable for the
higher royalty payments in the first year of the license
to reflect a higher proportion of the total license
value being transferred to C in that year because C has
sold a disproportionately large number of shirts.
Accordingly, the structure of the royalty payments
appropriately depicts progress toward satisfying S’s
performance obligation of providing access to its IP
throughout the license period. It is unnecessary for S
to defer any of the royalty payments received in year 1
over the remainder of the license term.
In this example, although the royalties payable are
higher in the first year of the royalty arrangement, the
magnitude of the royalty payments corresponds to greater
value received by the customer in that year and,
consequently, is still consistent with progress toward
satisfaction of the performance obligation over time.
Scenario 2
In Scenario 2, S would be likely to conclude that the
first royalty payment of $1 million corresponds to the
benefit of the license being transferred for the first 1
million sales made by C. Accordingly, S could recognize
the first royalty payment of $1 million over the period
in which the first 1 million shirts are sold. For any
sales made in excess of the first 1 million items, S
would recognize the royalty payments of $1 per shirt
sold upon the sale of each item because the structure of
those subsequent royalty payments aligns with the
transfer of the benefit of the license to C.
In this scenario, it would not be appropriate for S to
recognize as revenue the entire $1 million royalty
payment received when the first shirt is sold because
that would not be a reasonable reflection of the
progress toward satisfaction of S’s performance
obligation. Because the royalties have been front-end
loaded in a way that does not reflect the value to the
customer, the royalties that have become payable on the
basis of sales or usage exceed the amount of revenue
that S determined by applying an appropriate measure of
progress. Therefore, revenue recognized is restricted to
the latter.
The example below illustrates the accounting for variable
royalty rates over the term of a right-to-access license.
Example 12-29
Entity S, a sports team, enters into a noncancelable
license agreement with Entity M, a manufacturer, under
which M can use the sports team’s logo on a product that
it manufactures and sells. The license is a right to
access S’s IP and is transferred to the customer over
time. The license is for a five-year period in exchange
for a royalty for every product sold.
The royalty rate decreases during the term of the
license: in years 1 through 3, M is required to pay 10
percent of the sales price of the product to S, whereas
in years 4 and 5, M is required to pay 8 percent of the
sales price of the product to S. The volume of product
sales on which the royalty is based is expected to be
approximately equal for each of the five years of the
license.
To apply the guidance in ASC 606-10-55-65, S will need to
determine an appropriate measure of progress toward
satisfying the performance obligation over time. Entity
S could consider whether the structure of the royalty
payments appropriately depicts progress toward
satisfying its performance obligation to provide access
to its IP throughout the license period.
Although the royalty rate decreases for the last two
years of the license period, S might conclude that the
structure of the royalty payments appropriately depicts
progress toward satisfying its performance obligation if
the change in rate reflects the decreased value of the
license to M in those years. For example, this might be
the case if M’s product was expected to have a higher
selling price in years 1 through 3 than in years 4 and
5; the reduction in royalty rate might have been
intended to reflect the lower gross margins that M could
expect in years 4 and 5 and, consequently, the lower
value of the license to M in those years.
However, if the structure of the royalty payments does
not appropriately depict progress toward satisfying S’s
performance obligation, S will need to determine an
appropriate measure of progress and use this to apply
the guidance in ASC 606-10-55-65. For example, because
the volume of product sales is expected to be broadly
flat, S may conclude that it is reasonable to regard the
benefit of the license as being transferred to M on a
straight-line basis over time. If so, S will need to
develop an appropriate method for determining what
amount of royalties received should be deferred to meet
the requirements of ASC 606-10-55-65. For example, if S
is able to reasonably estimate the royalties, it could
apply a blended rate to recognize revenue if doing so
would result in an appropriate measure of progress and
would not result in recognizing revenue before the
underlying sales or usage occurs.
The example below illustrates the accounting for variable
royalty rates paid in exchange for a right-to-use license.
Example 12-30
An entity enters into a contract to provide a customer
with a noncancelable license to the entity’s IP. There
are no other promised goods or services in the contract.
The entity determines that the license is a right-to-use
license (i.e., a license for which revenue is recognized
at a point in time) for a three-year period. The
customer’s estimated sales are expected to be
approximately equal for each of the three years under
license. For the use of the IP, the agreement requires
the customer to pay the entity a royalty of 10 percent
of the customer’s sales in year 1, 8 percent of the
customer’s sales in year 2, and 6 percent of the
customer’s sales in year 3.
The entity should account for the royalty payments in a
manner consistent with the legal form of the arrangement
and in accordance with the exception to the variable
consideration guidance for licenses of IP that include a
sales- or usage-based royalty. Consequently, the entity
would include the royalties in the transaction price on
the basis of the applicable contractual rate and the
customer’s sales in each year and then, in accordance
with ASC 606-10-55-65, recognize revenue at the later of
when (1) the “subsequent sale or usage occurs” or (2)
the “performance obligation to which some or all of the
sales-based or usage-based royalty has been allocated
has been satisfied (or partially satisfied).” Because
the license is a right-to-use license for which control
is transferred at the inception of the contract, the
“later” of the two conditions is met when the subsequent
sales occur.
12.7.3 Scope of the Sales- or Usage-Based Royalty Exception
12.7.3.1 Sale of IP Versus License of IP in Exchange for a Sales- or Usage-Based Royalty
The sales- or usage-based royalty exception is limited to narrow
circumstances in which the entity licenses its IP. Stakeholders have
questioned the scope of the sales- or usage-based royalty recognition
constraint in arrangements that are economically similar but legally
different.
The sales- or usage-based royalty exception in ASC 606-10-55-65 should be
applied by the licensor when accounting for the transfer of a license of
IP promised in exchange for a sales- or usage-based royalty; a sale
of IP does not qualify for the exception and, accordingly, would be
accounted for under the general revenue measurement and recognition guidance
in ASC 606.
The FASB and IASB decided against applying the exception for
sales- or usage-based royalties to IP more broadly. As indicated in
paragraph BC421 of ASU 2014-09, the boards believed that although the
exception “might not be consistent with the principle of recognizing some or
all of the estimate of variable consideration,” the disadvantage of such an
inconsistency in these limited circumstances is “outweighed by the
simplicity of [the exception’s requirements], as well as by the relevance of
the resulting information for this type of transaction.” Further, the boards
concluded that the exception should not be applied “by analogy to other
types of promised goods or services or other types of variable
consideration.” The boards’ full rationale for their decision is set out in
paragraphs BC415 through BC421 of ASU 2014-09. In addition, the sales- or
usage-based royalty exception should be applied to a contract that is a
licensing arrangement in form even if the arrangement is an in-substance
sale of IP. That is, the legal form of the transaction will determine which
revenue accounting guidance is applied (see Section 12.2.2).
Example 12-31
Entity X provides its customer with a license to
broadcast one of X’s movies on the customer’s
networks in exchange for a royalty of $10,000, which
is payable each time the movie is broadcasted over
the five-year license period. Entity X considers the
guidance in ASC 606-10-55-59 through 55-64A and
concludes that X has promised to its customer a
right to use X’s IP (i.e., X has satisfied its
performance obligation at the point in time at which
the customer is able to use and benefit from the
license).
Entity X applies the requirements of ASC 606-10-55-65
and does not recognize any revenue when the license
is transferred to the customer. Instead, X
recognizes revenue of $10,000 each time the customer
uses the licensed IP and broadcasts X’s movie.
Example 12-32
Entity X sells the copyright to one of its music
albums (i.e., all rights related to the IP) to a
customer in exchange for a promise of future
payments equal to $1 for each album sold by the
customer in the future and $0.01 for each time a
song on the album is played on the radio. Entity X
considers the guidance in ASC 606-10-25-23 through
25-30 and determines that its performance obligation
is satisfied at the point in time at which it
transfers the copyright to the customer.
Entity X should not apply the sales- or usage-based
royalty exception in ASC 606-10-55-65. Rather, in
accordance with ASC 606-10-32-2 and 32-3, upon
transferring control of the IP to the customer, X
recognizes revenue equal to its estimate of the
amount to which it will be entitled, subject to the
constraint on variable consideration specified by
ASC 606-10-32-11 and 32-12. Entity X then updates
its estimate and records a cumulative catch-up
adjustment at each subsequent reporting period as
required by ASC 606-10-32-14.
12.7.3.2 Whether Application of the Sales- or Usage-Based Royalty Exception Is Optional
The guidance in ASC 606-10-55-65 must be applied whenever a license to IP
that is the predominant item is subject to a sales- or usage-based royalty.
That is, applying the exception is not optional when the consideration due
in a licensing arrangement is in the form of a sales- or usage-based
royalty. Consider the examples below.
Example 12-33
Entity LN, a professional basketball
team, licenses its logo to a manufacturer of sports
apparel and receives a royalty payment for each item
of sports apparel sold. Entity LN has historical
experience that is highly predictive of the amount
of royalties that it expects to receive.
The sales- or usage-based royalty exception in ASC
606-10-55-65 states that revenue should be
recognized at the later of when (1) the
“subsequent sale or usage occurs” or (2) the
“performance obligation to which some or all of the
sales-based or usage-based royalty has been
allocated has been satisfied (or partially
satisfied).” The application of the sales- or
usage-based royalty exception is not optional, and
LN would be precluded from recognizing the royalty
revenue until the later of (1) the actual sale of
the sports apparel or (2) LN’s satisfaction of the
performance obligation to which the sales- or
usage-based royalty is related.
Example 12-34
Entity S licenses its software
(i.e., functional IP) to an OEM, which then
integrates S’s software with its own software for
inclusion in hardware devices (e.g., computers,
tablets, and smart devices) to be sold to end users.
Entity S sells 5,000 licenses to the OEM for $10 per
license (i.e., $50,000 in total consideration) that
is paid at contract inception. In addition, S
provides the OEM with 5,000 activation keys, each of
which allows the OEM to download S’s software for
integration with the OEM’s software to be included
in one hardware device. The license agreement allows
the OEM to acquire additional software licenses for
$10 per license by requesting additional activation
keys, which S readily provides to the OEM. Entity S
has concluded that providing additional license keys
to the OEM does not transfer any additional rights
not already controlled by the OEM (see Section
12.3.3).
The OEM can return any activation keys that are paid
for but not used to download and integrate the
software for inclusion in the OEM’s devices. The OEM
will receive a refund of $10 per license for any
activation keys returned.
Because S’s consideration for the transfer of the
licensed software (i.e., functional IP) is
contingent on the OEM’s subsequent usage, S must
apply the sales- or usage-based royalty exception
described in ASC 606-10-55-65. It would not be
appropriate for S to recognize revenue on the sale
of the license with the right of return before the
OEM’s subsequent usage.
Although the OEM has paid for the activation keys at
contract inception, because the amounts are
refundable to the extent that the OEM does not use
the IP by integrating it with the OEM’s software to
be included in hardware devices, the consideration
is in the form of a sales- or usage-based royalty.
Entity S would therefore be prohibited from
recognizing revenue until the subsequent sale or
usage of the IP occurs (in accordance with
606-10-55-65(a)). That is, it would not be
appropriate for S to estimate and constrain the
amount of consideration to which it expects to be
entitled and recognize such at the time the initial
5,000 licenses are transferred to the OEM.
12.7.3.3 Fixed Payments for a License of IP Receivable on Reaching a Sales- or Usage-Based Milestone
In many industries, it is common for contracts related to a license of IP to
include payment terms tied to milestones (“milestone payments”). These
milestone payments are frequently structured in such a way that entitlement
to or payment of an amount specified in the contract is triggered once a
sales target (i.e., a specified level of sales) has been reached (e.g., a
$10 million milestone payment is triggered once cumulative sales by the
licensee exceed $100 million).
Revenue with respect to such milestone payments should be recognized when the
sales- or usage-based milestone is reached (or later if the related
performance obligation has not been satisfied), as required by the exception
for sales- or usage-based royalties set out in ASC 606-10-55-65. This
requirement applies to milestone payments triggered by reference to any
sales- or usage-based thresholds even when the milestone amount to be paid
is fixed.
However, this exception should not be applied to
milestone payments related to the occurrence of any other event or indicator
(e.g., regulatory approval or proceeding into a beta phase of testing).
Paragraph BC415 of ASU 2014-09 states, “The [FASB and IASB] decided that for
a license of intellectual property for which the consideration is based on
the customer’s subsequent sales or usage, an entity should not recognize any
revenue for the variable amounts until the uncertainty is resolved (that is,
when a customer’s subsequent sales or usage occurs).” This paragraph
illustrates the boards’ intent that the exception should apply to
consideration only when the consideration is (1) related to licenses of IP
and (2) based on the customer’s subsequent sales or usage.
12.7.3.4 Application of the Sales- or Usage-Based Royalty Exception to a Refundable Up-Front Payment
There are certain situations in which (1) an up-front payment is made for the
sale of a license and (2) the up-front payment is refundable depending on
actual sales or usage of the license. In these cases, we believe that the
sales- or usage-based royalty exception would apply.
Example 12-35
Entity S licenses its software to an OEM, which then
integrates S’s software with its own software in
hardware devices (e.g., computers, tablets, and
smart devices) to be sold to end users. The license
constitutes a right-to-use license under ASC
606-10-55-58(b) and ASC 606-10-55-59(a) (i.e., a
license of functional IP). Entity S sells 5,000
licenses to the OEM for $10 per license (i.e.,
$50,000 in total consideration) that is paid at
contract inception. In addition, S provides the OEM
with 5,000 activation keys, each of which allows the
OEM to download S’s software for integration with
the OEM’s own software to be included in one
hardware device. The license agreement allows the
OEM to acquire additional software licenses for $10
per license by requesting additional activation
keys, which S readily provides to the OEM. Entity S
has concluded that providing additional license keys
to the OEM does not transfer any additional rights
not already controlled by the OEM.
The OEM can return any unused activation keys (i.e.,
with respect to licensed software not integrated
with the OEM’s devices). The OEM will receive a
refund of $10 per license for any activation keys
returned.
Entity S’s consideration for the transfer of the
licensed software is contingent on the OEM’s
subsequent usage. Accordingly, S must apply the
requirements of ASC 606-10-55-65 (with respect to
both the initial 5,000 licenses sold and any
additional licenses that may be purchased by the
OEM).
Although the OEM has paid for the initial 5,000
activation keys at contract inception, because the
amounts are refundable to the extent that the OEM
does not use the IP by integrating it with the OEM’s
software to be included in hardware devices, the
consideration is in the form of a sales- or
usage-based royalty. Entity S would therefore be
prohibited from recognizing revenue until the
subsequent usage of the IP occurs (i.e., when the
OEM integrates the software with the hardware and no
longer has the right to return the activation
keys).
Because the sales- or usage-based royalty exception
applies to this transaction, it would not be
appropriate for S to account for the transaction
under the general guidance on sales with a right of
return (see Section
6.3.5.3).
12.7.4 Recognition of Sales-Based Royalties When Information Is Received From the Licensee After the End of the Reporting Period
In certain licensing arrangements for which the consideration received from the
customer is based on the subsequent sales of IP, information associated with
those subsequent sales may not be available before the end of the reporting
period. Provided that the related performance obligation has been satisfied or
partially satisfied, ASC 606-10-55-65 requires that sales-based royalties
received for a license of IP be recognized when the subsequent sale or usage by
the licensee occurs. It would not be appropriate to delay recognition until the
sales information is received.
Example 12-36
Entity LN enters into a software license with Entity B
that allows inclusion of the software in computers that
B sells to third parties. Under the terms of the
license, LN receives royalties on the basis of the
number of computers sold that include the licensed
software. Upon delivery of the software to B, LN
satisfies the performance obligation to which the
sales-based royalty was allocated. Thereafter, LN
receives quarterly sales data in arrears, which allow it
to calculate the royalty payments due under the
license.
Entity LN should recognize revenue (royalty payments) for
computer sales made by B up to the end of its reporting
period even though sales data had not been received at
the end of that reporting period.
In this scenario, royalties should be recognized for
sales made by B up to the end of LN’s reporting period
on the basis of sales data received before LN’s
financial statements are issued or available to be
issued. If necessary, LN should estimate sales made in
any period not covered by such data. It would not be
appropriate for entities to omit sales-based royalties
from financial statements merely because the associated
sales data were received after the end of the reporting
period or were not received when the financial
statements were issued or available to be issued.
This conclusion is consistent with the
following view expressed in a speech delivered on
June 9, 2016, by Wesley Bricker, then deputy chief
accountant in the SEC's Office of the Chief Accountant,
at the 35th Annual SEC and Financial Reporting Institute
Conference:
The standard setters did not
provide a lagged reporting exception with the new
standard. Accordingly, I believe companies should
apply the sales- and usage-based royalty guidance
as specified in the new standard. The reporting,
which may require estimation of royalty usage,
should be supported by appropriate internal
accounting controls.
12.7.5 Sales- or Usage-Based Royalties With a Minimum Guarantee
Sometimes, the sales- or usage-based royalty may be subject to a minimum
guarantee, which establishes a floor for the amount of consideration to be paid
to the entity. The sales- or usage-based royalty exception applies only when the
consideration due under the licensing agreement is variable and the variability
is directly related to sales or usage of the underlying IP. That is, the
exception does not apply to any fixed consideration in a licensing
arrangement.
12.7.5.1 Application of the Sales- or Usage-Based Royalty Exception to Guaranteed Minimum Royalties Related to Functional IP
If there are no other performance obligations, a minimum guarantee related to
functional IP (i.e., a right-to-use license) should be recognized as revenue
at the point in time that 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 related to the IP occurs, in
accordance with ASC 606-10-55-65.
Example 12-37
Entity LH enters into a five-year license agreement
with Customer MC under which MC can air all of the
existing seasons of a TV show in exchange for
royalties from MC’s sales and usage of the IP. In
addition, the contract contains a minimum guarantee
of $1 million per year. The existing seasons of the
TV show have stand-alone functionality and thus
represent functional IP.
Ignoring potential effects of financing, LH should
recognize the total minimum guarantee of $5 million
for the contract when control of the functional IP
is transferred to the customer and the license
period begins. This is because (1) the $5 million is
fixed as a result of the minimum guarantee and (2)
the underlying IP (i.e., the TV show) is functional
(revenue is recognized at a point in time).
Additional royalties that exceed the $1 million
minimum guarantee in any year should be recognized
as the subsequent sales and usage occur.
The above issue is addressed in Implementation Q&A 60 (compiled from previously
issued TRG Agenda Papers 58 and 60). For additional information and
Deloitte’s summary of issues discussed in the Implementation Q&As, see
Appendix
C.
12.7.5.2 Application of the Sales- or Usage-Based Royalty Exception to Guaranteed Minimum Royalties Related to Symbolic IP
For licenses of symbolic IP, the revenue standard does not prescribe a
one-size-fits-all model for recognizing revenue over time in situations in
which a sales- or usage-based royalty contract with a customer includes a
minimum guaranteed amount of consideration. As discussed at the November
2016 TRG meeting, the following are three acceptable approaches for
recognizing revenue in those situations:
-
Approach A — Recognize revenue as the subsequent sales or usage occurs in accordance with ASC 606-10-55-65 if an entity expects that the total royalties will exceed the minimum guarantee. This approach would be appropriate only if the estimated sales- or usage-based royalties are expected to exceed the minimum guarantee.
-
Approach 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, but limit cumulative revenue recognized to the cumulative royalties in excess of the minimum guarantee. Like Approach A, this approach would be appropriate only if the estimated sales- or usage-based royalties are expected to exceed the minimum guarantee. Under this approach, an 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).
-
Approach C — Recognize the minimum guarantee over time by using an appropriate measure of progress over the license period, and recognize incremental royalties in excess of the minimum guarantee as the subsequent sales or usage related to those incremental royalties occurs.
An entity should evaluate its facts and circumstances to determine which
method under the standard appropriately depicts its progress toward
completion. In addition, entities should consider providing appropriate
disclosures to help users of their financial statements understand which
approach is being applied. Examples of such disclosures include the key
judgments the entity applied in selecting a measure of progress for
recognizing revenue from a license of symbolic IP.
The above issue is addressed in Implementation Q&A 59 (compiled from previously
issued TRG Agenda Papers 58 and 60). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
The example below further illustrates how to apply the three acceptable
approaches for recognizing revenue from symbolic IP arrangements with sales-
or usage-based royalties that include minimum guarantees.
Example 12-38
Entity G, a professional sports team, enters into a
three-year contract with Entity Y to license G’s
team logo trademark (which is symbolic IP). Entity Y
intends to include the trademark on various sports
merchandise (e.g., hats, shirts, and shorts) and
sell this merchandise to end consumers. In exchange
for the three-year trademark license, Y will pay G
sales-based royalties equal to 6 percent of Y’s
gross sales of merchandise that includes G’s
trademark. The contract also guarantees a minimum of
$1.5 million in royalties for the three-year
period.
Over the term of the contract, Y generates annual
gross sales, and is therefore required to pay
royalties to G, as follows:
- Year 1 — Annual gross sales of $15 million, royalties of $900,000.
- Year 2 — Annual gross sales of $8 million, royalties of $480,000.
- Year 3 — Annual gross sales of $13 million, royalties of $780,000.
Entity G would recognize revenue over the three-year
period under Approach A, B, or C in the manner
described below.
Approach A
Entity G could apply Approach A only if it expects
its estimated sales-based royalties to exceed the
minimum guarantee of $1.5 million. Under this
approach, G would use a measure of progress that
corresponds to the annual gross sales realized by Y
(for which there are corresponding royalty payments
due to G) and recognize annual revenue in the
amounts shown in the table below.
Under Approach A, G would recognize revenue as the
subsequent sales occur. Entity G should monitor its
estimates of royalties each reporting period and
update its measure of progress if it no longer
expects to earn total royalties that exceed the
minimum guarantee.
Approach B
Like Approach A, Approach B could be applied only if
G expects its estimated sales-based royalties to
exceed the minimum guarantee of $1.5 million. Under
this approach, G would estimate the total
transaction price (for the three-year period) and
select a measure of progress that results in G’s
recognition of the estimated (and constrained)
transaction price as G transfers the right to access
its symbolic IP to Y. If G uses a time-based measure
of progress, it would recognize annual revenue in
the amounts shown in the table below.
Under Approach B, G would estimate the total
consideration it expects to receive from Y during
the three-year period (as fixed consideration for
the minimum guarantee plus expected royalties to be
earned over the license term) and recognize revenue
over time by using an appropriate measure of
progress, but limit cumulative revenue recognized to
the cumulative royalties due. Therefore, in year 1,
G recognizes annual revenue of $720,000, one-third
of the total expected consideration to be received
of $2.16 million. However, in year 2, G is limited
to recognizing revenue of $660,000 because the
cumulative royalties received through year 2 is
$1.38 million. As a result, the cumulative revenue
recognized through year 2 is constrained to the
cumulative amount of royalties due.
Entity G should 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).
Entity G should also monitor its estimates of
royalties each reporting period and update its
measure of progress if it no longer expects to earn
total royalties that exceed the minimum
guarantee.
Approach C
Entity G would be required to apply Approach C if it
does not expect its estimated sales-based royalties
to exceed the minimum guarantee of $1.5 million.
Under this approach, G would recognize the minimum
guarantee over time by using an appropriate measure
of progress and recognize incremental royalties in
excess of the minimum guarantee as the subsequent
sales related to those incremental royalties occur.
If G uses a time-based measure of progress, it would
recognize annual revenue in the amounts shown in the
table below.
Under Approach C, G would recognize $500,000 in each
of year 1 and year 2, which is equal to one-third of
the minimum guarantee amount of $1.5 million. Entity
G would not recognize any variable consideration
(i.e., royalties earned above the $1.5 million
minimum guarantee) until year 3, when the cumulative
consideration received exceeds the minimum guarantee
of $1.5 million. The revenue recognized in year 3 is
the sum of (1) the remaining $500,000 of the minimum
guarantee and (2) the incremental royalties of
$660,000 in excess of the minimum guarantee.
12.7.6 Allocating Fixed Consideration and Sales- or Usage-Based Royalties in a Licensing Arrangement With More Than One Performance Obligation
Complexities related to the allocation of the transaction price
to multiple performance obligations may arise when licensing contracts include a
combination of fixed consideration and royalties subject to the sales- or
usage-based royalty exception. As discussed in Section 12.7.5.2, there are several
acceptable approaches to accounting for a licensing arrangement that includes
both a minimum guaranteed amount and a sales- or usage-based royalty for any
sales or usage in excess of that minimum amount in a license of symbolic IP.
ASC 606-10
Example 35 — Allocation of Variable Consideration
55-270 An entity
enters into a contract with a customer for two
intellectual property licenses (Licenses X and Y), which
the entity determines to represent two performance
obligations each satisfied at a point in time. The
standalone selling prices of Licenses X and Y are $800
and $1,000, respectively.
Case A — Variable Consideration Allocated Entirely to
One Performance Obligation
55-271 The price
stated in the contract for License X is a fixed amount
of $800, and for License Y the consideration is 3
percent of the customer’s future sales of products that
use License Y. For purposes of allocation, the entity
estimates its sales-based royalties (that is, the
variable consideration) to be $1,000, in accordance with
paragraph 606-10-32-8.
55-272 To allocate
the transaction price, the entity considers the criteria
in paragraph 606-10-32-40 and concludes that the
variable consideration (that is, the sales-based
royalties) should be allocated entirely to License Y.
The entity concludes that the criteria in paragraph
606-10-32-40 are met for the following reasons:
-
The variable payment relates specifically to an outcome from the performance obligation to transfer License Y (that is, the customer’s subsequent sales of products that use License Y).
-
Allocating the expected royalty amounts of $1,000 entirely to License Y is consistent with the allocation objective in paragraph 606-10-32-28. This is because the entity’s estimate of the amount of sales-based royalties ($1,000) approximates the standalone selling price of License Y and the fixed amount of $800 approximates the standalone selling price of License X. The entity allocates $800 to License X in accordance with paragraph 606-10-32-41. This is because, based on an assessment of the facts and circumstances relating to both licenses, allocating to License Y some of the fixed consideration in addition to all of the variable consideration would not meet the allocation objective in paragraph 606-10-32-28.
55-273 The entity
transfers License Y at inception of the contract and
transfers License X one month later. Upon the transfer
of License Y, the entity does not recognize revenue
because the consideration allocated to License Y is in
the form of a sales-based royalty. Therefore, in
accordance with paragraph 606-10-55-65, the entity
recognizes revenue for the sales-based royalty when
those subsequent sales occur.
55-274 When License
X is transferred, the entity recognizes as revenue the
$800 allocated to License X.
Case B — Variable Consideration Allocated on the Basis
of Standalone Selling Prices
55-275 The price
stated in the contract for License X is a fixed amount
of $300, and for License Y the consideration is 5
percent of the customer’s future sales of products that
use License Y. The entity’s estimate of the sales-based
royalties (that is, the variable consideration) is
$1,500 in accordance with paragraph 606-10-32-8.
55-276 To allocate
the transaction price, the entity applies the criteria
in paragraph 606-10-32-40 to determine whether to
allocate the variable consideration (that is, the
sales-based royalties) entirely to License Y. In
applying the criteria, the entity concludes that even
though the variable payments relate specifically to an
outcome from the performance obligation to transfer
License Y (that is, the customer’s subsequent sales of
products that use License Y), allocating the variable
consideration entirely to License Y would be
inconsistent with the principle for allocating the
transaction price. Allocating $300 to License X and
$1,500 to License Y does not reflect a reasonable
allocation of the transaction price on the basis of the
standalone selling prices of Licenses X and Y of $800
and $1,000, respectively. Consequently, the entity
applies the general allocation requirements in
paragraphs 606-10-32-31 through 32-35.
55-277 The entity
allocates the transaction price of $300 to Licenses X
and Y on the basis of relative standalone selling prices
of $800 and $1,000, respectively. The entity also
allocates the consideration related to the sales-based
royalty on a relative standalone selling price basis.
However, in accordance with paragraph 606-10-55-65, when
an entity licenses intellectual property in which the
consideration is in the form of a sales-based royalty,
the entity cannot recognize revenue until the later of
the following events: the subsequent sales occur or the
performance obligation is satisfied (or partially
satisfied).
55-278 License Y is
transferred to the customer at the inception of the
contract, and License X is transferred three months
later. When License Y is transferred, the entity
recognizes as revenue the $167 ($1,000 ÷ $1,800 × $300)
allocated to License Y. When License X is transferred,
the entity recognizes as revenue the $133 ($800 ÷ $1,800
× $300) allocated to License X.
55-279 In the first
month, the royalty due from the customer’s first month
of sales is $200. Consequently, in accordance with
paragraph 606-10-55-65, the entity recognizes as revenue
the $111 ($1,000 ÷ $1,800 × $200) allocated to License Y
(which has been transferred to the customer and is
therefore a satisfied performance obligation). The
entity recognizes a contract liability for the $89 ($800
÷ $1,800 × $200) allocated to License X. This is because
although the subsequent sale by the entity’s customer
has occurred, the performance obligation to which the
royalty has been allocated has not been satisfied.
Example 57 — Franchise Rights
55-375 An entity
enters into a contract with a customer and promises to
grant a franchise license that provides the customer
with the right to use the entity’s trade name and sell
the entity’s products for 10 years. In addition to the
license, the entity also promises to provide the
equipment necessary to operate a franchise store. In
exchange for granting the license, the entity receives a
fixed fee of $1 million, as well as a sales-based
royalty of 5 percent of the customer’s sales for the
term of the license. The fixed consideration for the
equipment is $150,000 payable when the equipment is
delivered.
Identifying Performance Obligations
55-376 The entity
assesses the goods and services promised to the customer
to determine which goods and services are distinct in
accordance with paragraph 606-10-25-19. The entity
observes that the entity, as a franchisor, has developed
a customary business practice to undertake activities
such as analyzing the consumers’ changing preferences
and implementing product improvements, pricing
strategies, marketing campaigns, and operational
efficiencies to support the franchise name. However, the
entity concludes that these activities do not directly
transfer goods or services to the customer.
55-377 The entity determines
that it has two promises to transfer goods or services:
a promise to grant a license and a promise to transfer
equipment. In addition, the entity concludes that the
promise to grant the license and the promise to transfer
the equipment are each distinct. This is because the
customer can benefit from each good or service (that is,
the license and the equipment) on its own or together
with other resources that are readily available (see
paragraph 606-10-25-19(a)). The customer can benefit
from the license together with the equipment that is
delivered before the opening of the franchise, and the
equipment can be used in the franchise or sold for an
amount other than scrap value. The entity also
determines that the promises to grant the franchise
license and to transfer the equipment are separately
identifiable in accordance with the criterion in
paragraph 606-10-25-19(b). The entity concludes that the
license and the equipment are not inputs to a combined
item (that is, they are not fulfilling what is, in
effect, a single promise to the customer). In reaching
this conclusion, the entity considers that it is not
providing a significant service of integrating the
license and the equipment into a combined item (that is,
the licensed intellectual property is not a component
of, and does not significantly modify, the equipment).
Additionally, the license and the equipment are not
highly interdependent or highly interrelated because the
entity would be able to fulfill each promise (that is,
to license the franchise or to transfer the equipment)
independently of the other. Consequently, the entity has
two performance obligations:
- The franchise license
- The equipment.
Allocating the Transaction Price
55-378 The entity
determines that the transaction price includes fixed
consideration of $1,150,000 and variable consideration
(5 percent of the customer’s sales from the franchise
store). The standalone selling price of the equipment is
$150,000 and the entity regularly licenses franchises in
exchange for 5 percent of customer sales and a similar
upfront fee.
55-379 The entity
applies paragraph 606-10-32-40 to determine whether the
variable consideration should be allocated entirely to
the performance obligation to transfer the franchise
license. The entity concludes that the variable
consideration (that is, the sales-based royalty) should
be allocated entirely to the franchise license because
the variable consideration relates entirely to the
entity’s promise to grant the franchise license. In
addition, the entity observes that allocating $150,000
to the equipment and allocating the sales-based royalty
(as well as the additional $1 million in fixed
consideration) to the franchise license would be
consistent with an allocation based on the entity’s
relative standalone selling prices in similar contracts.
Consequently, the entity concludes that the variable
consideration (that is, the sales-based royalty) should
be allocated entirely to the performance obligation to
grant the franchise license.
Licensing
55-380 The
entity assesses the nature of the entity’s promise to
grant the franchise license. The entity concludes that
the nature of its promise is to provide a right to
access the entity’s symbolic intellectual property. The
trade name and logo have limited standalone
functionality; the utility of the products developed by
the entity is derived largely from the products’
association with the franchise brand. Substantially all
of the utility inherent in the trade name, logo, and
product rights granted under the license stems from the
entity’s past and ongoing activities of establishing,
building, and maintaining the franchise brand. The
utility of the license is its association with the
franchise brand and the related demand for its
products.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
55-381 The
entity is granting a license to symbolic intellectual
property. Consequently, the license provides the
customer with a right to access the entity’s
intellectual property and the entity’s performance
obligation to transfer the license is satisfied over
time in accordance with paragraph 606-10-55-58A. The
entity recognizes the fixed consideration allocable to
the license performance obligation in accordance with
paragraph 606-10-55-58A and paragraph 606-10-55-58C.
This includes applying paragraphs 606-10-25-31 through
25-37 to identify the method that best depicts the
entity’s performance in satisfying the license (see
paragraph 606-10-55-382).
55-382 Because the
consideration that is in the form of a sales-based
royalty relates specifically to the franchise license
(see paragraph 606-10-55-379), the entity applies
paragraph 606-10-55-65 in recognizing that consideration
as revenue. Consequently, the entity recognizes revenue
from the sales-based royalty as and when the sales
occur. The entity concludes that recognizing revenue
resulting from the sales-based royalty when the
customer’s subsequent sales occur is consistent with the
guidance in paragraph 606-10-55-65(b). That is, the
entity concludes that ratable recognition of the fixed
$1 million franchise fee plus recognition of the
periodic royalty fees as the customer’s subsequent sales
occur reasonably depict the entity’s performance toward
complete satisfaction of the franchise license
performance obligation to which the sales-based royalty
has been allocated.
The examples below illustrate possible approaches that may be
appropriate when a licensing arrangement includes (1) fixed consideration and
sales- or usage-based royalties and (2) more than one performance
obligation.
Example 12-39
Entity X, a cable TV network company, enters into a
four-year contract with Entity Y on January 1, 201X. The
contract gives Y an exclusive license, including digital
streaming rights (within specific territories), to a
preexisting library of X’s historical content in
addition to any new content that becomes available
during the four-year term. Entity X determines that
there are two distinct performance obligations in
accordance with ASC 606-10-25-19 through 25-22 as follows:
-
A license of the preexisting library of content (i.e., the historical content) transferred to Y at the outset of the contract. Entity X determines that this is a right-to-use license of IP for which revenue is recognized at a point in time in accordance with ASC 606-10-55-63.
-
A license for any new content that is transferred to Y as it becomes available throughout the duration of the contract. Entity X determines that the obligation to update the license arrangement to include new content is a stand-ready obligation to provide updates to Y over the license term. Entity X concludes that it will satisfy this obligation ratably over the four-year license term.
Entity Y is required to pay X a royalty fee of $2 per
subscriber per month over the contract term, subject to
a minimum guaranteed amount of $10 million. Entity X
estimates that over the contract term, it is probable
that X will be entitled to total royalties of $30
million. In addition, X determines that (1) the
stand-alone selling price of the license of historical
content is $12 million (40 percent of the total
estimated transaction price) and (2) the stand-alone
selling price of the license of new content is $18
million (60 percent of the total estimated transaction
price). The number of subscribers to Y’s service in year
1 is such that X is entitled to a royalty of $13
million.
Entity X determines that there are at least two
acceptable approaches (“Approach A” and “Approach B”) to
allocating the $10 million guaranteed minimum fee and
the $2 per subscriber royalty fee between the two
performance obligations in the contract.
Whichever approach is adopted, as discussed below, X will
need to consider whether it is required to constrain the
amount of revenue recognized in accordance with ASC
606-10-32-11 and apply the sales- or usage-based royalty
exception in ASC 606-10-55-65.
Revenue Recognition Based on Initial Allocation of
Fixed and Variable Consideration
Approach A
Under Approach A, X allocates both the fixed and variable
consideration to each performance obligation on the
basis of the relative stand-alone selling prices of the
historical and new content as follows:
In year 1, X recognizes revenue as follows:
- $4 million of the guaranteed minimum revenue allocated to the historical content is recognized upon the initial transfer of the historical content to Y.
- $1.5 million of the guaranteed minimum revenue is allocated to and recognized for the new content ($6 million ÷ 4 years of license term).
- The royalty payments received in excess of the $10 million guaranteed revenue are subject to the guidance in ASC 606-10-55-65 on recognizing revenue related to sales- or usage-based royalties. Therefore, $3 million ($13 million of royalties owed for year 1 less the $10 million of guaranteed minimum revenue) is allocated on a relative stand-alone selling price basis. Accordingly, $1.2 million is allocated to and recognized for the historical content, and $1.8 million is allocated to and recognized for the new content.
Thus, the total revenue recognized in year 1 under
Approach A is $8.5 million, as illustrated in the table
below.
Note that the royalties in excess of the guaranteed
minimum that are allocated to the new content in year 1
($1.8 million) do not need to be restricted in
accordance with ASC 606-10-55-65 because the total
revenue recognized for the new content ($3.3 million) is
less than the amount corresponding to the measure of
progress ($18 million ÷ 4 years of license term = $4.5
million).
Approach B
Under Approach B, X allocates the
consideration on a first in, first out basis.
Accordingly, the guaranteed minimum and estimated
royalties are first allocated to the historical content
and then to the new content, as illustrated in the table
below. Note that the estimated royalties are subject to
the constraint that it is probable that a significant
reversal in the amount of cumulative revenue recognized
will not occur when the uncertainty associated with the
variable consideration is subsequently resolved (see
Section 6.3.3
for further discussion of this objective).
In year 1, X recognizes revenue as follows:
- $10 million of the guaranteed minimum allocated to the historical content is recognized upon the initial transfer of the historical content to Y.
- $2 million of the variable consideration allocated to the historical content is recognized when the first $2 million of royalties earned in excess of the guaranteed $10 million becomes payable by Y.
- While on a pro rata basis, X would recognize $4.5 million ($18 million ÷ 4 years of license term) with respect to the new content, X is able to recognize only $1 million with respect to the new content ($13 million of royalties owed for year 1 less the $12 million recognized with respect to the historical content) since the variable consideration is subject to the restriction in ASC 606-10-55-65 on recognizing revenue related to sales- or usage-based royalties.
Thus, the total revenue recognized in year 1 under
Approach B is $13 million, as illustrated in the table
below.
Revenue Recognition Based on Updated Allocation of
Fixed and Variable Consideration
Each of the approaches discussed above
is affected differently by a change in the estimate of
royalties to which the entity expects to be entitled.
The impact of any change in estimate under each approach
should be carefully considered in accordance with the
guidance on estimating and constraining variable
consideration, whose objective is to include some or all
of an amount of variable consideration estimated in the
transaction price only to the extent that it is probable
that a significant reversal in the amount of cumulative
revenue recognized will not occur when the uncertainty
associated with the variable consideration is
subsequently resolved (see Section 6.3.3 for further discussion of
this objective).
Suppose that after one year, X updates the transaction
price in accordance with ASC 606-10-32-14 and concludes
that it is probable that X will be entitled to total
royalties of only $20 million over the four-year
contract term as a result of changing market conditions
(i.e., $10 million less than the original estimated
transaction price). Under ASC 606-10-32-43, X is
required to reallocate the transaction price to each
performance obligation on the same basis as at contract
inception. Also assume that in year 2, only $2 million
in additional royalties is earned and payable to X
(total consideration of $15 million has been earned to
date, and there is an expectation that an additional $5
million will be received for the remaining contract
term).
The effect of the updated expectations on revenue
recognized in year 2 under each approach is discussed
below.
Approach A
Under Approach A, X updates the allocation of the fixed
and variable consideration to each performance
obligation on the basis of the relative stand-alone
selling prices of the historical and new content as
follows:
Accordingly, revenue is recognized as follows:
Note that the royalties allocated to the
new content ($3 million) are not restricted in
accordance with ASC 606-10-55-65 because the total
revenue recognized for new content ($6 million) does not
exceed the amount corresponding to the measure of
progress, or ($12 million ÷ 4 years of license term) × 2
years = $6 million.
Approach B
Under Approach B, X updates the allocation of the fixed
and variable consideration to each performance
obligation on the basis of the relative stand-alone
selling prices of the historical and new content as
follows:
As a result of the updated estimate of the transaction
price, X is limited in recognizing additional revenue in
year 2 when it reallocates the total expected
consideration between the historical and new content.
Revenue is recognized as follows:
Note that the royalties allocated to the
new content ($5 million) are restricted under Approach B
in accordance with ASC 606-10-55-65 because the total
revenue otherwise recognized for the new content ($7
million) would exceed the amount corresponding to the
measure of progress, or ($12 million ÷ 4 years of
license term) × 2 years = $6 million. Consequently, $1
million of the royalties received in year 2 would need
to be deferred.
As noted in the tables above, Approach A and Approach B
have different accounting outcomes for both the
consideration recognized as revenue in year 1 of the
agreement and the changes in subsequent years to the
estimated consideration to which X expects to be
entitled. Care should be taken in the election of a
policy, and careful evaluation of the objective behind
constraining estimates of variable consideration should
guide this election.
Example 12-40
Entity K, a biotechnology company, enters into a contract
with Customer C to provide a license of functional IP as
well as R&D services. As a result of the late stage
of development of the IP and other factors, K has
concluded that the license and R&D services are
distinct performance obligations. The contract
consideration includes (1) an up-front payment ($30
million), (2) royalties of 8 percent of future sales
(estimated to be $50 million), and (3) a reimbursement
for the R&D services at cost plus a fixed margin
(estimated to be $20 million). Entity K has concluded
that the license to IP is predominant in the
arrangement.
Entity K has estimated the stand-alone selling prices of
the performance obligations as follows:
Performance Obligation
|
Stand-Alone Selling Price
|
---|---|
License
|
$ 80 million
|
R&D services
|
$ 20 million
|
Because the sales- or usage-based
royalty exception is a recognition constraint (applied
as part of step 5 of ASC 606’s revenue model), K could
still consider the sales-based royalties in the
estimated transaction price to be allocated even though
they are subject to the sales- or usage-based royalty
exception (and are constrained at contract inception).
That is, K might reasonably conclude that it can
allocate the royalties (estimated to be $50 million)
together with the up-front fee of $30 million (a total
expected amount of $80 million) entirely to the license
since such allocation would be consistent with the
stand-alone selling price of the license and, therefore,
with the allocation objective in ASC 606-10-32-28 and
ASC 606-10-32-40. Entity K could also allocate the $20
million to which it expects to be entitled for
performing the R&D services entirely to the R&D
services performance obligation. Such allocation would
also be consistent with the allocation objective because
the consideration to which K expects to be entitled as
it performs the R&D services represents the
stand-alone selling price for those services. The
approach described herein is consistent with the
approach illustrated in Example 35, Case A, of ASC
606.
As a result of the above allocations, K would recognize
(1) revenue of $30 million when the license is
transferred at contract inception ($80 million total
consideration allocated to the license, of which $50
million is constrained because of the sales- or
usage-based royalty exception) and (2) revenue for the
R&D services at the contractual reimbursement rate
as services are performed. Additional revenue related to
the transfer of the license would be recognized as
royalties become due (i.e., once sales associated with
the licensed IP occur).
Example 12-41
Assume the same facts as in the previous
example, except that the R&D services are reimbursed
by Customer C at cost with no margin (estimated to be
$15 million). Since Entity K would not typically provide
R&D services on a stand-alone basis for cost (i.e.,
with no margin), use of the allocation approach
described in the previous example would not result in an
allocation that is consistent with the allocation
objective in ASC 606-10-32-28 and ASC 606-10-32-40.
Consequently, K would not be able to use the same
approach in this situation.
If K continues to believe that the royalties are entirely
related to the license, K could allocate the total
expected transaction price ($95 million) to the
performance obligations on a relative stand-alone
selling price basis as follows:
Performance Obligation
|
Stand-Alone Selling Price
|
Relative Allocation
|
Allocation of Estimated Contract
Consideration
|
---|---|---|---|
License
|
$ 80 million
|
80%
|
$ 76 million
|
R&D services
|
$ 20 million
|
20%
|
$ 19 million
|
Total
|
$ 100 million
|
100%
|
$ 95 million
|
As the table illustrates, this approach would result in
the allocation of $76 million to the license and $19
million to the R&D services. If K concludes that the
royalties are entirely related to the license (i.e., the
criteria in ASC 606-10-32-40 are met), it would
recognize revenue of $26 million when the license is
transferred at contract inception (the $76 million
allocated transaction price less the $50 million that is
constrained because of the sales- or usage-based royalty
exception). Further, K would recognize (1) revenue of
$19 million allocated to the R&D services as the
R&D services are performed by using a single measure
of progress and (2) additional revenue related to the
transfer of the license as royalties become due (i.e.,
once sales associated with the licensed IP occur).
12.7.7 Applicability of the Sales- or Usage-Based Royalty Exception to Agents
The guidance in ASC 606-10-55-65 discusses situations in which
an entity transfers a license of IP to a customer in exchange for a sales- or
usage-based royalty. However, in some cases, an entity may be compensated in the
form of a sales- or usage-based royalty for services that are directly related
to a license of IP, but the entity itself is not licensing the IP because it is
not the owner of the IP. The examples below illustrate situations in which an
entity provides services in exchange for a sales- or usage-based royalty that is
directly related to a license of IP.
Example 12-42
Company X, acting as a film distributor (agent), enters
into arrangements to distribute filmed media content to
theaters or other outlets (e.g., video on demand service
providers) to make the content available for viewing by
various audiences. The filmed content was produced and
is owned by another entity (the “licensor”). In such
arrangements, X acts as an agent between the licensor
and the customer (e.g., a theater or another outlet). In
exchange for performing the agency services, X is
entitled to variable consideration based on the
licensor’s royalties underlying the sales related to the
licensed IP (e.g., ticket sales). The licensor’s
earnings and, in turn, the fees earned by X are directly
tied to the sales of the licensed IP.
Example 12-43
Company Y, acting as a talent agent, finds roles for its
clients in films or other theatrical productions. Each
of Y’s clients is paid a stated royalty percentage based
on the sales or usage of the film or production (i.e.,
the IP), and Y’s commission is equal to a stated
percentage of the royalty earned by the client. Company
Y does not own or control the film or production at any
point, and neither does Y’s client; rather, Y’s ability
to generate commissions depends on how the film or
production is monetized. Accordingly, the client’s
earnings and, in turn, the commissions earned by Y are
directly tied to the sales or usage of the licensed
IP.
Example 12-44
Company Z, acting as an agent, identifies licensees to
enter into contracts with Z’s clients (i.e., licensors).
Each of Z’s clients is paid a stated royalty percentage
based on the sales and usage of the IP licensed by the
licensee (e.g., a college logo on merchandise), and Z’s
commission is a stated percentage of the royalty earned
by its client. Company Z does not own or control the IP
at any point; rather, Z’s ability to generate
commissions is dependent on the existence of its
client’s IP. Accordingly, the client’s earnings and, in
turn, the commissions earned by Z are directly tied to
the sales or usage of the licensed IP.
In each of the examples above, the agent may account for the
fees or commissions it earned in accordance with either of the following views,
which are equally acceptable:
-
View 1 — The sales- or usage-based royalty exception in ASC 606-10-55-65 is applicable.
-
View 2 — The sales- or usage-based royalty exception in ASC 606-10-55-65 does not apply. Because the agent is not licensing IP on its own, it determines that the consideration it received was not in exchange for a license of IP; rather, the consideration was in exchange for the agency service it promised to perform under the contract. Therefore, the agent concludes that it should apply the variable consideration guidance in ASC 606-10-32-5 through 32-14, including the guidance on constraining estimates of variable consideration (see Section 6.3.3).
Generally, the sales- or usage-based royalty exception may be applied only in
limited situations by the licensor (i.e., when an entity licenses its IP and is
compensated in the form of a royalty that varies on the basis of the customer’s
sales or usage of the licensed IP). However, there are situations in which an
entity may apply the sales- or usage-based royalty exception even though it does
not own the IP or act as the principal in the arrangement (i.e., it does not
control or license the IP). When determining whether it is appropriate to apply
the sales- or usage-based royalty exception in these situations, entities should
consider the nature of the services being provided to the customer and use
judgment to determine whether such services are directly related to the IP that
is being licensed. That is, if the revenue to be received is based on a sales-
or usage-based royalty from a license of IP and the service provided by the
entity is directly related to that IP, it would be acceptable to apply the
royalty exception in ASC 606-10-55-65.
This conclusion is consistent with the discussion in paragraph BC415 of ASU
2014-09, which explains that if the exception did not apply, an entity would be
required to “report, throughout the life of the contract, significant
adjustments to the amount of revenue recognized at inception of the contract as
a result of changes in circumstances, even though those changes in circumstances
are not related to the entity’s performance.” On the basis of discussion with
the FASB staff, we understand that the Board did not intend to limit the
exception to owners of the IP (i.e., the logic for providing the exception would
apply equally to the owners of the IP and others receiving a portion of a
royalty for services directly related to the license of the IP).
If the services being provided are not directly linked to the underlying IP being
licensed or the entity’s compensation does not vary on the basis of the sales or
usage of the licensed IP, it would not be appropriate to apply the sales- or
usage-based royalty exception.