result in relevant information, especially for contracts in which the sales-based or
usage-based royalties are paid over a long period of time. [IFRS 15.BC415].
In some contracts, a sales-based or usage-based royalty may be related to both a licence
of intellectual property and another good or service that may, or may not, be distinct.
Paragraph B63A of IFRS 15 requires that the royalty recognition constraint be applied
to the overall royalty stream when the sole or predominant item to which the royalty
relates is a licence of intellectual property (including when no single licence of
intellectual property is the predominant item to which the royalty relates, but the
royalty predominantly relates to two or more licences of intellectual property in the
contract). [IFRS 15.B63A, BC421G]. That is, this application guidance is applicable to all
licences of intellectual property, regardless of whether they have been determined to
be distinct. The standard does not provide a bright line for determining the
‘predominant’ item in a contract that includes a licence of intellectual property. The
Board acknowledged in the Basis for Conclusions that significant judgement may be
required to determine when a licence is the predominant item to which a royalty relates.
However, the judgement for determining whether a licence is the predominant item is
likely to be less than the judgement needed to apply the general requirements for
variable consideration to such contracts. [IFRS 15.BC421E].
It is important to note that the application guidance in IFRS 15.B63-B63B applies only
to licences of intellectual property for which some or all of the consideration is in the
form of a sales-based or usage-based royalty. The Board said in the Basis for
Conclusions that the royalty recognition constraint was structured to apply only to a
particular type of transaction (i.e. a licence of intellectual property). Therefore, other
transactions that may be economically similar would be accounted for differently.
[IFRS 15.BC416]. That is, entities cannot analogise to the royalty recognition constraint for
other types of transactions. For example, it cannot be applied if consideration in a
contract is in the form of a sales-based or usage-based royalty, but there is no licence
of intellectual property (e.g. the sale of a tangible good that includes a significant amount
of intellectual property). When the royalty recognition constraint cannot be applied an
entity follows the requirements in the general model on estimating variable
consideration and applying the constraint on variable consideration (see 6.2 above). In
some cases, it may not be obvious as to whether the arrangement is an in-substance sale
of intellectual property (i.e. a promise that is in the form of a licence, but, in substance,
has the characteristics of a sale) or a licence of intellectual property. In such instances,
entities would have to exercise judgement to determine whether the control over the
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underlying intellectual property has been transferred from the entity to the customer
and therefore, has been sold.
The following figure illustrates an entity’s evaluation when determining whether the
royalty recognition constraint should be applied to a royalty stream:
Figure 28.17:
Determining whether the royalty recognition constraint applies
to a royalty stream
Does the consideration in the contract include a sales-based or usage-
based royalty?
Yes
No
Royalty recognition constraint
application guidance does not apply.
Royalty recognition constraint
application guidance does not apply.
Is the sales-based or usage-based
No
The variable consideration
royalty promised in exchange for a
requirements in paragraphs 50-59
licence of intellectual property?
of IFRS 15 must be applied
(see 6.2 above).
Yes
No
Is the licence of intellectual property
Is the licence of intellectual property
No
the only item to which the sales-
the predominant item to which the
based or usage-based royalty relates?
sales-based or usage-based royalty
relates?*
Yes
Yes
Royalty recognition constraint
Royalty recognition constraint
application guidance applies.
application guidance applies.
This includes situations in which no single licence is the predominant item to which the sales-based or
* usage-based royalty relates, but the sales-based or usage-based royalty predominantly relates to two or
more licences in the contract.
The standard provides the following example of a contract that includes two
performance obligations, including a licence that provides a right to use the entity’s
intellectual property and consideration in the form of sales-based royalties. In the
example, the licence is determined to be the predominant item to which the royalty
relates. [IFRS 15.IE307-IE308].
Example 28.77: Sales-based royalty for a licence of intellectual property
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:
(a) provide memorabilia from the filming to the customer for display at the customer’s cinemas before the
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beginning of the six-week screening period; and (b) sponsor radio advertisements for Movie XYZ on popular
radio stations in the customer’s geographical area throughout the six-week screening period. In exchange for
providing the licence and the additional promotional goods and services, the entity will receive a portion of
the operator’s ticket sales for Movie XYZ (i.e. variable consideration in the form of a sales-based royalty).
The entity concludes that the licence 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 licence than to the related promotional goods or services. The entity recognises revenue
from the sales-based royalty, the only consideration to which the entity is entitled under the contract, wholly
in accordance with paragraph B63. If the licence, the memorabilia and the advertising activities are separate
performance obligations, the entity would allocate the sales-based royalty to each performance obligation.
As illustrated in Example 28.77 above, Paragraph B63B of IFRS 15 requires that, when
the royalty recognition constraint is applied, the royalty stream must be accounted for
either entirely under the royalty recognition constraint or entirely under the general
variable consideration constraint requirements (see 6.2.3 above). [IFRS 15.B63B]. That is,
an entity would not split a single royalty and apply the royalty recognition constraint to
a portion of the sales-based royalty and the general constraint requirements for variable
consideration to the remainder. The Board indicated in the Basis for Conclusions that
it would be more complex to account for part of a royal
ty under the royalty recognition
constraint and another part under the general requirements for variable consideration
and that doing so would not provide any additional useful information to users of
financial statements. This is because splitting a royalty would result in an entity
recognising an amount at contract inception that would reflect neither the amount to
which the entity expects to be entitled, based on its performance, nor the amount to
which the entity has become legally entitled during the period. [IFRS 15.BC421J].
Regardless of whether an entity applies the royalty recognition constraint or the general
requirements for variable consideration, it is still required to allocate sales-based or
usage-based royalties to separate performance obligations in a contract (as noted in
Example 28.77 above). In order to perform such an allocation, an entity may need to
include expected royalties in its estimate of the stand-alone selling price of one or more
of the performance obligations. Example
35 from the standard (included as
Example 28.55 at 7.3 above) also illustrates the allocation of the transaction price
(including sales-based or usage-based royalties) to the performance obligations in the
contract. [IFRS 15.IE178-IE187].
9.5.1
Recognition of royalties for a licence that provides a right to access
intellectual property
The IASB explained in the Basis for Conclusions that the royalty recognition constraint is
intended to align the recognition of sales or usage-based royalties with the standard’s key
principle that revenue should be recognised when (or as) an entity satisfies a performance
obligation. As discussed above, IFRS 15 requires that royalties received in exchange for
licences of intellectual property are recognised at the later of when: (1) the subsequent
sales or usage occurs; and (2) the performance obligation to which the sales-based or
usage-based royalties relates has been satisfied (or partially satisfied). That is, an entity
recognises the royalties as revenue when (or as) the customer’s subsequent sales or usage
occurs, unless that pattern of recognition accelerates revenue recognition ahead of the
entity’s satisfaction of the performance obligation to which the royalty solely or partially
relates, based on an appropriate measure of progress (see 8.2 above). [IFRS 15.BC421I].
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Consider the following example, which was provided by the FASB, that illustrates when
revenue recognition may be inappropriately accelerated ahead of an entity’s performance,
if revenue was recognised under paragraph B63(a) of IFRS 15 for a right-to-access licence.
Example 28.78: Licensing contract with a declining royalty rate123
A contract provides a customer with the right to access an entity’s intellectual property and the entity receives
royalties of 8% on total sales up to £1 million, 4% on the next £3 million in sales and 2% on all sales above
£4 million. The declining royalty rate does not reflect changing value to the customer.
In this example, the FASB noted that recognising royalties as they are due (i.e. according to the contractual
formula) would not be aligned with the principle of recognising revenue only when (or as) an entity satisfies
a performance obligation because the right to access the intellectual property is provided evenly over the
licence term while the declining royalty rate does not reflect the value to the customer. However, the FASB
stated that the existence of a declining royalty rate in a contract does not always mean that recognising revenue
for sales-based or usage-based royalties as the customer’s underlying sales or usage occur is inappropriate.
In fact, it would be appropriate if the declining royalty rate reflects the changing value to the customer.
The above example notwithstanding, for many contracts with licences that provide a right
to access an entity’s intellectual property, applying the royalty recognition constraint
results in an entity recognising revenue from sales-based or usage-based royalties when
(or as) the customer’s underlying sales or usage occurs in accordance with
paragraph B63(a) of IFRS 15. An output-based measure of progress that is the same as, or
similar to, the application of the practical expedient in paragraph B16 of IFRS 15 (i.e. when
the right to consideration corresponds directly with the value to the customer of the
entity’s performance to date) is appropriate because the entity’s right to consideration
(i.e. the sales-based or usage-based royalties earned) often corresponds directly with the
value to the customer of the entity’s performance completed to date. The practical
expedient in paragraph B16 of IFRS 15 is discussed further at 8.2.1.A above.
In addition, an output-based measure could also be appropriate for a licence that provides
a right to access intellectual property in which the consideration is in the form of a fixed fee
and royalties. The following example from the standard illustrates this. [IFRS 15.IE309-IE313].
Example 28.79: Access to intellectual property
An entity, a well-known sports team, licenses the use of its name and logo to a customer. The customer, an
apparel designer, has the right to use the sports team’s name and logo on items including t-shirts, caps, mugs
and towels for one year. In exchange for providing the licence, the entity will receive fixed consideration of
CU2 million and a royalty of five per cent of the sales price of any items using the team name or logo. The
customer expects that the entity will continue to play games and provide a competitive team.
The entity assesses the goods and services promised to the customer to determine which goods and services
are distinct in accordance with paragraph 27 of IFRS 15. The entity concludes that its only performance
obligation is to transfer the licence. The additional activities associated with the licence (i.e. continuing to
play games and provide a competitive team) do not directly transfer a good or service to the customer because
they are part of the entity’s promise to grant the licence.
The entity assesses the nature of the entity’s promise to transfer the licence in accordance with paragraph B58
of IFRS 15. In assessing the criteria the entity considers the following:
(a) the entity concludes that the customer would reasonably expect that the entity will undertake activities that
will significantly affect the intellectual property (i.e. the team name and logo) to which the customer has
rights. This is on the basis of the entity’s customary business practice to undertake activities that support
and maintain the value of the name and logo such as continuing to play and providing a competitive team.
The entity determines that the ability of the customer to obtain benefit from the name and logo is
substantially derived from, or dependent upon, the expected activities of the entity. In addition, the entity
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observes that because some of its consideration is dependent on the success of the customer (through the
sales-based royalty), the entity has a shared economic interest with the customer, which indicates that the
customer will expect the entity to undertake those activities to maximise earnings;
(b) the entity observes that the rights granted by the licence (i.e. the use of the team’s name and logo) directly
expose the custo
mer to any positive or negative effects of the entity’s activities; and
(c) the entity also observes that even though the customer may benefit from the activities through the rights
granted by the licence, they do not transfer a good or service to the customer as those activities occur.
The entity concludes that the criteria in paragraph B58 of IFRS 15 are met and the nature of the entity’s
promise to grant the licence is to provide the customer with access to the entity’s intellectual property as it
exists throughout the licence period. Consequently, the entity accounts for the promised licence as a
performance obligation satisfied over time (i.e. the criterion in paragraph 35(a) of IFRS 15 is met).
The entity then applies paragraphs 39–45 of IFRS 15 to determine a measure of progress that will depict the entity’s
performance. For the consideration that is in the form of a sales-based royalty, paragraph B63 of IFRS 15 applies
because the sales-based royalty relates solely to the licence, which is the only performance obligation in the contract.
The entity concludes that recognition of the CU2 million fixed consideration as revenue rateably over time plus
recognition of the royalty as revenue as and when the customer’s sales of items using the team name or logo occur
reasonably depicts the entity’s progress towards complete satisfaction of the licence performance obligation.
In Example 28.79 above, the fixed consideration of CU2 million is an explicit term in
the contract with the customer. In some contracts, fixed consideration may be implied,
such as when a guaranteed minimum amount of royalties is part of the transaction price.
In addition, as discussed in 9.3.1.A above, many licences that provide a right to access
intellectual property may constitute a series of distinct goods or services that are
substantially the same and have the same pattern of transfer to the customer (e.g. a series
of distinct periods of access to intellectual property, such as monthly access or quarterly
access). In cases where the criteria for a performance obligation to be accounted for as
a series of distinct goods or services have been met, an entity needs to consider whether
any variable consideration in the contract (e.g. sales-based or usage-based royalties)
should be allocated directly to the distinct periods of access, if the criteria for certain
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 446
