allocation exceptions are met. The allocation of sales-based or usage-based royalties in
this manner generally results in the recognition of royalties as revenue when (or as) the
customer’s underlying sales or usage occurs.
An entity may need to apply significant judgement to determine the appropriate pattern
of revenue recognition for royalties received on a licence that provides a right to access
intellectual property.
9.5.2
Implementation questions on the sales-based or usage-based royalty
recognition constraint
9.5.2.A
Can the recognition constraint for sales-based or usage-based royalties
be applied to royalties that are paid in consideration for sales of
intellectual property (rather than just licences of intellectual property)?
As noted in the Basis for Conclusions, the Board discussed but decided not to expand
the scope of the royalty recognition constraint to include sales of intellectual
property. The Board also stated that the royalty recognition constraint is intended to
apply only to limited circumstances (i.e. those circumstances involving licences of
intellectual property) and, therefore, entities cannot apply it by analogy to other
types of transactions. [IFRS 15.BC421, BC421F].
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9.5.2.B
If a contract for a licence of intellectual property includes payments with
fixed amounts (e.g. milestone payments) that are determined by
reference to sales-based or usage-based thresholds, would the royalty
recognition constraint need to be applied?
We generally believe the royalty recognition constraint would apply to fixed amounts
of variable consideration (i.e. fixed amounts of consideration that are contingent on
the occurrence of a future event), such as milestone payments, provided the amounts
are determined by reference to sales-based or usage-based thresholds. This is the case
even if those payments are not referred to as ‘royalties’ under the terms of the
contract. However, entities need to apply judgement and carefully evaluate the facts
and circumstances of their contracts for licences of intellectual property to determine
whether these types of payments should be accounted for using the royalty
recognition constraint.
Consider the following example.
Example 28.80: Application of the royalty recognition constraint to a milestone
payment
An entity enters into a contract to grant a customer a right to use the entity’s licence. The contract contains
payment terms that include a ¥100 million milestone payment that is payable to the entity once the customer
has achieved sales of ¥1 billion.
The entity determines that the milestone payment is based on the customer’s subsequent sales and
represents variable consideration because it is contingent on the customer’s sales reaching ¥1 billion.
The entity accounts for the ¥100 million milestone payment in accordance with the royalty recognition
constraint and only recognises revenue for the milestone payment once the customer’s sales reach
¥1 billion.
9.5.2.C
Can an entity recognise revenue for sales-based or usage-based royalties
for licences of intellectual property on a lag if actual sales or usage data
is not available at the end of a reporting period?
The standard requires that sales-based or usage-based royalties promised in exchange
for licences of intellectual property be recognised as revenue 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).
Therefore, after the conditions in the royalty recognition constraint application
guidance have been met (i.e. the underlying sales or usage has occurred and the
performance obligation to which the royalties relate has been satisfied, or partially
satisfied), we believe that licensors without actual sales or usage data from the licensee
need to make an estimate of royalties earned in the current reporting period. This may
result in a change in practice for entities that have previously recognised revenue from
royalties on a lag (i.e. in a reporting period subsequent to when the underlying sales or
usage occurs).
9.5.2.D
Recognition of royalties with minimum guarantees promised in
exchange for a licence of intellectual property that is satisfied at a
point in time
In November 2016, FASB TRG members were asked to consider how a minimum
guarantee affects the recognition of sales-based or usage-based royalties promised in
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exchange for a licence of intellectual property that is satisfied at a point in time.124 The
FASB TRG members generally agreed that a minimum guaranteed amount of sales
based or usage-based royalties promised in exchange for a licence of intellectual
property that is satisfied at a point in time (IFRS: right-to-use licence; US GAAP:
licence of functional intellectual property) would need to be recognised as revenue at
the point in time that the entity transfers control of the licence to the customer
(see 9.3.2 above). Any royalties above the fixed minimum would be recognised in
accordance with the royalty recognition constraint (i.e. at the later of when the sale
or usage occurs or when the entity satisfies the performance obligation to which some
or all of the royalty has been allocated).125
9.5.2.E Recognition
of
royalties with minimum guarantees promised in exchange
for a licence of intellectual property that is satisfied over time
In November 2016, FASB TRG members were asked to consider how a minimum
guarantee affects the recognition of sales-based or usage-based royalties promised in
exchange for a licence of intellectual property that is satisfied over time.126 The FASB
TRG members generally agreed that various recognition approaches could be
acceptable for minimum guarantees promised in exchange for licences of intellectual
property that are satisfied over time (IFRS: right-to-access licences; US GAAP:
licences of symbolic intellectual property, see 8.3.1 above). This is because, as the
FASB staff noted in the TRG agenda paper, this question is asking what is an
appropriate measure of progress for such contracts and the standard permits
reasonable judgement when selecting a measure of progress. Because the standard
does not prescribe a single approach that must be applied in all circumstances in
which a sales-based or usage-based royalty is promised in exchange for a licence of
intellectual property and the contract includes a minimum guaranteed amount, an
entity should consider the nature of its arrangements and make sure that the measure
of progress it selects does not override the core principle of the standard that ‘an
entity shall recognise revenue to depict the transfer of promised goods or services to
customers in an amount that reflects the consideration to which the entity expects to
be entitled in exchange for those goods or services’. [IFRS 15.2]. An entity would need
to disclose the accounting policy it selects because it is likely that this would affect
the amount and timing of r
evenue recognised.
The agenda paper describes two approaches. Under one approach, an entity would
estimate the total consideration (i.e. the fixed minimum and the variable consideration
from future royalties) and apply an appropriate measure of progress to recognise
revenue as the entity satisfies the performance obligation, subject to the royalty
recognition constraint. Alternatively, under the other approach, an entity could apply a
measure of progress to the fixed consideration and begin recognising the variable
component after exceeding the fixed amount on a cumulative basis.
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The first approach can be applied in two different ways, as follows:
• View A: If an entity expects royalties to exceed the minimum guarantee, the
entity may determine that an output-based measure is an appropriate measure
of progress and apply the right-to-invoice practical expedient
(i.e. paragraph B16 of IFRS 15, see 8.2.1.A above) because the royalties due for
each period correlate directly with the value to the customer of the entity’s
performance each period. As a result of applying the practical expedient for
recognising revenue, the entity would not need to estimate the expected
royalties beyond determining whether it expects, at contract inception, that the
royalties will exceed the minimum guarantee. However, the entity would be
required to update that assessment at the end of each reporting period. It is
important to note that this view is likely to be appropriate if the entity expects
cumulative royalties to exceed the minimum guarantee.
• View B: An entity estimates the transaction price for the performance obligation
(including both fixed and variable consideration) and recognises revenue using an
appropriate measure of progress, subject to the royalty recognition constraint. If
an entity does not expect cumulative royalties to exceed the minimum guarantee,
the measure of progress is applied to the minimum guarantee since the transaction
price will at least equal the fixed amount.
The second approach can be summarised, as follows:
• View C: An entity recognises the minimum guarantee (i.e. the fixed consideration)
using an appropriate measure of progress and recognises royalties only when
cumulative royalties exceed the minimum guarantee.
The FASB staff noted in the TRG agenda paper that, in order for an entity to apply
View C, the over-time licence would have to be considered a series of distinct goods or
services (i.e. a series of distinct time periods) and the variable consideration (i.e. the
royalties in excess of the minimum guarantee) would have to be allocated to the distinct
time periods to which they relate.
To illustrate the application of these views, the following example has been adapted
from one included in the FASB TRG agenda paper.
Example 28.81: Accounting for a licence of intellectual property that is satisfied over
time in exchange for a minimum guarantee and sales-based royalty
An entity enters into a five-year arrangement to licence a trademark. The trademark is determined to be a
licence of intellectual property that is satisfied over time (IFRS: right-to-access licence; US GAAP: licence
of symbolic intellectual property). The licence requires the customer to pay a sales-based royalty of 5% of its
gross sales associated with the trademark. However, the contract includes a guarantee that the entity will
receive a minimum of £5 million for the entire five-year period.
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The customer’s actual gross sales associated with the trademark and the related royalties each year are, as
follows (this information is not known at the beginning of the contract):
Year 1 – £15 million (royalties equal £750,000)
Year 2 – £30 million (royalties equal £1.5 million)
Year 3 – £40 million (royalties equal £2 million)
Year 4 – £20 million (royalties equal £1 million)
Year 5 – £60 million (royalties equal £3 million)
Total royalties equal £8.25 million.
View A: The entity expects total royalties to exceed the minimum guarantee. The entity determines that an
output-based measure is an appropriate measure of progress and applies the right-to-invoice practical
expedient because the royalties due for each period correlate directly with the value to the customer
of the entity’s performance for each period. The entity recognises revenue from the sales-based royalty when
the customer’s subsequent sales occur.
(in £000s)
Year 1
Year 2
Year 3
Year 4
Year 5
Royalties received
750
1,500
2,000
1,000
3,000
Annual revenue
750
1,500
2,000
1,000
3,000
Cumulative revenue
750
2,250
4,250
5,250
8,250
View B: The entity estimates the transaction price (including fixed and variable consideration) for the contract.
The entity determines that time elapsed is an appropriate measure of progress and recognises revenue rateably
over the five-year term of the contract, subject to the royalty recognition constraint (i.e. cumulative revenue
recognised cannot exceed the cumulative royalties received once the minimum guarantee has been met).
(in £000s)
Year 1
Year 2
Year 3
Year 4
Year 5
Royalties received
750
1,500
2,000
1,000
3,000
Royalties (cumulative) 750
2,250
4,250
5,250
8,250
Fixed + Variable
1,650
1,650
1,650
1,650 1,650
(rateable)(a)
Annual revenue
1,650
1,650
1,650
300
3,000
Cumulative revenue
1,650
3,300
4,950
5,250(b) 8,250
(a) Assuming the entity’s estimated transaction price (including both fixed and variable consideration) is £8.25 million, the annual revenue that could be recognised is £1.65 million (£8.25 million divided by five years, being contract term).
(b) In Year 4, the cumulative revenue using a time-elapsed measure of progress of £6.6 million (£4.95 million plus
£1.65 million) exceeds the cumulative royalties received (£5.25 million). As such, the total cumulative revenue
recognised through to the end of Year 4 is constrained to the total cumulative royalties received of £5.25 million.
View C: The entity recognises the minimum guarantee (i.e. the fixed consideration) using an appropriate
measure of progress and recognises royalties only when cumulative royalties exceed the minimum guarantee.
The entity determines that time elapsed is an appropriate measure of progress.
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The entity applies the royalty recognition constraint to the sales-based royalties that are in excess of the
minimum guarantee (i.e. recognise the royalties as revenue when the minimum guarantee is exceeded on a
cumulat
ive basis). The variable consideration (royalties in excess of the minimum guarantee) is allocated to
the distinct periods using the variable consideration allocation exception (see 7.3 above). [IFRS 15.85]. As
previously discussed, the FASB staff noted in the TRG agenda paper that, in order for an entity to apply
View C, the over-time licence would have to be considered a series of distinct goods or services (i.e. a series
of distinct time periods) and the variable consideration (i.e. the royalties that are in excess of the minimum
guarantee) would have to be allocated to the distinct time periods to which they relate.
(in £000s)
Year 1
Year 2
Year 3
Year 4
Year 5
Royalties received
750
1,500
2,000
1,000
3,000
Royalties (cumulative) 750
2,250
4,250
5,250
8,250
Fixed (rateable)(a)
1,000
1,000
1,000
1,000 1,000
Annual revenue
1,000
1,000
1,000
1,250(b) 4,000(c)
Cumulative revenue
1,000
2,000
3,000
4,250
8,250
(a) Because the minimum guarantee is £5 million over the contract term, the annual revenue (excluding royalties that are in excess of the minimum guarantee) is £1 million (£5 million divided by five years, being the contract term).
(b) In Year 4, the cumulative royalties received (£5.25 million) exceed the total minimum guarantee (£5 million) by
£250,000. As such, the annual revenue recognised in Year 4 is £1.25 million (£1 million annual revenue plus £250,000 of
royalties in excess of the minimum guarantee).
(c) In Year 5, the annual revenue recognised (£4 million) is calculated as the £1 million annual revenue plus the royalties for that year (£3 million) since the royalties exceeded the minimum guarantee in Year 4.
The FASB staff noted in the TRG agenda paper that other measures of progress, in addition
to those set out above, could be acceptable because the standard permits entities to use
judgement in selecting an appropriate measure of progress and that judgement is not
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 447
