Accounting

Revenue Recognition: Round Two (Part Two)


by FEI Daily Staff

The second Joint Transition Resource Group for Revenue Recognition (TRG) meeting -- held by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) -- turned to “determining the nature of a license of intellectual property” during its October 31 agenda.

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This is the second part of a series. For the previous article click here
Determining the Nature of a License of Intellectual Property

The new standards contain implementation guidance about whether an entity’s promise to grant a license of intellectual property is satisfied either (a) over time (provides a right to access the entity’s IP as it exists at any given time throughout the license period) or (b) at a point in time (provides a right to use the entity’s IP as it exists at the time the license is granted).

A license can either be dynamic (meaning the IP is expected to be significantly affected by the licensor’s ongoing activities or non-performance of those activities) or static (meaning IP is not significantly affected by the licensor’s ongoing activities), where the difference between the two is satisfaction over time, versus satisfaction at a point in time.

Therefore, the TRG discussed the following items:

Issue 1: For a license of IP that is not a separate performance obligation, does an entity need to determine the nature of the license as a right to access the entity’s IP or a right to use the entity’s IP ( meaning, determine whether the license is satisfied over time or at a point in time)?

The TRG debated whether there was enough guidance within the new standard for a contract containing a license that is bundled with service contracts. Based on comments of the TRG, the guidance seems to imply that if the license is not distinct, and not dominant and still substantive, licensing guidance should not be used – this may result in more upfront recognition of a longer license.

As remediation, some TRG members suggested bringing the Basis of Conclusion (BC) paragraph 407 into the standard itself. BC 407 suggests:

If the customer cannot benefit from the license on its own, and/or the license cannot be separated from other promises in the contract, the license would not be distinct and, thus, would be combined with those other promises (see paragraph 606-10-25-22 [30]). The entity would then determine when the single performance obligation is satisfied on the basis of when the good or service (that is, the output) is transferred to the customer. The Boards noted that in some cases, the combined good or service transferred to the customer may have a license as its primary or dominant component. When the output that is transferred is a license, or when the license is distinct, the entity would apply the criteria in paragraph 606-10-55-60 [B58] to determine whether the promised license provides the customer with access to the entity’s intellectual property or a right to use the entity’s intellectual property.

However, other members suggest the new guidance is sufficient, and that the BC 407 is helpful to determine something sensible with a bundled contract, but do not necessarily feel it should be brought to the standard. The TRG member further suggested that if an entity does end up with a bundle that is transferred overtime and/or at a point in time or cannot come up with a measure of progress that reflects the economics, perhaps go back to the beginning and re-evaluate if the contract was separated properly.

There was no consensus or agreement among the TRG with this issue.

Issue 2: For the nature of a license to be a right to access the entity’s intellectual property as it exists throughout the license period, (a) do the contractual or expected activities of the licensor have to change the form and/or functionality of the underlying IP or (b) do significant changes in the value of the IP alone constitute a change to the IP?

This issue is the most frequently raised issue by constituents with respect to the licenses implementation guidance. It addresses how to distinguish between licenses that represent a right to use the licensor’s IP satisfied at a point in time and a license that represents a right to access the licensor’s IP satisfied over time. Interpretations of the new standard by constituents suggested three possible views: 1. Interpretation A: For a license to constitute a right of access, form and functionality of the underlying IP must be subject to change over the license term, or if the IP is subject to change throughout the license period. This view is most supported by the constituents. (Guidance in ASC 606-10-55-59 [B57])

2. Interpretation B: Under this view, not only should the IP change in form and functionality, it should also change in the value of the IP. For a license to constitute a right of access under this view, (Guidance in ASC 606-10-55-60 [B58]). Those that support Interpretation B think paragraph 606-10-55-60 [B58] defines what it means for IP to change, and observe that that paragraph does not state the form or functionality of the IP itself must change. Instead, the paragraph states “the entity will undertake activities that significantly affect the intellectual property” and that those activities “directly expose the customer to any positive or negative effects of the entity’s activities as those activities occur.”

3. Interpretation C: This interpretation adapts views in Interpretation B, except that the notion of “significant affects the intellectual property” is a high threshold, and not simply more than significant. (ie Logos, Brand names, trade names etc).

Both Boards were mixed on which view best reflected the Boards' intension - however, most members did agree that reading the standard may lead two reasonable people to arrive at different conclusions as to what the model is and which to apply. One TRG member was concerned about clarification because the impacts could shift revenues, in the millions of dollars. Many TRG members thought Interpretation C was the Boards intentions.

The next two issues, 2a and 2b, where discussed together by the TRG, as they weren’t as frequently questioned by constituents.

Issue 2a stated; if a customer is not required to use the most recent version of the underlying IP, do the licensor’s activities directly expose the customer to positive or negative effects of the IP to which the customer has rights? This second criteria, which is in ASC 606-10-55-60 requires that in order for a license to represent a right to access the entity’s IP (revenue recognized over time), the license must directly expose the customer to the positive and negative effects of the licensor’s activities that significantly affect the IP to which the customer has rights. If a customer had the continuing right and ability to use prior versions of the licensed IP, the licensor’s activates would not appear to directly expose the customer to positive or negative effects. This avoidance is because the customer can use prior versions of IP.

Issue 2b states: activities that transfer a good or service that is not separable from the license of IP considered in determining the nature of the license (3rd criteria in ASC 606-10-60(c))? This third criterion must be met in order for a license to represent a right of access (and therefore recognized over time) is that the expected activities of the licensors do not result in the transfer of a good or service to the customer as those activities occur. Constituents have read the basis of conclusion paragraphs 409 and 410, as suggesting that expected activities of a licensor are excluded from the right of use and right of access valuation only if they transfer a separate performance obligation, others however view the guidance in the ASC 606-10-60 explicitly clear.

The staff preparing the agendas believed as a whole that the guidance within the new standard was specifically written. TRG members did not have comments on this section - therefore they decided the two sections within the guidance are operational.

The final issue, Issue 3, within the agenda paper was; can restrictions in a contract for a license of IP affect the determination of whether that contract contains one or multiple licenses when applying Step 2 (identifying performance obligations) of new revenue standards? Paragraph ASC 606-10-55-64 [B62] states that restrictions of time geography or use do not affect the licensor’s determination as to whether the license is satisfied over time or at a point in time. Constituents suggest the standard is unclear about whether in the case of certain restrictions the contract includes a promise to deliver a single license or to deliver multiple licenses (for example, movies that have a right to air at a specific time). TRG believed that there is not enough “distinct” guidance to address the issue.

With 1/1/2015 fast approaching, companies looking to apply the modified retrospective approach are looking for answers to the TRG issues expedited to ensure that their implementation policies are in line with the Boards' intentions.