The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are still working on refining their recent revenue recognition standard, now expected to become effective for most public companies in 2018. It became clear during the recent Joint Transition Resource Group (TRG) discussions that the standard could use some clarification in one particular area: how to recognize revenue on license agreements.
Licenses are prevalent in a number of industries, but can vary greatly from one to the next. As a result, the standard setters agreed that it is appropriate to record revenue from some licenses over time and from others at a point in time.
Distinguishing between when an entity must recognize revenue from a license over time -- or at a point in time -- can be a challenge. Generally, an entity must recognize revenue from a license when or as control of the right to the intellectual property transfers. In order to assist with this determination, Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (as well as IFRS 15), introduced a distinction between dynamic and static intellectual property. The distinction is based on whether the customer has a right to the intellectual property with all of the changes the vendor may have made at the time of access, or whether it can only use it in its shape and form at the time of the contract. Constituents raised a number of issues related to this distinction with the TRG. In particular, a number of questions were geared towards the nature of activities that a licensor must undertake to support a license of intellectual property. Such activities could change the physical form and functionality of the intellectual property, but could also affect its value.
To address the issues that were raised, in Proposed Accounting Standards Update (ASU) No. 2015-250, Revenue from Contracts with Customers (Topic 606)—Identifying Performance Obligations and Licensing, the FASB proposed a new distinction: the timing of revenue recognition would depend on whether the license relates to a functional intellectual property or a symbolic one.
Are you licensing functional or symbolic intellectual property? The proposed consequences for revenue recognition
A license of functional intellectual property grants the customer the right to use the intellectual property without the seller having to provide ongoing maintenance or support to provide value to the customer. A functional intellectual property has value by itself in its current form. Examples of functional intellectual property include software that allows a user to process a transaction (a point-of-sale application in the restaurant industry, for instance), and a television program ready for broadcast in the entertainment industry. Because this type of license does not require the licensor to provide any additional goods or services to complete its performance obligation, revenue from functional intellectual property is generally recognized at a point in time when control is transferred to the user.
A license of symbolic intellectual property grants the customer the right to access the intellectual property as it stands at any point in time throughout the license period. This type of intellectual property requires the seller to support or maintain the value of the property through ongoing activities or the property will lose its value for the users. Examples of symbolic intellectual property are brands, team names, logos, and franchise rights. A baseball team, for instance, loses its value if the team does nothing to maintain its fan base. Its logo, for instance, would not be as valuable to those who license it. Because this type of license requires the licensor to perform additional activities to complete its performance obligation, revenue from symbolic intellectual properties is generally recognized over time.
The IASB has not proposed a similar distinction between functional and symbolic intellectual property. Instead, the IASB is proposing to clarify which activities significantly affect the intellectual property. In the IASB’s proposal, an intellectual property is not significantly affected by activities of the licensor unless they:
- Change the form or functionality of the property for the user, or
- Modify the ability of the user to obtain benefit from the property.
While not intended to be widely different in practice, these different proposals by the FASB and the IASB may result in different interpretations and result in similar fact patterns being accounted for differently. Ultimately, both sets of proposed changes leave significant room for judgment.
In addition to the clarification of the nature of the intellectual property being licensed, the Boards also proposed clarifications on the guidance for sales-based or usage-based royalty and its interaction with the rules for variable consideration. The rules for sales and usage-based royalties would be used when the predominant item to which the royalty relates is a license of intellectual property. If the predominant item to which the royalty relates is something else, an entity would apply the rules for variable consideration. The appropriate guidance would then be applied to the royalty in its entirety.
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