A licensor grants a customer a license to functional intellectual property in exchange solely for a 3% royalty on the customer's monthly sales of products that embed the licensed technology. The license itself is a single performance obligation satisfied at a point in time, and that point in time occurred before the first month in which the customer generates any sales subject to the royalty. Under ASC 606-10-55-65, when should the licensor recognize revenue for the royalty owed on a given month's sales?
- In the month the customer's sales giving rise to the royalty actually occur, because the license performance obligation was already satisfied before the royalty accrues, so the later of the two required events is the occurrence of the underlying sales
- At contract inception, by estimating and constraining a royalty amount using the general variable consideration guidance applicable to other forms of variable consideration
- Ratably over the license term regardless of when the customer's sales actually occur in any given month
- Only when the licensor actually collects cash for the royalty, regardless of when the customer's underlying sales occurred
Why A? And why not the others?
Correct answer: A. In the month the customer's sales giving rise to the royalty actually occur, because the license performance obligation was already satisfied before the royalty accrues, so the later of the two required events is the occurrence of the underlying sales
ASC 606-10-55-65 creates a specific exception for a sales-based or usage-based royalty promised in exchange for a license of intellectual property: the licensor recognizes revenue only when, or as, the later of the underlying sale or usage occurring and the related performance obligation being satisfied or partially satisfied. Since the license performance obligation here was already satisfied at a point in time before any royalty-bearing sales occurred, the later of the two events in any given month is the occurrence of that month's sales, so revenue is recognized as those sales happen. Estimating and constraining the royalty at contract inception under the general variable consideration guidance is exactly what this exception overrides; the royalty exception exists precisely so that sales- or usage-based royalties tied to a license of intellectual property are not estimated in advance the way other variable consideration is. Recognizing the royalty ratably over the license term ignores that the royalty is contractually tied to actual sales volumes, which typically do not occur evenly, and the standard ties recognition to when the sales actually occur, not to a straight-line pattern. Waiting until cash is collected would apply cash-basis timing to an accrual-based standard; ASC 606-10-55-65 ties recognition to when the underlying sale or usage occurs, not to when payment is received.
Source: FASB Accounting Standards Codification: ASC 606-10-55-65, Revenue from Contracts with Customers — Sales-Based or Usage-Based Royalties