Stakeholders informed the staff that minimum guarantees are used in license arrangements for intellectual property in which the consideration is in the form of a sales-based or usage-based royalty. The minimum guarantee effectively establishes a floor for the amount of consideration to be paid to the licensor. For example, an arrangement might state that a licensor will receive 10% of a customer’s subsequent sales as consideration, but the minimum amount of consideration will be $1 million. Alternatively, an arrangement might state that the licensor will receive $1 million plus 10% of a customer’s sales in excess of $10 million. For purposes of this Q&A, the term minimum guarantee refers to a contractual clause for fixed consideration that is unconditional.

Stakeholders have informed the staff that there are differing views about how a minimum guarantee impacts the accounting for sales-based or usage-based royalties promised in exchange for a symbolic license of intellectual property. The issue arises because Topic 606 includes a recognition constraint for sales-based or usage-based royalties promised in exchange for a license of intellectual property, but that constraint for royalties does not apply to fixed consideration. In effect, consideration in the form of a sales-based or usage-based royalty with a minimum guarantee includes elements of both fixed and variable consideration.

In contracts that do not include a license of intellectual property and that include variable consideration with a minimum guarantee, the minimum guarantee effectively establishes a floor for an entity’s estimate of the transaction price. However, in those arrangements, an entity would include the estimated variable consideration (subject to the general constraint on variable consideration) in the transaction price. In contrast, for a license of intellectual property, an entity is precluded from recognizing the variable consideration in the form of a sales-based or usage-based royalty before the customer’s subsequent sales or usage occurs because of the guidance in paragraph 606-10-55-65. An entity, however, is not precluded from estimating variable consideration in the form of a sales-based or usage-based royalty for a license of intellectual property in all cases (this is not to say that the estimate can be recognized as revenue, just that it can be estimated for other reasons).

In the staff’s view, Topic 606 does not prescribe a single approach on recognizing revenue for license arrangements of symbolic intellectual property with minimum guaranteed royalties. The standard permits judgment in selecting a measure of progress, as long as the measure of progress is consistent with the guidance in paragraphs 606-10-25-31 through 25-37.

The following example will be used for to illustrate the considerations for a license of symbolic intellectual property:

Minimum guarantees create tension in the application of Topic 606 in accounting for sales- based or usage-based royalties promised in exchange for a symbolic license of intellectual property because of (a) the different recognition models in Topic 606 for fixed consideration and variable consideration in the form of a royalty for a license of intellectual property and (b) the requirement in Topic 606 to select a single measure of progress for each performance obligation. For a contract for symbolic intellectual property that does not include a royalty, the measure of progress for the fixed consideration would likely be based on time elapsed because the customer simultaneously receives and consumes the benefits as the entity performs. For a contract for symbolic intellectual property that only includes a royalty, the variable consideration would be recognized at the later of when the customer’s subsequent sales or usage occurs or when the performance obligation is satisfied (or partially satisfied) in accordance with paragraph 606-10-55-65. For a contract for symbolic intellectual property that includes both fixed and variable consideration, the analysis can be more challenging and require more judgment.

For symbolic licenses of intellectual property with a minimum guarantee, stakeholders have reported two broad approaches for the recognition of sales-based or usage-based royalties.

Under the first approach, an entity would estimate the total consideration (including the fixed consideration and royalties) and apply an appropriate measure of progress to recognize revenue as the entity satisfies the performance obligation (subject to the royalties constraint). An entity might apply the practical expedient in paragraph 606-10-55-18 (P x Q practical expedient) and recognize the royalties as the customer’s sales or usage occurs, or an entity might estimate the consideration (including the fixed consideration and royalties) and apply an appropriate measure of progress (such as time elapsed) to recognize revenue over the term of the license, subject to the royalties constraint. This broad approach is summarized in Views A and B below.

Under the second approach, an entity would apply a measure of progress to the minimum guarantee (fixed consideration) and only recognize the royalties (variable consideration) when the cumulative royalties exceed the minimum guarantee. This approach is summarized in View C.

The following are the views that were discussed by the TRG:

Under View A, if an entity expects total royalties will exceed the minimum guarantee, the entity would recognize revenue from the sales-based or usage-based royalty when the customer’s subsequent sales or usage occurs. An output-based measure, such as the practical expedient in paragraph 606-10-55-18, could be an appropriate measure of progress when the royalties due each period correlate directly with the value to the customer of the entity’s performance to date and the entity expects the royalties will exceed the minimum guarantee. TRG Agenda Ref No. 40, Practical Expedient for Measuring Progress toward Complete Satisfaction of a Performance Obligation, indicated that an entity is not precluded from applying the paragraph 606-10-55-18 practical expedient in certain contracts with a guaranteed minimum if the entity expects to exceed the minimum amount of consideration. This is because a fixed minimum that an entity expects to exceed would not have an impact on the revenue recognition pattern for the selected measure of progress.

In addition, the symbolic license may constitute a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer in accordance with paragraph 606-10-25-14(b). The staff thinks that the performance obligation (the right to access the entity’s intellectual property for a period of time) could be multiple distinct services of providing access each day, week, month, etc. The staff thinks that allocating the royalties to the respective periods in which the customer’s sales occur could be consistent with the allocation objective. In that case, the variable consideration would be allocated to the distinct periods of access in accordance with paragraphs 606-10-32-39(b) and 606-10-32-40.

View A also would comply with the recognition constraint on sales-based royalties in paragraph 606-10-55-65 because the variable amounts are not recognized until the uncertainty is resolved (that is, when the underlying sales or usage occurs). View A applied to Example 1 would result in the following recognition pattern (in 000s):

Under View A, it is important that an entity has an expectation that the total royalties will exceed the guaranteed minimum in order to apply the practical expedient in paragraph 606-10-55-18 or the series allocation guidance in paragraph 606-10-32-40. The practical expedient in paragraph 606-10-55-18 is designed such that an entity would recognize the same (or substantially the same) pattern of revenue as it would if the practical expedient were not applied. In cases in which the total royalties exceed the minimum guarantee, this will hold true. However, in cases in which the total royalties do not exceed the minimum guarantee, an entity would have a true up to the minimum guarantee. In this case, the pattern of revenue recognition would not be consistent with paragraph 606-10-55-18 or the series allocation guidance in paragraph 606-10-32-40.

Stakeholders should evaluate this implementation consideration for View A. A potential resolution to this issue would be for an entity that applies View A to monitor its estimate of total royalties throughout the term of the license to ensure that the application of the practical expedient in paragraph 606-10-55-18 remains appropriate. To the extent there is a change in estimate such that an entity no longer expects total royalties to exceed the minimum, the entity would need to update its measure of progress based on its assessment of value to the customer to date compared to total expected value to the customer (value to the customer could be derived from the customer’s sales or usage).

Under View B, an entity would estimate the total transaction price (including fixed and variable consideration) that will be earned over the term of the license performance obligation and apply an appropriate measure of progress to recognize revenue for the performance obligation, subject to the restriction that the cumulative revenue recognized cannot exceed the cumulative royalties once the minimum guarantee has been met. View B applied to Example 1 would result in the following recognition pattern when using a time elapsed measure of progress (in 000s and assume that the entity’s estimate of the transaction price is $8.25 million):

Under View B, because an element of the consideration is fixed (that is, the amount up to $5 million), an entity might recognize revenue in advance of the royalty from a customer’s subsequent sales. This is illustrated in Years 1 to 3 where the annual revenue is $1.65 million in each year based on straight line recognition of the total estimated transaction price of $8.25 million, however, the royalties received at the end of Year 3 are $4.25 million. Once the minimum guarantee is met (that is, once there is no longer fixed consideration), the remaining consideration is variable, and an entity would be precluded from recognizing revenue for those sales-based royalties in advance of the underlying sales. This is illustrated in Year 4 when the annual revenue is constrained to $0.3 million because the cumulative revenue is constrained to $5.25 million (the total royalties received to date).

View B is intended to reflect an entity’s efforts to satisfy a performance obligation over time. If an entity did not expect that the total royalties will exceed the minimum guarantee, then the measure of progress would be applied to the minimum guarantee because the transaction price cannot be lower than the fixed amount. Because View B uses an estimate of the transaction price, that estimate would need to be updated each reporting period. Changes to the transaction price would be allocated to the partially satisfied performance obligation, subject to the constraint on cumulative royalties described above.

Under View C, the minimum guarantee is deemed to be fixed consideration and the variable consideration is only the amount in excess of the minimum guarantee. Some stakeholders are of the view that at the inception of the arrangement, only the minimum guarantee may be recognized as the entity satisfies the performance obligation because the royalties (that is, the consideration that is truly variable) cannot be recognized until the later of when subsequent sales or usage occurs or when the performance obligation has been satisfied (or partially satisfied). In Example 1, the $5 million minimum guarantee is deemed fixed consideration and the variable consideration is only the royalties in excess of the minimum, or $3.25 million.

Under View C, the recognition constraint on sales-based or usage-based royalties precludes the recognition of any amounts of variable consideration until the cumulative royalties exceed the minimum guarantee. An entity would apply a measure of progress to the minimum guarantee because only the minimum guarantee can be recognized until the royalty becomes unconstrained (that is, the minimum has been exceeded on a cumulative basis). In Example 1, assuming a time elapsed measure of progress is selected, an entity would recognize $1 million per year related to the minimum guarantee.

Under View C, the variable consideration only includes the royalties in excess of the minimum guarantee, and those royalties are constrained from being recognized until the customer’s subsequent sale or usage occurs. In order to apply View C, the symbolic license would be considered a series of distinct goods or services (that is, a series of distinct time periods) and the variable consideration (the royalties in excess of the minimum guarantee) would be allocated to the distinct time periods to which they relate. The variable consideration would be recognized in the period in which it can be allocated to the distinct time periods to which it relates. View C applied to Example 1 would result in the following recognition pattern (in 000s):

Under View C, an entity does not begin to recognize any variable consideration until the royalties received exceed $5 million on a cumulative basis because the variable consideration is only the amount in excess of the minimum guarantee of $5 million. Therefore, in Years 1 to 3, an entity would only recognize the $1 million per year related to the time elapsed measure of progress for the minimum guarantee, even though cumulative royalties at the end of year 3 are $4.25 million. In Year 4, cumulative royalties are $5.25 million and the variable consideration of $0.25 million (the difference between $5.25 million and $5 million) is allocated to Year 4 because this is the time period in which the customer’s subsequent sales occurred for the $0.25 million in variable consideration. Therefore, the variable consideration meets the series allocation criteria in paragraph 606-10-32-40. In Year 5, the entity recognizes $1 million from the minimum guarantee and $3 million in variable consideration representing the difference between $8.25 million and $5.25 million.

TRG members generally agreed that Views A, B, and C are all reasonable applications of Topic 606 depending upon facts and circumstances. However, TRG members acknowledged that there could be other acceptable applications that were not included in TRG Agenda Ref 58. TRG members observed that the revenue recognition for a license of symbolic intellectual property must be in accordance with various aspects of Topic 606, including but not limited to the following provisions:

The staff is aware of certain recognition models that it does not think would be reasonable applications of Topic 606. For instance, it would not be appropriate to apply multiple measures of progress to a single performance obligation, such as one measure for fixed consideration and a different measure for variable consideration. The staff also does not think it would be appropriate to purely apply the breakage model in paragraph 606-10-55-48 because a customer might not have an unexercised right in a license arrangement if the entity is providing the customer with access to its intellectual property over the entire term of the arrangement. Also, an approach that ignores that the royalties recognition constraint in paragraph 606-10-55-65 includes guidance about recognizing revenue at the later of two events would not be appropriate (see paragraph BC71 in Accounting Standards Update No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, for an example about a declining royalty rate).

The staff reminds stakeholders that Topic 606 requires an entity to disclose the significant judgments made in applying the guidance that significantly affect the determination of the amount and timing of revenue from contracts in customers. An entity is required to disclose the methods used to recognize revenue in accordance with paragraph 606-10-50-18 as well as information about significant payment terms, the timing of satisfaction of performance obligations, the methods, inputs and assumptions used for determining the transaction price and changes in the transaction price (paragraph 606-10-50-20).