1. Some stakeholders informed the staff that there are questions about the guidance in Accounting Standards Updates No. 2014-09, Revenue from Contracts with Customers (Topic 606) and No. 2016-10, Identifying Performance Obligations and Licensing (the new revenue standard), for determining how to account for a sales-based or usage-based royalty promised in exchange for a license of intellectual property that includes a minimum guaranteed amount. Specifically, those stakeholders question whether and how the guaranteed minimum impacts the application of the recognition constraint for sales-based or usage-based royalties for licenses of intellectual property.

2. This paper summarizes the implementation questions that were reported to the staff. The staff will seek input from members of the Transition Resource Group for Revenue Recognition (TRG) on the implementation questions.

3. A license establishes a customer’s rights to the intellectual property of an entity. Licenses of intellectual property may include, but are not limited to, licenses of any of the following:

4. Topic 606 includes guidance for determining whether a license transfers to a customer at a point in time or over time based on the nature of the entity’s promise to the customer.

5. Stakeholders have informed the staff that minimum guarantees are used in license arrangements 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 paper, the term minimum guarantee refers to a contractual clause for fixed consideration that is unconditional.

6. In some cases, the minimum guarantee is negotiated due to uncertainty about the customer’s performance and its ability to successfully exploit the intellectual property. In other cases, the minimum guarantee is established as a cash flow management tool to provide the licensor with predictable timing of some of the cash flows under the contract. For example, the contract might establish a minimum amount of consideration that is payable to the licensor in installments over the term of the license period. The minimum amount could also be paid at the beginning of the license period, or settled at the end of the license period in the event the sales-based or usage-based royalty is lower than the guaranteed amount.

7. 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.

8. Paragraph 606-10-55-65 provides an exception to the general guidance on the recognition of variable consideration for sales-based or usage-based royalties promised in exchange for a license of intellectual property.

9. 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. 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).

10. For purposes of illustrating the stakeholder views, the following example will be used for a license of symbolic intellectual property:

11. Minimum guarantees create tension in the application of the new revenue standard 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 the new revenue standard for fixed consideration and variable consideration in the form of a royalty for a license of intellectual property and (b) the requirement in the new revenue standard 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.

12. 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.

13. The relevant accounting guidance for measuring progress and allocating variable consideration to a series of distinct goods or services is included in Appendix A.

14. 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 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.

15. 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.

16. 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):

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17. 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.

18. 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).

19. 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):

20. 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).

21. 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.

22. 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.

23. 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.

24. 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):

25. 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.

26. In the staff’s view, the new revenue 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 license of intellectual property and the contract includes a minimum guaranteed amount. In the staff’s view, the question raised in this paper is about selecting an appropriate measure of progress. The new revenue standard permits judgment in selecting a measure of progress (with some boundaries). As previously discussed with the TRG, sometimes it will be challenging to select an appropriate measure of progress for each performance obligation, just like it sometimes is challenging to select an appropriate measure of progress under current GAAP.

27. In the staff’s view, the two broad views (and the more specific Views A, B, and C) described above are reasonable interpretations of the new revenue standard. An entity should consider the nature of their arrangements and ensure that the measure of progress that it selects does not override the core principle of the new revenue standard that “an entity shall recognize 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.”

28. The staff thinks it is possible that there could be other measures of progress that would be reasonable interpretations of the new revenue standard that were not reported to that staff by the parties that submitted this issue to the TRG. The staff’s point is not that any measure of progress is acceptable in any circumstance; instead, the staff’s point is that the Board clearly decided to permit judgment in selecting an appropriate measure of progress and that judgment is not necessarily limited to the views in this paper. Stakeholders applying other measures of progress should carefully evaluate those approaches for compliance with the new revenue standard. A few key pieces of guidance in the new revenue standard to consider include:

29. The staff is aware of certain recognition models that it does not think would be reasonable applications of the new revenue standard. 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 ASU No. 2016-10 for an example about a declining royalty rate).

30. The staff reminds stakeholders that the new revenue standard requires an entity to disclose the significant judgments made in applying the guidance in Topic 606 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. Below are some of the disclosure requirements.

31. 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 license of functional intellectual property. In contrast to symbolic intellectual property, a promise to provide a customer with the right to use functional intellectual property is satisfied at a point in time. The question is whether a guaranteed amount of royalties for a license of functional intellectual property should be recognized at the point in time that control of the license is transferred to the customer.

32. Stakeholders who support View A think that the minimum guarantee should be treated as fixed consideration and recognized at the point in time when the license transfers to the customer. View A proponents consider this treatment to be similar to a license of functional intellectual property that has a fixed fee only, in which the revenue is recognized at the point in time the license is transferred to the customer. Proponents of View A believe that there is no uncertainty with regard to the minimum guarantee amount, unlike a royalty which is uncertain prior to the point at which the customer’s subsequent sales or usage occurs. In addition, because functional intellectual property is recognized at a point in time, View A proponents think that the consideration that is fixed should be recognized when the performance obligation is satisfied. Under View A, the variable consideration (the royalties above the fixed minimum) would be recognized in accordance with the royalties recognition constraint in paragraph 606-10-55-65.

33. Stakeholders who support View B think that the minimum guarantee does not change the nature of the consideration, which is in the form of a sales-based or usage-based royalty. Proponents of View B think that the royalties recognition constraint should apply to all licenses of intellectual property, regardless of whether there is a minimum guaranteed amount. These stakeholders highlight the discussion in the basis for conclusions in paragraph BC415 of Update 2014-09:

34. Proponents of View B think that recognition of the minimum guarantee upfront distorts the pattern or revenue recognition and results in an inconsistency as compared with licenses of functional intellectual property that do not include a minimum guarantee.

35. In the staff’s view, View A is the appropriate application of the new revenue standard. A guaranteed amount is not variable consideration; therefore, it is not subject to the royalties recognition constraint. Under the new revenue standard, a performance obligation to transfer a license for functional intellectual property is satisfied at a point in time. Consequently, the fixed consideration is recognized when an entity transfers control of the license. However, the variable consideration in the form of a royalty (that is, the amount above the fixed consideration) is recognized in accordance with the royalties recognition constraint.

36. Some stakeholders have raised concerns about the staff’s view because they note operational challenges could exist, particularly in circumstances in which one overall guaranteed minimum in a contract applies to multiple performance obligations (for example, multiple licenses of intellectual property that are accounted for as separate performance obligations). The staff acknowledges the potential operational challenges with the allocation of a guaranteed minimum and has discussed those concerns with the Board. Allocation questions are outside the scope of this TRG submission, however, the staff is available to discuss those questions with interested stakeholders.

606-10-25-31 For each performance obligation satisfied over time in accordance with paragraphs 606-1025-27 through 25-29, an entity shall recognize revenue over time by measuring the progress toward complete satisfaction of that performance obligation. The objective when measuring progress is to depict an entity’s performance in transferring control of goods or services promised to a customer (that is, the satisfaction of an entity’s performance obligation).

606-10-25-32 An entity shall apply a single method of measuring progress for each performance obligation satisfied over time, and the entity shall apply that method consistently to similar performance obligations and in similar circumstances. At the end of each reporting period, an entity shall remeasure its progress toward complete satisfaction of a performance obligation satisfied over time.

606-10-25-33 Appropriate methods of measuring progress include output methods and input methods. Paragraphs 606-10-55-16 through 55-21 provide guidance for using output methods and input methods to measure an entity’s progress toward complete satisfaction of a performance obligation. In determining the appropriate method for measuring progress, an entity shall consider the nature of the good or service that the entity promised to transfer to the customer.

606-10-25-34 When applying a method for measuring progress, an entity shall exclude from the measure of progress any goods or services for which the entity does not transfer control to a customer. Conversely, an entity shall include in the measure of progress any goods or services for which the entity does transfer control to a customer when satisfying that performance obligation.

606-10-25-35 As circumstances change over time, an entity shall update its measure of progress to reflect any changes in the outcome of the performance obligation. Such changes to an entity’s measure of progress shall be accounted for as a change in accounting estimate in accordance with Subtopic 250-10 on accounting changes and error corrections.

606-10-55-17 Output methods recognize revenue on the basis of direct measurements of the value to the customer of the goods or services transferred to date relative to the remaining goods or services promised under the contract. Output methods include methods such as surveys of performance completed to date, appraisals of results achieved, milestones reached, time elapsed, and units produced or units delivered. When an entity evaluates whether to apply an output method to measure its progress, the entity should consider whether the output selected would faithfully depict the entity’s performance toward complete satisfaction of the performance obligation. An output method would not provide a faithful depiction of the entity’s performance if the output selected would fail to measure some of the goods or services for which control has transferred to the customer. For example, output methods based on units produced or units delivered would not faithfully depict an entity’s performance in satisfying a performance obligation if, at the end of the reporting period, the entity’s performance has produced work in process or finished goods controlled by the customer that are not included in the measurement of the output.

606-10-55-18 As a practical expedient, if an entity has a right to consideration from a customer in an amount that corresponds directly with the value to the customer of the entity’s performance completed to date (for example, a service contract in which an entity bills a fixed amount for each hour of service provided), the entity may recognize revenue in the amount to which the entity has a right to invoice.

606-10-32-39 Variable consideration that is promised in a contract may be attributable to the entire contract or to a specific part of the contract, such as either of the following:

606-10-32-40 An entity shall allocate a variable amount (and subsequent changes to that amount) entirely to a performance obligation or to a distinct good or service that forms part of a single performance obligation in accordance with paragraph 606-10-25-14(b) if both of the following criteria are met:

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