IFRS 15 Royalty income intellectual property provides application guidance on the recognition of revenue for sales-based or usage-based royalties on licences of intellectual property, which differs from the requirements that apply to other revenue from licences.
IFRS 15 B63 requires that royalties received in exchange for licences of intellectual property are recognised at the later of when:
(a) The subsequent sale or usage occurs.
(b) The performance obligation to which some or all of the sales-based or usage-based royalty has been allocated is satisfied (or partially satisfied).
Royalties revenue recognition
That is, an entity recognises the royalties as revenue for such arrangements when (or as) the customer’s subsequent sales or usage occurs, unless that pattern of recognition accelerates revenue recognition ahead of the entity’s satisfaction of the performance obligation to which the royalty solely or partially relates, based on an appropriate measure of progress.
Sales or usage based
For a licence of intellectual property for which the consideration is based on the customer’s subsequent sales or usage, an entity does not recognise any revenue for the variable amounts until the uncertainty is resolved (i.e., when a customer’s subsequent sales or usage occurs). [IFRS 15 BC219]
The application guidance in IFRS 15 B63-B63B addresses the recognition of sales-based or usage-based royalties received in exchange for a licence of intellectual property, rather than when such amounts are included in the transaction price of the contract. [IFRS 15 BC421L] As a result, this exception is a recognition constraint and the constraint on variable consideration does not apply. Royalty income intellectual property Royalty income intellectual property
Royalty recognition constraint
The royalty recognition constraint was added because both users and preparers of financial statements indicated that it would not be useful for entities to recognise a minimum amount of revenue for sales-based or usage based royalties received in exchange for licences of intellectual property (following the requirements in the general model on estimating the transaction price).
Requires significant revenue adjustments
That approach would inevitably require the entity to report significant adjustments to the amount of revenue recognised throughout the life of the contract as a result of changes in circumstances that are not related to the entity’s performance. It was considered that this would not result in relevant information, especially for contracts in which the sales-based or usage-based royalties are paid over a long period of time. [IFRS 15 BC415] Royalty income intellectual property
The following decision tree illustrates an entity’s evaluation when determining whether the royalty recognition constraint should be applied to a royalty stream:
Document your decisions in your financial close file to facilitate internal review and approval and external audits.
IFRS 15 provides the following example of a contract that includes two performance obligations, including a licence that provides a right to use the entity’s intellectual property and consideration in the form of sales-based royalties. In the example, the licence is determined to be the predominant item to which the royalty relates, see example 60 IFRS 15 IE307 – IE308.
As illustrated in Example 60, IFRS 15 B63B requires that, when the royalty recognition constraint is applied, the royalty stream must be accounted for either entirely under the royalty recognition constraint or entirely under the general variable consideration constraint requirements. That is, an entity would not split a single royalty and apply the royalty recognition constraint to a portion of the sales-based royalty and the general constraint requirements for variable consideration to the remainder.
General requirements for variable consideration
Regardless of whether an entity applies the royalty recognition constraint or the general requirements for variable consideration, it is still required to allocate sales-based or usage-based royalties to separate performance obligations in a contract (as noted in Example 60 above).
Need to include expected royalties
In order to perform such an allocation, an entity may need to include expected royalties in its estimate of the stand-alone selling price of one or more of the performance obligations. Example 35 (IFRS 15 IE178 – IE187) from the standard also illustrates the allocation of the transaction price (including sales-based or usage-based royalties) to the performance obligations in the contract. Royalty income intellectual property
See also: The IFRS Foundation