Licenses of intellectual property: right to use, right to access and royalties

• Determine whether a license is distinct from other promises in the contract
• Classify intellectual property as functional or symbolic
• Apply the point-in-time and over-time patterns to licenses
• Apply the sales- or usage-based royalty exception and the renewal timing rule

Is the license distinct

Start with step 2. A license is often bundled with services: installation, customization, hosting, updates or support. If the license is not distinct, the entity accounts for the combined performance obligation and applies the licensing guidance only to the extent needed to decide the pattern of transfer for the bundle. A license that is an input to a combined output (for example, software that only works with significant customization the entity is providing) is not distinct.

Functional or symbolic

ASU 2016-10 sorted intellectual property into two types:

• Functional IP has significant standalone functionality, such as the ability to process a transaction, perform a task, or be played or aired. Software, films, music and drug formulas are common examples. The customer gets most of the value from that functionality.
• Symbolic IP is everything else: brands, trade names, logos, franchise rights, sports team names. Its utility comes from the entity's past or ongoing activities that support the name.

Timing for each

Symbolic IP gives the customer a right to access the IP, satisfied over time because the customer simultaneously receives and consumes the benefit of the entity's continuing support. The entity picks a measure of progress, often time elapsed.

Functional IP gives a right to use the IP as it exists when the license is granted, satisfied at a point in time, unless both of these are met:

• the functionality is expected to change substantively during the license period because of entity activities that do not transfer a separate good or service; and
• the customer is contractually or practically required to use the updated IP.

When both are met (rare in practice), the license is a right to access, recognized over time. Software updates that the customer can choose to install are separate promises, not a reason to treat the license as over time.

The start of the license period

Under 606-10-55-58C, revenue for a license cannot be recognized before both:

• the entity provides (or otherwise makes available) a copy of the IP to the customer; and
• the period begins during which the customer can use and benefit from the license.

This drives renewal timing. If a customer signs a renewal of a three-year term license in October for a period that starts in January, revenue for the renewal is not recognized until January, even though the customer already has the software.

Restrictions are attributes, not promises

Contract terms that restrict time, territory or use define the attributes of a single license. They do not create extra performance obligations. A promise to defend a patent is also not a separate performance obligation. Contrast terms that require the entity to transfer additional rights, such as rights to a second territory starting next year, which are separate promises.

Sales-based and usage-based royalties

Under 606-10-55-65, a sales-based or usage-based royalty promised in exchange for a license of IP is recognized only when (or as) the later of these occurs:

• the subsequent sale or usage occurs; or
• the performance obligation to which the royalty is allocated has been satisfied (or partially satisfied).

This exception replaces the general variable consideration estimate and constraint for those royalties. It applies when the license is the predominant item to which the royalty relates. Minimum guarantees are fixed consideration and are recognized under the normal model.

Audit focus

Read the license and the related statements of work together. Test the start date of each license period against delivery evidence (keys, download logs). For royalty revenue, obtain licensee reports and compare them to cash receipts and contractual rates. The software licensing guide and the franchisor guide apply these rules.

A term software license with a royalty and a renewal