Finishing strong in the ASC 606 marathon: An in-depth look at licensing, modifications, and other potential hurdles

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Original Publication Date: June 13, 2017 CPE

1 Finishing strong in the ASC 606 marathon: An in-depth look at licensing, modifications, and other potential hurdles Please disable popup blocking software before viewing this webcast Original Publication Date: June 13, 2017 CPE Credit is not available for viewing archived programs

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2 CPE Reminders To receive CPE, you must be active for the entire webcast and respond to at least 75% of the polls. You will have 90 seconds to answer each poll. CPE is not offered for audio-only attendees or replay viewing. Group participation will not receive CPE. You must be logged in individually to receive CPE credit. Upon conclusion of the program, please complete the final evaluation and your CPE certificate will be available if you have met the minimum CPE requirements. Turn off all pop-up blockers to download your CPE certificate. Use Q&A to ask questions during the webcast. Grant Thornton LLP. All rights reserved. 2

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3 For a Better Webcast Experience Use a wired internet connection from your local office and turn off your computer's Wi-Fi signal. For optimal viewing speed, close all other applications, including Outlook. Most technical issues (e.g., buffering, silenced audio) can be resolved by refreshing your feed using the F5 key. Use the Help button if you have technical difficulties. You can also call or contact GTWebcast@Level3.com Click the Resources button to download the presentation materials. Grant Thornton LLP. All rights reserved. 3

Speakers Lynne Triplett Partner Accounting Principles +1 312 602 8060

com Sheri Fabian Partner Accounting Principles +1 732 516 5543 sheri.

5 Finishing strong in the ASC 606 marathon webcast series Part 1 An in-depth look at designing for success (April 18) Part 2 Steps 1 and 2 of the new revenue model (April 26) Part 3 Steps 3 and 4 of the new revenue model (May 10) Part 4 Step 5 and contract costs (May 23) Listen to the replay of prior events Register for future Grant Thornton webcasts grantthornton.com > Events Part 5 - Licensing, modifications, and other potential hurdles June 13, :30 p.m. CT 1.5 CPE hours Grant Thornton LLP. All rights reserved. 5

Learning objectives Differentiate functional and symbolic intellectual property Apply the sales-based and usage-based royalties guidance Identify contract modifications in

6 Learning objectives Differentiate functional and symbolic intellectual property Apply the sales-based and usage-based royalties guidance Identify contract modifications in ASC 606 and link to the appropriate accounting treatment Assess whether an entity is acting as principal or agent in a transaction Grant Thornton LLP. All rights reserved. 6

Agenda Licensing Sales-based and usage-based royalties guidance Contract modifications

8 Resources Joint Transition Resource Group for Revenue Recognition (TRG) FASB.org > Standards > Revenue Recognition Transition Resource Group AICPA Revenue Recognition Industry Task Forces AICPA.org > Interest Areas > FRC > Accounting & Financial Reporting > Revenue Recognition Grant Thornton LLP. All rights reserved. 8

11 Functional versus symbolic IP Functional IP Symbolic IP Right to use IP that has significant standalone functionality Right to access IP that does not have significant stand-alone functionality Grant Thornton LLP. All rights reserved. 11

13 Functional versus symbolic IP N Does the IP have significant stand-alone functionality? Y Symbolic IP (trade name, brand, team name) Functional IP (software and media content) Y 1. Functionality expected to substantially change due to entity's actions that do not transfer a promised good/service and 2. Customer contractually or practically required to use the updated IP N Over time Point in time Grant Thornton LLP. All rights reserved. 13

14 Measuring Progress Are licenses for symbolic IP always recognized based on time elapsed? Should not default to a straight-line revenue attribution method if such an attribution would not depict the entity's performance of satisfying the performance obligation. Grant Thornton LLP. All rights reserved. 14

Identifying when licenses are distinct NOT distinct if the IP is a

functionality of the good Software and hardware substantively

distinct if the IP provides additive functionality Software is not

15 Identifying when licenses are distinct NOT distinct if the IP is a component of a tangible good and is integral to the essential functionality of the good Software and hardware substantively contribute to each other's functionality (two-way dependency) IS distinct if the IP provides additive functionality Software is not essential to the hardware's functionality Grant Thornton LLP. All rights reserved. 15

16 Identifying when licenses are distinct Antivirus software and related updates Not distinct due to the rapid changes and the need for the customer to have current updates License to existing IP and right to any future updates Drug compound with research and development Distinct updates are not essential to the functionality of the IP It depends can the customer benefit from the license without the services? Grant Thornton LLP. All rights reserved. 16

Y Y Creates an obligation for the entity to transfer additional rights to use/access its IP (evaluate as a separate promise)

17 Contractual restrictions Do the restrictions require an entity to transfer control of additional goods/services to a customer? OR Do the restrictions define the attributes of a single promised license? Y Y Creates an obligation for the entity to transfer additional rights to use/access its IP (evaluate as a separate promise) Does not create an obligation for the entity to transfer additional rights to use/access its IP (do not evaluate as a separate promise) Grant Thornton LLP. All rights reserved. 17

18 Contractual restriction Example Separate promise or attribute? Establishes the amount the customer may use the license A radio company licenses a song for use 3 times a week for a one-year period Attribute Defines the jurisdiction in which the customer may use the license Expands the rights provided under the license over the contractual period Expands the scope of the rights over the contractual period The licensee may use the patent in the U.S. only from January 1, 2017 through December 31, 2017 The software licensee is granted access for 10 users from January 1, 2017 through December 31, 2017, and 20 users from January 1, 2018 through December 31, 2018 The licensee may use the patent in the U.S. from January 1, 2017 through December 31, 2017, and in the UK as well as the U.S. from January 1, 2018 through December 31, 2018 Attribute Separate Promise Separate Promise Grant Thornton LLP. All rights reserved. 18

Example Contractual restrictions Adapted from ASC 606 Example 61B On December 15, 2016, an entity enters into a contract with a customer that permits the customer to embed the entity's functional IP

19 Example Contractual restrictions Adapted from ASC 606 Example 61B On December 15, 2016, an entity enters into a contract with a customer that permits the customer to embed the entity's functional IP into two classes of the customer's consumer products (Class 1 and Class 2) for five years beginning on January 1, 2017 During 2017, the customer is permitted to embed the IP in Class 1 and beginning in 2018, the customer can embed the IP in Class 2 The entity provides the IP to the customer on December 20, 2016 Question Did the entity grant: A. A promise for a license that has an attribute that restricts the customer from embedding the IP in Class 2 until 2018? B. Two promises a license for a right to embed IP into Class 1 for 5 years and a right to embed the entity's IP in Class 2 for 4 years? Grant Thornton LLP. All rights reserved. 19

20 License renewals Revenue from a license of IP cannot be recognized before both: An entity provides or makes a copy of the IP available to the customer The beginning of the period during which the customer is able to use and benefit from its right to use or right to access the IP That is, an entity would not recognize revenue before the beginning of the license period, even if the entity provides a copy of the IP before the start of the license period. Grant Thornton LLP. All rights reserved. 20

Example License renewals ASC 606 Example 59 Case B: Two-year license for a recording of a classical symphony to a customer beginning 1/1/17 $240,000 ($10,000/month) recorded on 1/1/17 for functional

21 Example License renewals ASC 606 Example 59 Case B: Two-year license for a recording of a classical symphony to a customer beginning 1/1/17 $240,000 ($10,000/month) recorded on 1/1/17 for functional IP satisfied at a point in time On December 31, 2017, the entity and customer agree to renew the license for two additional years subject to the same terms and conditions Q. When should the entity recognize the $240,000 for the renewal? A. December 31, 2017 B. January 1, 2019 Grant Thornton LLP. All rights reserved. 21

23 Sales-based and usage-based royalties exception Recognize revenue for a sales-based or usage-based royalty promised in exchange for a license of intellectual property only when (or as) the later of the following events occurs: (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 has been satisfied (or partially satisfied) Do not analogize! Apply this guidance when royalty relates only to a license of IP or when the IP license is the predominant item to which the royalty relates. Grant Thornton LLP. All rights reserved. 23

24 Example Applying the sales-based and usage-based guidance Sports Team licenses the use of their name and logo to a customer, Chicago Sports Outfitters Right to use Sports Team s name/logo on merchandise for one year beginning on 1/1/X8 Sports Team will receive a royalty of 5% of the sales price of any items using the team name or logo Sports Team estimates they will receive the following royalty payments (in millions): Jan Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec Total $10 $15 $15 $10 $12 $9 $12 $14 $12 $10 $16 $9 $144 How should Sports Team account for the royalties? A. Recognize revenue as the customer s subsequent sales occur B. Recognize $12M each month of the license period C. Recognize $144M in revenue on 1/1/X8 Grant Thornton LLP. All rights reserved. 24

Example royalties exception Marquis Movie Company enters into a contract with the city of Chicago to license a movie series for showing in Grant Park throughout the summer.

25 Example royalties exception Marquis Movie Company enters into a contract with the city of Chicago to license a movie series for showing in Grant Park throughout the summer. In addition, Marquis agrees to sponsor radio advertisements on local radio stations for the movies being played in Grant Park. In exchange, Marquis receives a portion of the city's ticket sales to the summer movie series. Does the sales-based and usage-based royalties exception apply? Grant Thornton LLP. All rights reserved. 25

Royalties data on a lag Q3 Q4 6/30/X7 9/30/X7 12/31/X7 Q3 sales data

27 Royalty payments with a fixed minimum Five-year arrangement to license a trademark (IP). Customer pays a sales-based royalty of 5% of the customer's gross sales associated with the trademark. Guaranteed minimum of $5 million for the entire five-year period. Q. How does a minimum guarantee impact the recognition of a sales-based or usagebased royalty in exchange for a license of symbolic IP? The customer s actual gross sales associated with the trademark and the related royalties each year are as follows: Year Sales Royalties 1 $15 million $750, million 1.5 million 3 40 million 2 million 4 20 million 1 million 5 60 million 3 million Total $165,000,000 $8,250,000 Grant Thornton LLP. All rights reserved. 27

28 Example Royalty payments with a fixed minimum How should the entity recognize revenue for the license of symbolic IP in exchange for a sales-based royalty, subject to a minimum guarantee? A. Because the entity expects the total royalties to exceed the minimum guarantee, it can recognize revenue from the royalties when the subsequent sales occur. B. The entity estimates the total transaction price (including both fixed and variable consideration) and recognizes revenue using an appropriate measure of progress subject to the royalties constraint. C. The 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. D. Any of the above methods could be appropriate depending on facts and circumstances. Grant Thornton LLP. All rights reserved. 28

29 Example Royalty payments with a fixed minimum Approach A: Because the entity expects the total royalties to exceed the minimum guarantee, it recognizes revenue from the royalties when the subsequent sales occur. Year 1 Year 2 Year 3 Year 4 Year 5 Total Royalties received 750 1,500 2,000 1,000 3,000 8,250 Annual revenue 750 1,500 2,000 1,000 3,000 8,250 Cumulative revenue 750 2,250 4,250 5,250 8,250 Grant Thornton LLP. All rights reserved. 29

30 Example Royalty payments with a fixed minimum Approach B: The entity estimates the total transaction price (including both fixed and variable consideration) and recognizes revenue using an appropriate measure of progress subject to the royalties constraint. Year 1 Year 2 Year 3 Year 4 Year 5 Total Royalties received 750 1,500 2,000 1,000 3,000 8,250 Annual revenue 1,650 1,650 1, ,000 8,250 Cumulative revenue 1,650 3,300 4,950 5,250 8,250 Grant Thornton LLP. All rights reserved. 30

31 Example Royalty payments with a fixed minimum Approach C: The 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. Year 1 Year 2 Year 3 Year 4 Year 5 Total Royalties received 750 1,500 2,000 1,000 3,000 8,250 Annual revenue 1,000 1,000 1,000 1,250 4,000 8,250 Cumulative revenue 1,000 2,000 3,000 4,250 8,250 Grant Thornton LLP. All rights reserved. 31

32 Functional IP minimum guarantee What if instead of a trademark, the license was for functional IP? (TRG Paper 58) The minimum guarantee would be treated as fixed consideration and recorded at the point in time that the license transfers to the customer. The royalties above the fixed minimum would be recognized in accordance with the royalties exception. Grant Thornton LLP. All rights reserved. 32

Contract modifications Contract modification change in

creates new or changes existing enforceable rights and

34 Contract modifications Contract modification change in contract scope or price (or both) that is approved by the parties to the contract. Modification exists when parties approve a change that either creates new or changes existing enforceable rights and obligations May exist even though parties dispute scope and/or price Grant Thornton LLP. All rights reserved. 34

35 Contract modifications Does the scope increase because the entity adds distinct goods or services? Y Does the price increase by SASP of the additional goods or services? Y Treat as a separate contract, account for pre-modification contract as before N N Update the transaction price and measure of progress for effects of modification (cumulative catch-up method) Allocate remaining transaction price not yet recognized to outstanding performance obligations (treat as termination and new contract) Grant Thornton LLP. All rights reserved. 35

Modification and the series guidance Company enters a three-year contract to process medical insurance claims for $100,000 per year (SASP) Revenue of $100,000 per year is recognized during the first

36 Modification and the series guidance Company enters a three-year contract to process medical insurance claims for $100,000 per year (SASP) Revenue of $100,000 per year is recognized during the first 2 years of providing services At the end of the second year, the contract is modified - Fee for the third year is reduced to $80,000 - Customer extends for 3 additional years for $200,000 ($66,667 at the beginning of years 4, 5, 6) - SASP at the beginning of the third year is $80,000 per year ($240,000 total) Q. How should the entity account for the contract modification? Grant Thornton LLP. All rights reserved. 36

37 Contract modifications Does the scope increase because the entity adds distinct goods or services? Y Does the price increase by SASP of the additional goods or services? Y Treat as a separate contract, account for pre-modification contract as before N Update the transaction price and measure of progress for effects of modification (cumulative catch-up method) N Allocate remaining transaction price not yet recognized to outstanding performance obligations (treat as termination and new contract) Grant Thornton LLP. All rights reserved. 37

38 Renewals Option in the original contract No option in the original contract Not a modification Modification How would you determine whether a discount on additional goods/services relates to past performance? Grant Thornton LLP. All rights reserved. 38

40 Principal versus agent considerations Step 1: Identify the specified goods or services (think 'distinct' goods or services) to be provided to the customer Step 2: Determine whether the entity controls the specified goods/services before they are transferred to the customer Y Principal N Agent Recognize revenue in the gross amount of consideration to which the entity expects to be entitled Recognize revenue in the amount of any fee or commission to which the entity expects to be entitled Grant Thornton LLP. All rights reserved. 40

41 Principal versus agent considerations Obtaining control A principal obtains control of any one of the following: A good or another asset from another party that it then transfers to the customer A right to a service to be performed by the other party, giving the entity the ability to direct that party on its behalf A good or service from the other party that it then combines with other goods or services to provide the specified deliverable to the customer Grant Thornton LLP. All rights reserved. 41

42 Principal versus agent considerations Indicators Indicators that an entity controls the specified good or service before it is transferred to the customer (in other words, indicators of principal) include, but are not limited to: 1. The entity is primarily responsible for fulfilling the contract 2. The entity has inventory risk before transfer to the customer or after transfer of control to the customer 3. The entity has discretion in establishing prices Grant Thornton LLP. All rights reserved. 42

Example Principal versus agent considerations An entity sells nonrefundable vouchers that entitle customers to discounted meals at specified restaurants Does not purchase or commit itself to purchase

43 Example Principal versus agent considerations An entity sells nonrefundable vouchers that entitle customers to discounted meals at specified restaurants Does not purchase or commit itself to purchase vouchers in advance of the sale of a voucher to a customer Price at which the vouchers will be sold to customers is determined jointly Entity is entitled to 30% of the voucher price Responsibilities: Entity Assist customers in resolving complaints Restaurant Fulfill the obligations associated with the voucher Grant Thornton LLP. All rights reserved. 43

44 Example Principal versus agent considerations Step 1: Identify the specified goods or services (think 'distinct' goods or services) to be provided to the customer Right to a meal (in the form of a voucher) at a specified restaurant which the customer can use or transfer to another person Step 2: Determine whether the entity controls the specified goods/services before they are transferred to the customer Entity does not control the voucher at any time Vouchers are created only at the time they are transferred to the customer Consider how the indicators support the control assessment Entity does not have inventory risk Entity is not the primary obligor Grant Thornton LLP. All rights reserved. 44

Example Principal versus agent considerations An entity sells airline tickets at reduced rates compared to tickets sold by airlines directly to the public Commits to purchase a specific number of

45 Example Principal versus agent considerations An entity sells airline tickets at reduced rates compared to tickets sold by airlines directly to the public Commits to purchase a specific number of tickets at a negotiated rate in advance of the sale to end customers Price at which the tickets will be sold to end customers is set by the entity Entity sells and collects consideration from the customer when tickets are purchased Responsibilities: Entity Assist customers in resolving complaints Airline Fulfill the obligations associated with the ticket Grant Thornton LLP. All rights reserved. 45

Contract assets, liabilities, and receivables ASC 606-10-45-1 When either party to a contract has performed, an entity shall present the contract in the statement of financial position as a contract

47 Contract assets, liabilities, and receivables ASC When either party to a contract has performed, an entity shall present the contract in the statement of financial position as a contract asset or a contract liability, depending on the relationship between the entity's performance and the customer's payment. An entity shall present any unconditional rights to consideration separately as a receivable. Grant Thornton LLP. All rights reserved. 47

48 Example Contract assets, liabilities, and receivables On January 1, an entity enters into a cancellable contract to transfer a machine to a customer on June 30 The contract requires the customer to pay $500,000 in advance on January 31 The customer pays on March 31 and the entity transfers the machine on June 30 Control transfers at a point in time Journal entry on March 31 (when customer pays): Cash $500,000 Contract liability $500,000 Journal entry on June 30 (when the entity satisfies its obligation): Contract liability $500,000 Revenue $500,000 Grant Thornton LLP. All rights reserved. 48

Example Contract assets, liabilities, and receivables On January 1, an entity enters into a cancellable contract to transfer a machine to a customer on June 30 The contract requires the customer to

49 Example Contract assets, liabilities, and receivables On January 1, an entity enters into a cancellable contract to transfer a machine to a customer on June 30 The contract requires the customer to pay $500,000 in advance on January 31 at which time the contract becomes noncancellable The customer pays on March 31 and the entity transfers the machine on June 30 Journal entry on January 31 (when the entity has an unconditional right to consideration): Receivable $500,000 Contract liability $500,000 Journal entry on March 31 (when the entity receives cash): Cash $500,000 Receivable $500,000 Journal entry on June 30 (when the entity satisfies its obligation): Contract liability $500,000 Revenue $500,000 Grant Thornton LLP. All rights reserved. 49

Example Contract assets, liabilities, and receivables On January 1, an entity enters into a cancellable contract to transfer Machine A and Machine B to a customer in exchange for $750,000 Machine A

50 Example Contract assets, liabilities, and receivables On January 1, an entity enters into a cancellable contract to transfer Machine A and Machine B to a customer in exchange for $750,000 Machine A must be delivered first Payment for A is conditional on the delivery of Machine B Machine A (SASP of $500,000) and Machine B (SASP of $250,000) are distinct performance obligations Revenue is recognized upon transfer of each machine to the customer When the entity transfers Machine A: Contract asset $500,000 Revenue $500,000 When the entity transfers Machine B: Receivable $750,000 Contract asset $500,000 Revenue 250,000 Grant Thornton LLP. All rights reserved. 50

51 Presentation Implementation questions Can an entity present both contract liabilities and contract assets for a single contract? Do contract assets and contract liabilities need to be presented as current and noncurrent? Must contract assets be presented separately in the balance sheet? When can an entity offset other balance sheet items against the contract asset or liability? Grant Thornton LLP. All rights reserved. 51

52 Presentation Disclosure questions If the sales- or usage-based royalty exception applies, does the entity need to disclose information about remaining performance obligations? How should an entity disclose the amount of transaction price allocated to remaining performance obligations? Grant Thornton LLP. All rights reserved. 52

55 Finishing strong in the ASC 606 marathon webcast series Part 1 An in-depth look at designing for success (April 18) Part 2 Steps 1 and 2 of the new revenue model (April 26) Part 3 Steps 3 and 4 of the new revenue model (May 10) Part 4 Step 5 and contract costs (May 23) Listen to the replay of prior events Register for future Grant Thornton webcasts grantthornton.com > Events Part 5 Licensing, modifications, and other potential hurdles (June 13) Grant Thornton LLP. All rights reserved. 55

56 Disclaimer This Grant Thornton LLP presentation is not a comprehensive analysis of the subject matters covered and may include proposed guidance that is subject to change before it is issued in final form. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this presentation. The views and interpretations expressed in the presentation are those of the presenters and the presentation is not intended to provide accounting or other advice or guidance with respect to the matters covered. For additional information on matters covered in this presentation, contact your Grant Thornton, LLP adviser. Grant Thornton LLP. All rights reserved. 56

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