FASB Clarifies Identifying Performance Obligations and Licenses Guidance in the New Revenue Standard
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The FASB recently issued ASU 2016-10,1
amending the new revenue recognition standard that it issued jointly with the IASB in 2014. The amendments do not change the core principles of the standard, but clarify the accounting for licenses of intellectual property, as well as the identification of distinct performance obligations in a contract. The ASU becomes effective concurrently with ASU 2014-092
and is available here
In May 2014, the FASB issued ASU 2014-09 (“the new revenue standard”), establishing a comprehensive revenue recognition standard for virtually all industries , including those that previously followed industry-specific guidance such as the real estate, construction and software industries.
The amendments in ASU 2016-10 resulted from implementation issues discussed by the joint FASB/IASB Transition Resource Group (TRG). After considering the issues, the FASB decided certain changes are needed to make the new revenue standard more operational.
The amendments in ASU 2016-10 provide more detailed guidance, including additional implementation guidance and examples in the following key areas: 1) identifying performance obligations and 2) licenses of intellectual property.
Identifying Performance Obligations
In order to identify performance obligations, an entity must assess whether goods or services promised in the contract are distinct. The amendments more clearly articulate the guidance for assessing whether promises are separately identifiable in the overall context of the contract—for example, assessing whether a customer has contracted separately for bricks and lumber vs. a completed building in a construction contract. The “separately identifiable” test is one of two criteria for determining whether the promises are distinct.3
The amendments also clarify the factors an entity should consider when assessing whether two or more promises are separately identifiable,4
and provide additional examples within the implementation guidance for assessing these factors.
In addition, ASU 2016-10 clarifies that an entity is not required to identify promised goods or services that are immaterial in the context of the contract, which some stakeholders believed was necessary based on language in the basis for conclusions in ASU 2014-09. However, customer options to purchase additional goods or services which represent a material right should not be designated as immaterial in the context of the contract.5
Further, an entity is now permitted to account for shipping and handling activities as a fulfillment activity rather than as an additional promised service in certain circumstances. This is an accounting policy election to be applied consistently to similar types of transactions, and related accounting policy disclosures apply. If elected, those shipping and handling activities would not be identified as separate performance obligations and no revenue would be allocated to them. Shipping and handling costs must be accrued when the related revenue is recognized, if the shipping and handling activities have not yet occurred.
Licenses of Intellectual Property
The new revenue standard includes implementation guidance on determining whether an entity’s promise to grant a license provides a customer with either a right to use
the entity’s intellectual property (IP) (which is satisfied at a point in time) or a right to access the entity’s intellectual property (which is satisfied over time). To this end, the amendments clarify whether a license of IP represents a right of use or a right of access by categorizing the underlying IP as either functional
IP has significant standalone functionality because it can be used as is for performing a specific task, or be aired or played. A license to functional IP represents a right to use the IP as it exists at a point in time; the customer’s ability to derive substantial benefit from the license is not dependent upon the seller supporting or maintaining the IP during the license period (although post-contract support and when-and-if-available updates may be provided as one or more separate performance obligations). A license to functional IP is generally satisfied at the point in time the customer is able to use and benefit from the license. Examples of functional IP include software, biological compounds or drug formulas, and completed media content.
IP does not have significant standalone functionality. A license to symbolic IP represents a promise to both (a) grant the customer rights to use and benefit from the IP and (b) support or maintain the IP during the license period (or over the remaining economic life of the IP, if shorter). This type of license is satisfied over time because the customer simultaneously receives and consumes the benefit as the entity performs its obligation to provide access. Examples of symbolic IP include brands, team or trade names, logos, and franchise rights.
The ASU includes a flowchart to assist entities in determining whether a license to IP represents a right to access IP (symbolic) or a right to use IP (functional).
The amendments also clarify that a promise to grant a license that is not a separate performance obligation must be considered in the context above (i.e., functional or symbolic), in order to determine whether the combined performance obligation is satisfied at a point in time or over time, and how to best measure progress toward completion if recognized over time.
Regardless of a license’s nature (i.e., functional or symbolic), an entity may not recognize revenue from a license of IP before 1) it provides or otherwise makes available a copy of the IP to the customer, and
2) the period during which the customer is able to use and benefit from the license has begun (i.e., the beginning of the license period).
Additionally, the new revenue standard includes implementation guidance on when to recognize revenue for a sales-based or usage-based royalty promised in exchange for a license of IP. The amendments clarify two aspects of that guidance:
- An entity should not split a sales-based or usage-based royalty into a portion subject to the guidance on sales-based and usage-based royalties and a portion that is not subject to that guidance. In other words, a royalty is either subject to the guidance on sales-based and usage-based royalties, or it is not.
- The guidance on sales-based and usage-based royalties applies whenever the predominant item to which the royalty relates is a license of IP.
Lastly, the amendments distinguish contractual provisions requiring the transfer of additional rights to use or access IP that the customer does not already control from provisions that are attributes of a license (for example, restrictions of time, geography, or use). License attributes define the scope of the rights conveyed to the customer; they do not determine when the entity satisfies a performance obligation (point in time vs. over time).
Effective Date and Transition
The effective date and transition requirements for ASU 2016-10 are the same as the effective date and transition requirements of Topic 606, specifically:
Public business entities
will adopt the standard for annual reporting periods beginning after December 15, 2017, including interim periods within that year. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim periods within that year.
All other entities
will adopt the standard for annual reporting periods beginning after December 15, 2018, and interim periods within annual reporting periods beginning after December 15, 2019. Early adoption is permitted as of either:
- An annual reporting period beginning after December 15, 2016, including interim periods within that year, or
- An annual reporting period beginning after December 15, 2016 and interim periods within annual reporting periods beginning one year after the annual period in which an entity first applies the new standard.
The IASB recently issued similar (but not identical) amendments7
to the standard. The Boards do not expect significant divergence as a result of their respective amendments.
For questions related to matters discussed above, please contact Ken Gee
, Angela Newell
or Adam Brown
1 Identifying Performance Obligations and Licensing
2 Revenue from Contracts with Customers (Topic 606) is substantially converged with IFRS 15,
the IASB’s companion standard.
3 The other criterion is that the customer can benefit from the good or service, either on its own or with other readily available resources.
4 Paragraph 606-10-25-21
5 The entity would apply the guidance in paragraphs 606-10-55-42 through 55-43 to determine whether an option gives rise to a material right.
6 A not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market, and an employee benefit plan that files or furnishes financial statements with or to the SEC have the same effective date as public business entities.
7 Clarifications to IFRS 15