Licenses and Royalties: Amendments Planned for Revenue Reporting Guidance
Revenue recognition from customer contracts is a hot topic from Wall Street to Main Street. Many businesses are uncertain how to apply the recently converged, principles-based guidance in a real-world setting. The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) are trying to provide greater clarity to help companies consistently implement the changes before their landmark revenue recognition standards go live for public companies in 2017.
U.S. business and accounting opposition
Last May, FASB and the IASB issued sweeping, converged standards on how to recognize contract revenue. FASB’s Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, eliminates about 180 pieces of industry-specific revenue accounting guidance in U.S. GAAP. Instead of following guidance specific to their industry, companies will need to calculate the top lines in their income statements using a single, principles-based approach.
However, the converged standards have been met with widespread opposition and confusion from businesses and the accounting profession. Because the new revenue model is supposed to work for all types of businesses, it requires accountants to exercise more judgment than under current U.S. GAAP. Businesses have questions about some of the judgments they will need to employ. And in some cases, they’ll arrive at different conclusions for relatively similar accounting scenarios.
Because revenue is such an important metric of a company’s financial health, the revenue recognition standards won’t affect just a company’s accountants. Many employees — including those outside a company’s finance and accounting department — will need to be trained to do things differently. For example, sales teams may have to structure deals differently to meet sales targets that fit with new revenue recognition patterns. Human resources departments, which often tie employee incentive pay to company revenues, may have to revise their procedures. And, of course, accounting personnel will have to modify their internal reporting to capture and record revenues.
Limited resistance overseas
Companies overseas have had fewer questions. This has made several IASB members reluctant to tweak International Financial Reporting Standard (IFRS) 15, Revenue from Contracts with Customers.
Companies that follow IFRS are already accustomed to exercising judgment in financial reporting, rather than referring to rule books and checklists for individual industries. And the IASB is reluctant to make changes, in part because it took the boards more than a decade — and lengthy, repeated rounds of debate — to get the converged standard published.
Although public companies are expected to comply with the new standards in 2017, many U.S. businesses have been lobbying for an extra year. A nearly three-year period between the publication of the final standards in May 2014 and an effective date that should be reflected in first quarter 2017 financial statements should theoretically provide ample time to complete the transition to the new accounting standards.
But to adopt the revised accounting rules in 2017 with comparisons to 2015 and 2016 results, companies should have updated their financial reporting systems by the beginning of 2015. In other words, the implementation process needed to be collapsed into a few months instead of close to three years.
In light of these concerns, the chief accountant of the Securities and Exchange Commission recommended last fall that the boards meet to consider deferring the effective date. FASB and the IASB have said they will take a vote on a potential delay no earlier than April 2015.
Licenses, royalties and more
To further allay concerns about implementing these new standards, FASB and the IASB recently decided to refine the accounting guidance for revenues from licenses of intellectual property and royalties. The boards also plan to clarify how to separate different promises in multipart customer contracts.
The converged revenue recognition standards call for businesses to determine whether a license represents a promise to deliver a service at a point in time or over time. Entertainment companies have specifically raised many questions about how they should determine the timing.
FASB also decided to offer more information about accounting for licenses of symbolic intellectual property, such as brands or logos. For royalties that are determined by sales volume or the rate of usage, the boards agreed they would clarify that companies don’t have to separate revenue streams for single contracts if there are portions that may be subject to the concept of “constraint.” Constraint is related to the timing of a company’s recognition of revenue from a customer contract. It’s based on the likelihood that a company will collect revenue from a customer.
The boards agreed that they would clarify that a business’s promise to the customer in granting a license is to provide a right to access the intellectual property when the contract requires or the customer expects the company to undertake activities that significantly affect “the utility of the intellectual property” to which the customer has rights. The standard-setters said they would add guidance to determine the intellectual property’s usefulness.
Separately, the boards agreed to add examples to the revenue recognition standards to clarify how to identify separate performance obligations in a customer contract. FASB plans to address questions about identifying promised goods or services subject to separation guidance, application of what it means for a promise to be “distinct in the context of a contract,” and accounting for shipping and handling activities.
FASB wants to issue a proposed version for public comment in June. The IASB also plans to issue a proposal but may add more tweaks on separate parts of the revenue recognition standard into its proposal.
Clarity in the works
With the implementation date looming, FASB and the IASB remain committed to the landmark revenue recognition guidance they worked so hard to publish. But the boards will continue to clarify some of the more troublesome aspects of their revenue recognition standards — without resorting to the rules and industry-based guidance they are trying to leave behind.