IFRS 15 Revenue from Contracts with Customers (contents page is here) introduced a single and comprehensive framework which sets out how much revenue is to be recognised, and when. The core principle is that a vendor should recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the vendor expects to be entitled in exchange for those goods or services. See a summary of IFRS 15 here.
This section is part of step 3 determining the transaction price. When an entity earns royalties based on the extent to which a customer uses or benefits (through onward sales) from a license of Intellectual Property (IP), it has transferred control of the IP to its customer, with uncertainty over the amount of consideration (i.e. the consideration is variable). As an exception to the general principles in IFRS 15 that revenue is recognised when control of a good or service has been transferred to a customer and measured at an amount to which it expects to be entitled, royalties earned from sales- or usage-based licenses of intellectual property are recognised only at the later of the following:
- The subsequent sale or usage occurs; and
- The performance obligation to which some or all of the sales- or usage-based royalty has been allocated has been satisfied (or partially satisfied).
The interaction of this restriction, and the requirement to consider stand-alone selling prices when allocating consideration to multiple performance obligations in a contract, can lead to patterns of revenue recognition which differ from amounts stated in contracts. This arises, for example, in cases where two or more licenses over intellectual property that are to be transferred to a customer at different times are included in a single overall contract, and the prices specified in the contract do not reflect the stand-alone selling prices of the licenses. The approach required by IFRS 15 is designed to ensure that the timing and profile of revenue recognition is not affected by what might be considered to be artificial price allocations in contracts.