In 2018, Accounting Standards Codification (ASC) Topic 606 became effective for all public entities. This major overhaul of the revenue recognition standard has affected almost every industry, and media and entertainment entities are no exception. The complex arrangements between entities in this industry and their clients pose some difficult issues when applying ASC 606.
The AICPA and the major accounting firms have assembled task forces to research industry-specific issues within ASC 606, and we will draw from the guides they have published as we provide a brief explanation of the key issues media and entertainment entities face when applying ASC 606. We will also refer to SEC comment letters to illustrate key issues. For more information on any of these issues, see:
- AICPA, Audit & Accounting Guide: Revenue Recognition
- EY, Technical Line: How the new revenue standard will affect media and entertainment entities
- EY, Applying IFRS: A closer look at the new revenue recognition standard
- PwC, In Depth: Revenue: Implementation in Entertainment and Media
Licenses of Intellectual Property (IP) under ASC 606
Determining whether a license is distinct
Media and Entertainment (M&E) contracts often have explicit and implicit promises, making it difficult to determine whether the license of their IP is distinct from other promised goods and services, and therefore a separate performance obligation. The ability for a customer to make use of the licensed IP without the purchase of other promised goods and services is an indicator that the two promised goods and services may be separate and distinct. M&E entities must look closely at the details of their contracts containing licensed IP to determine the nature of their obligations. A high level of professional judgement is required, and careful consideration should be given to each unique circumstance.
For more information on evaluating contracts for distinct goods and services, see:
- Identifying Promised Goods & Services
- Distinct Goods or Services: Case Studies
- Distinct within the Context of the Contract
Determining the nature of the entity’s promise
M&E entities must determine whether their licensed IP is either functional or symbolic, as these two classifications result in differences in the timing of revenue recognition. Though the actual analysis for determining whether the license of IP is functional or symbolic is fairly simple, IFRS 15 and ASC 606 do differ slightly, such that an entity that has licensed the use of a brand that it no longer actively supports (a racecar driver who no longer races, or a sports team that no longer exists) may reach different conclusions when evaluating the contract under the two different standards. Consider a scenario in which the brand for the defunct St. Louis Gunners is licensed to Adidas for a retro line of sweaters. Under IFRS standards, if there were no ongoing activities that would have a significant impact on the value of the IP, the revenue would be recognized at a point in time. In contrast, under ASC 606 the revenue from such a contract would be recognized over the license period and the IP would be classified as symbolic. Unlike IFRS rules, ASC 606 states that the ongoing activities related to the IP would have no effect on the classification of the IP.
M&E entities often include provisions or restrictions in their contracts that delineate the appropriate use of the licensed IP. These provisions should not affect the timing of revenue recognition or the number of performance obligations present in the contract. A challenge arises for M&E entities, however, when contracts include additional provisions that do more than just define the nature and extent to which the IP is to be used. These types of provisions may change the timing and number of performance obligations present in the contract. Due to their often-similar appearance and nature, extensive professional judgement must be used to determine the character of the restrictions.
For more information on how to analyze the provisions included in a contract for licensed IP, please refer to the Licenses for Intellectual Property article.
Restrictions on a licensee’s ability to use and benefit from a license
Recognition of revenue occurs at a point in time for contracts that provide customers with a right to use IP (i.e., functional IP). This point in time is measured as of the date that the licensed IP is transferred to the customer. ASC 606-10-55-58C clarifies that for this revenue recognition timing to be appropriate, two things must take place: the licensor must provide access to a copy of the IP, and the period of benefit stipulated by the licensor must have begun. These two criteria are important, as a licensor may provide access to the IP before the contractual period of benefit has begun, thus preventing the recognition of revenue.
Furthermore, revenue recognition is limited by approval rights placed in IP licensing contracts by licensors. These rights give the licensor the ability to reject the planned use of their IP, thus restricting the use and benefit of the IP for the licensee. The restriction inhibits the licensor’s ability to recognize revenue, as the customer is not receiving the right to use and benefit from the IP until planned use is approved.
Lastly, under ASC 606, licensors may not recognize revenue related to the renewal of an IP license until the day the renewal period begins, as opposed to the day that the renewal is executed.
Sales- or usage-based royalties
M&E entities often enter into contracts in which they license IP in exchange for a fixed fee as well as a sales- or usage-based royalty. ASC 606 requires that revenue be recognized either at the time that the performance obligation to which the royalties are allocated is satisfied, or when the sale or usage by the customer occurs, whichever comes later. The recognition of revenue in these circumstances is complicated by the difficulty of determining whether the fee received is a sales- or usage-based royalty. This determination will require substantial professional judgement.
Further complicating sales- or usage-based royalty revenue recognition are lag sales. This can occur when the customer has sold or used the IP but has not yet reported sales or usage to the licensor. Prior to ASC 606, many entities did not recognize revenue from such royalties until the lag data became available. Under ASC 606, no specific guidance has been given related to lag sales, thus requiring entities that deal with lag sales to follow the normal guidance found in ASC 606 for revenue recognition. This requires entities to create estimates for lag sales because the revenue should be recognized in the period in which the sales or usage of the IP occurs, and not subsequently when the licensee makes the data available.
For more information on sales- and usage-based royalties, refer to the Sales- and Usage-Based Royalties article.
Nonrefundable minimum guarantees
To protect against times when sales- or usage-based royalty fees are not earned by a licensor, it is common for M&E entities to negotiate for a nonrefundable minimum guarantee in their contracts. These guarantees act as a floor for the licensor, ensuring they will receive a certain amount of consideration no matter the sales or usage achieved by the licensee. The proper accounting for this minimum guarantee varies by IP type.
When only one performance obligation exists in a contract, revenue will be recognized at a point in time once control of the functional IP is transferred to the licensee. When multiple obligations exist, the nonrefundable minimum guarantee will require allocation among the various obligations and recognition once those obligations are satisfied.
In the case of symbolic IP, the Financial Accounting Standards Board (FASB) has stated that multiple accounting approaches for nonrefundable minimum guarantees are acceptable. A Q&A issued by the FASB in January 2020 explains the most common and acceptable approaches. One approach described would allow for entities to recognize revenue over time, using an estimate of total consideration and measuring progress as the performance obligation is satisfied. The recognition of revenue would still be constrained (as described earlier) by the later of when the performance obligation to which the royalties are allocated is satisfied, or when the sale or usage by the customer occurs.
If an entity chooses to use this approach, there are two ways it can be applied. The first uses the right-to-invoice practical expedient, permitting the entity to recognize revenue up to the full value of the invoice, so long as the amount invoiced and payable to the entity equals the value of the performance that has been completed. This application is only appropriate if the minimum guarantee is expected to be exceeded by royalties. The second application requires an entity to estimate the transaction price and then recognize revenue in conjunction with progress achieved over time. The estimated transaction price would be limited by the royalty recognition constraint explained earlier.
Another approach described in the FASB Q&A separates the recognition of the minimum guarantee from the recognition of the royalty fee. Entities measure their progress as they satisfy the performance obligation and recognize revenue proportionately over time, until the minimum guarantee is fully recognized. After recognizing revenue for the full amount of the minimum guarantee, the entity would begin to recognize the royalty fees.
For more information on recognizing revenue in IP licensing arrangements, refer to the Minimum Guarantee on Sales- and Usage-Based Royalties Case Study.
License of content library
ASC 606 requires entities to determine whether the licensing of a content library constitutes a single performance obligation or if multiple performance obligations exist within the contract. This is especially important to evaluate in circumstances where access to the library is promised in addition to future changes, updates, or additions to the library. If two performance obligations exist in the contract, the transaction price will need to be allocated between the two obligations based on their standalone selling price.
For more information, see the following articles:
- Distinct within the Context of the Contract
- Case Study: Transaction Price Allocation
- Standalone Selling Prices
M&E entities often enter into agreements with affiliates to provide an outlet for their programming. These agreements will include a fee per affiliate subscriber, a fixed fee, or a combination of the two. M&E entities must determine whether they are providing a license of IP to their affiliates or if they are providing a service to the affiliate that includes the use of the M&E entity’s IP as a part of the affiliate’s final product. When affiliate partners have the right to store the IP on their servers and modify the use of the program so that subscribers can fast forward, rewind, pause, and record the program for future viewing, the entity may determine that the affiliate is retaining control of the IP and is therefore licensing the use of the IP. This scenario will require the application of the same criteria explained earlier regarding sales- or usage-based royalty revenue recognition.
If the M&E entity determines that control of their IP is not retained by their affiliate partner, then the royalty revenue recognition constraint explained earlier would not apply. The M&E entity would be required to determine the appropriate amount and timing of revenue to recognize as it fulfills its obligation to provide an input to the affiliate’s output.
For more information, see the following articles:
Other industry considerations
M&E entities will need to consider how changes in the allocation of non-refundable minimum guarantees to multiple performance obligations will affect participation costs, which are covered in ASC 926. The FASB’s mastery glossary describes participation costs as contingent payments based on the success of a film to the contracted parties involved. Entities should also contemplate how the timing of minimum guarantee for symbolic IP will change the recognition of these participation costs.
Free goods and services
M&E entities often offer free goods or services as an incentive to purchase a paid product. Free goods and services that are deemed to be material within the context of the contract should be evaluated to determine if they represent separate performance obligations. If the free goods and services are deemed to be separate performance obligations, a portion of the transaction price will need to be allocated to the free goods and services and recognized upon their transfer to the customer.
Exchange of advertising
M&E entities may enter into contracts wherein they license their IP to a customer in exchange for advertising rights, cash, or a combination of the two. If advertising rights are obtained, the M&E entity must determine whether they represent contingent payments for the use of the IP, non-cash consideration for the IP, or something else entirely.
If the M&E entity determines that the advertising rights represent an asset (non-cash consideration), the fair market value of the rights should be recognized as revenue upon the transfer of the IP.
If the M&E entity determines that the advertising rights represent a contingent payment, the usage-based royalty treatment described above (the section titled “Sales- or usage-based royalties”) may be appropriate. Any fixed consideration received should be recognized upon the transfer of control of the IP, and the usage-based royalty revenue should be recognized upon actual usage subject to the constraint described above.
Free trial periods with a subscription
In contracts where customers are provided a free product for a specified time period, after which the customer (and seller) have no commitment to pay for (or provide) additional goods, then no contract would exists beyond the specified time period and no related revenue should be recognized. If, however, the free trial includes an obligation for the entity to send additional product in exchange for customer payment for a period of time after the trial ends, a contract exists and revenue may be recognized, as the free products represent promises in the contract which are being fulfilled.
Multiyear agreements with changing prices
Entities with contracts that allow for changing prices over the course of the contract life may be able to recognize revenue for the amount they expect to invoice their customer, so long as the change in price reflects a change in the value of the good or service being provided in the contract. The SEC has noted that entities with these multiyear, price-changing contracts must be able to provide adequate proof that the changed price represents actual value that will be provided to the customer.
Customer options for additional goods or services
Similar to many entities in other industries, M&E entities often enter into agreements that include an option for customers to purchase additional goods or services. Depending on the nature of the option, it may qualify as a material right to the customer that must be accounted for as a separate performance obligation.
Entities must determine whether an option to purchase additional goods and services is independent from the current contract. Discounted prices for future purchases act as evidence that a material right may exist for the customer, but significant judgement is required when analyzing each unique circumstance.
Nonrefundable upfront fees are of particular importance to M&E entities and are often charged for setup and installation of services provided by the entity. If a material right is deemed to exist in a contract with nonrefundable upfront fees, a portion of the transaction price must be allocated to the material right and recognized over the period of time that the customer receives a benefit from the activation or installation. It is worth noting that the activation and/or installation fee is included in the transaction price.
If a material right is deemed to exist, the standalone selling price of the right must be determined. There are two alternatives for determining this amount. The first is to estimate the price, which would require significant judgement. A second option can be used only if 1) the goods provided originally and those provided upon the exercise of the option are similar, and 2) the additional goods are provided under the same terms and conditions of the original contract. If these two criteria are met, the entity would calculate the value of the option as follows:
- Calculate the total consideration expected to be received as the amount of consideration received via the original contract, plus consideration received as a result of the exercise of the option.
- Total consideration expected to be received is allocated to all of the goods or services expected to be transferred to the customer, including those transferred as a result of the exercise of the option.
- Calculate the amount allocated to the option at contract inception as the total consideration expected to be received, minus the amount allocated to the goods and services that the entity must transfer under the original contract.
For more information, refer to the Customer Options for Additional Goods and Services article.
It is likely that many other issues and questions will arise for M&E entities as they continue to apply ASC 606. This article serves as a base reference for your research into some of the focal issues anticipated by industry experts. Similar analysis, discussions, and resources can be found for other industries on our Industry-Specific Issues page.