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.
In its correspondence with the SEC, Discovery explained why it accounts for video on demand licensing as a distinct performance obligation:
Many of our distribution arrangements, particularly in the United States, include a performance obligation to provide previously aired content so that the distributor can make recently aired content available on their video on demand (“VOD”) platform. The license of VOD content is considered distinct since the customer can benefit from the VOD content on its own and the VOD content is separately identifiable from other promises in the contract. (September 2018 Letter)
Take-Two Interactive Software, Inc. argued that its online software license is not a distinct performance obligation from the game related services:
We evaluated the guidance of ASC 606-10-25-19 through 25-21 and ASC 606-10-55-56(b) and concluded that we have a single performance obligation to provide an online gaming experience. Our conclusion is supported by ASC 606-10-55-56(b), which states that a “license that the customer can benefit from only in conjunction with a related service (such as an online service provided by the entity that enables, by granting a license, the customer to access content)” is not distinct. While the game’s code and related assets reside on the user’s game console, the user can only benefit from that online gameplay in conjunction with our online services. Further, we considered the factors listed in ASC 606-10-25-21(a) and (c) in determining whether the game’s online gameplay and online services are separately identifiable, noting that, in the context of the game design, the online software is highly dependent on, and interrelated with, the game related services and therefore would not be distinct. We therefore concluded that the software license and game related services should be combined into a single performance obligation and revenue would be recognized over an estimated service period. (October 2019 Letter)
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.
Twitter argued that its data, which includes Tweets and “related content,” constitutes intellectual property. Twitter also described how this IP could represent both symbolic IP and functional IP in its correspondence with the SEC:
In evaluating the nature of the Company’s performance obligation, the Company considered ASC 606-10-55-54 through 63. While Tweets and related content are not specifically referenced in ASC 606-10-55-54 (which the Financial Accounting Standards Board (FASB) acknowledges is not an exhaustive list), the Company believes that its data, consisting of Tweets and related content, satisfy the requirement set forth in the standard as constituting IP because such intangible assets are similar to those listed in ASC 606-10-55-54.
The value derived from the Company’s IP is based on the predictive and comparative utility provided from a continuous feed of licensed data. The interdependency of each incremental data source satisfies the promise of a license to real-time information that is used by the customer for decision-useful analytics. Accordingly, the Company has concluded that such arrangements contain a license of symbolic IP. In limited circumstances, the Company provides a static set of historical data that is accounted for as functional IP as the utility derived has standalone functionality. (October 2018 Letter)
In response to these claims, the SEC asked Twitter to “Tell us why you believe your data can represent both a functional and symbolic license of IP.” Twitter clarified that all its IP licenses are actually functional, not symbolic—though certain aspects of the functional IP licenses act as symbolic licenses—and walked the SEC through its analysis.
Twitter respectfully advises the Staff that all its intellectual property (“IP”) licenses are for functional IP because such IP licenses have significant standalone functionality.
Twitter’s IP license agreements provide its customers with access to, and at the customer’s discretion, the ability to take delivery of its IP, which consists of, for example, Tweet content, Twitter interaction information, and Twitter metadata (the “licensed data”), which collectively is proprietary. For example, subject to approval and in accordance with Twitter’s terms, customers can query the licensed data, select the relevant information and download it to their own infrastructure for their use. These IP licenses include a continuous transfer of control of IP as the customer consumes and benefits from its continuous use of the licensed data. As the licensed data is subject to control by Twitter on an exclusive basis, Twitter’s IP licenses also restrict the customer’s usage of its data (except as permitted in mutually agreed-upon use cases). In permitted use cases, Twitter’s customers may integrate the licensed data within their own offerings to their end customers and/or display the licensed data individually or in the aggregate, subject to contractual restrictions. Where permitted, Twitter’s customers can also use the licensed data and their cognitive analytic tools to target their own customers with relevant information and solutions. The Company considered the guidance in ASC 606-10-55-56, with a specific focus on the example in subparagraph (b.); however, given Twitter’s customers have the right and ability to take delivery of the licensed data, to use in their offerings or to use with their own cognitive analytical tools and processes, Twitter does not believe that it is providing a service.
With respect to Twitter’s previous statement in paragraph six of its response to comment number one, where Twitter made reference to a license of symbolic IP, we were describing its performance obligation to provide the licensed data originating in future periods (i.e., post-contract signing), which we refer to herein as “Future IP”. Twitter recognizes revenue for Future IP over time, which is similar to the revenue recognition treatment for a symbolic IP license as the nature of its promise is to provide Future IP (which is functional IP) over time. (December 2018 Letter)
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.
In its correspondence with the SEC, CBS Corporation explained when it satisfies performance obligations within its program licensing arrangements:
The Company respectfully advises the Staff that within its program licensing arrangements, each individual episode of a television series, including library programming (i.e., programs which are no longer in production), existing content and new content, is considered to be a separate performance obligation. In such arrangements, the Company satisfies its performance obligation when the episode is delivered to the customer and the license period has begun, in accordance with ASC 606-10-55-58C. (September 2018 Letter)
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.
Comcast explained in its correspondence with the SEC how it recognizes revenue when data is reported on a lag:
For our content licensing agreements that also include variable pricing, such as pricing based on the number of subscribers to a subscription video on demand service sold by our customers, revenue is subject to the royalty constraint in ASC 606-10-55-65 and is generally recognized when the licensee’s sales occur. The licensee generally provides their sales information to us on a monthly or quarterly basis, and sometimes with a lag in reporting. When subscriber data is reported on a lag, we estimate the revenue until actual subscriber data is received. Estimated amounts are not material for any period presented. (October 2018 Letter)
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.
Discovery disclosed how it recognizes revenue from contracts containing minimum guarantees:
Comment 2: The Company also has fixed price or minimum guarantee contracts that include periodic rate adjustments, and management concluded that the right to consideration corresponds with the satisfaction of performance obligations. This assessment considers market-specific data including rate adjustments in non-fixed price distribution contracts, historical rate adjustments in its distribution arrangements, and other factors such as the cost increases incurred by the Company to acquire or produce the underlying content delivered in its distribution contracts.
Comment 3: Distribution contracts containing minimum guarantees comprise approximately 3% of year-to-date distribution revenue as of June 30, 2018. These minimum guarantees represent instances where the distributor stipulates that the monthly license fee fluctuates based on the number of subscribers but will not fall below a guaranteed minimum. These provisions are contained in contracts where the performance obligations relate to the delivery of content in a license of functional IP. The continuous delivery of content in satisfaction of the performance obligations and associated pattern of revenue recognition is the same as described in the response to question 2) above. Royalties due to the Company in excess of the minimum guarantee are recognized using the sales and usage-based royalty exception under ASC 606-10-55-66. (September 2018 Letter)
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.
In its correspondence with the SEC, NBCUniversal discussed its analysis of revenue recognition for content libraries:
NBCUniversal does not have content licensing arrangements that provide access rights to its content library as a whole with a promise to refresh the library as new content is created. Instead, our content licensing arrangements generally include fixed pricing, span multiple years, and specify, at the onset of the agreement, individually identified content to be delivered in a defined geographic area (i.e., titles). Revenue from these agreements is recognized when the content is delivered and available for use by the licensee.
If content has been identified but is not yet available for use by the licensee, a portion of the overall fixed consideration is allocated to the content that will be available in future license periods. In addition, these arrangements often include general terms for future content, which has yet to be produced or otherwise identified. The pricing related to these titles will often be established at a future point, such as when box office statistics are made available. We recognize revenue related to future content after the content is delivered and available for use by the licensee. (October 2018 Letter)
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.
CBS Corporation explained how it recognizes revenue for variable- and fixed-fee affiliate agreements in its correspondence with the SEC:
All of the Company’s affiliate arrangements are licenses of functional intellectual property because the performance obligations, which have standalone functionality, consist of multiple licenses of programming being delivered on a continuous basis throughout the term of the agreement. The Company respectfully advises the Staff that licenses of functional intellectual property (which includes the delivery of content for both the linear feeds and VOD viewing) are the only performance obligations in the contract and therefore these are the items to which royalties relate.
Substantially all of the Company’s agreements with MVPDs provide for a variable fee that is based on an agreed upon contractual rate applied to the number of subscribers to the MVPD’s service. Since the Company’s fee is based on the MVPD’s subsequent sale of its service to its subscriber, and the arrangement represents a license, the Company recognizes revenues at the later of the satisfaction of the performance obligation or the customer’s subsequent sale, based on the sales-based or usage-based royalty guidance in ASC 606-10-55-65. The Company respectfully advises the Staff that there is no judgment used to determine the timing of satisfaction and amounts allocated to each performance obligation since the sales-based or usage-based royalty guidance is used to recognize revenues for agreements with variable fees.
For affiliate agreements that provide for a fixed fee, primarily consisting of agreements with network affiliates, such fixed fee is recognized based on the relative fair value of the performance obligations (which the Company uses as a proxy for relative standalone selling price as defined in ASC 606-10-32-29), which are delivered continuously throughout the term of the agreement. For fixed fee contracts, the Company applies judgment to allocate the transaction price in a manner that depicts the standalone selling price throughout the contract. Please refer to the response to comment #7 below for more information on these arrangements and the method used to determine standalone selling price over the term of the agreement. (September 2018 Letter)
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.
AMC Networks (2018 SEC Correspondence): Free Goods and Services Within a Single Performance Obligation
AMC Networks offers free video on demand programming to customers along with the license to programming content. In its correspondence with the SEC, AMC described why this represents a single performance obligation:
In addition to the delivery of a license to programming content by means of the linear feed, the Company typically provides free video-on-demand (“FVOD”) programming. The FVOD programming provided to distributors consists of the same functional intellectual property that is provided through the linear feed and is delivered contemporaneously with the linear feed. The FVOD programming that we provide to distributors does not include library content. Although the delivery method is different for the linear feed and FVOD offering, the Company concluded that the programming provided to distributors via both delivery methods is not distinct within the context of the contract. Consequently, the Company considers the combination of the linear feed and FVOD programming as a single performance obligation. (September 2018 Letter)
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.