KINGFISHER SCHOOL OF BUSINESS AND FINANCE ACCTG 10 ONLINE CLASS Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment John Leo D. Ambuyoc, CPA Instructor Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment Licenses ❑ Allow customer to use the seller’s intellectual property. It is a permission that establishes rights to the intellectual property. Types of License ❖ Right to use – seller provide the customer the right to use the intellectual property as it exists when the license is granted. Subsequent activity of the seller does not affect the benefit that the customer will receive. For Right to use Licenses revenue is recognized at the point in time when the right is transferred. ADVANCED FINANCIAL ACCOUNTING AND REPORTING PART 1 Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment Types of License ❖ Right to access – seller provide the customer with access to the intellectual property where in the seller will undertake ongoing activities during the license period that affect the benefit the customer receives. Requirement to be classified as Right to Access License 1. Contract Requires or customer expects that IP will change and customer has right to change. 2. Rights granted by license may have positive or negative effect on the customer. 3. No further transfer of goods or services For Right to Access Licenses, revenue is recognized over the period of time as for which the access is provided. ADVANCED FINANCIAL ACCOUNTING AND REPORTING PART 1 Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment Illustration: Types of Licenses Identify whether the performance obligation is satisfied at point in time or overtime? Situation 1: Lowela Ramos Microsoft licenses its enterprise resource planning software platform for a 3-year period, including software upgrades. Situation 2: Ma. Ella Tejada Guerrero Microhard licenses its office software to a customer, with no expectation that it will provide any additional services or upgrades, it recognizes satisfaction of the performance obligation when it transfers the licenses and software to the customer. ADVANCED FINANCIAL ACCOUNTING AND REPORTING PART 1 Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment Distinct Licenses ❑If the promise to grant a license is distinct & not interdependent from the other promised goods or services, it is a separate performance obligation. ❑If the promise to grant a license is not distinct & interdependent from the other promised goods or services, the entity should account for the licenses and other performance obligation as a single performance obligation. ADVANCED FINANCIAL ACCOUNTING AND REPORTING PART 1 Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment Illustration: Distinct Licenses AA computer licenses customer-relationship software to ABS Company. In addition to providing the software itself, AA Computer promises to provide consulting services by extensively customizing the software to ABS’s information technology environment, for a total consideration of P3,456,000. In this case, AA Computer is providing a significant service by integrating the goods and services into one combined item for which ABS has contracted. In addition, the software is significantly customized by AA computers in accordance with the specifications negotiated by ABS. License and the consulting services are interdependent, and therefore should be accounted for as one performance obligation. ADVANCED FINANCIAL ACCOUNTING AND REPORTING PART 1 Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment Illustration: Licensing – Performance Obligation Armel Gamboa Jonas licenses customer relationship software to Malen Cezar Hedges Inc. for 3 years. In addition to providing the software, Armel Gamboa Jonas promises to perform consulting services over the life of the license to maintain operability within Malen Cezar Hedges’ computer system. The total transaction price is P200,000. Based on stand-alone values, Armel Gamboa Jonas estimates the consulting services have a value of P75,000 and the software license has a value of P125,000. Upon installation of the software on July 1, 20x5, Malen Cezar Hedges pay P100,000; the contract balance is due on December 31, 20x5. Identify whether the performance obligation and the revenue in 20x5, assuming ❖ The performance obligation are interdependent, and ❖ The performance obligations are not interdependent ADVANCED FINANCIAL ACCOUNTING AND REPORTING PART 1 Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment Illustration: Licensing – Performance Obligation Identify whether the performance obligation and the revenue in 20x5, assuming ❖ The performance obligation are interdependent, Cash - 100,000 Notes Receivable – 100,000 Unearned Revenue – 200,000 ❖ The performance obligation are not interdependent, Cash -100,000 Notes Receivable – 100,000 Unearned Revenue – 75,000 Revenue – 125,000 ADVANCED FINANCIAL ACCOUNTING AND REPORTING PART 1 Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment Variable Consideration included in License ❑ Variable Consideration is the portion of contract price that depends on the outcome of future events. If variable consideration is based on sales or usage of a license, revenue should be recognized when; ❖ Sales or usage has actually occurred ❖ Performance obligation to which variable consideration has been allocated has been performed. ADVANCED FINANCIAL ACCOUNTING AND REPORTING PART 1 Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment Illustration: Variable Consideration included in License Juliet Mindanao Technologies licenses its intellectual property to Francis Bautista Industries. Terms of the arrangement require Francis Bautista to pay Juliet Mindanao P500,000 on April 1, 20x4, when Francis Bautista first obtains access to Juliet Mindanao’s intellectual property, and then to pay Juliet Mindanao a royalty of 4% of future sales of products that utilize that intellectual property. Juliet Mindanao anticipates receiving sales-based royalties of P1,000,000 during 20x4 and P1,500,000/year for the years 20x5–20x9. Assume Juliet Mindanao accounts for the Francis Bautista license as a right of use, because Juliet Mindanao’s actions subsequent to April 1, 20x4. What journal entry would Juliet Mindanao record on April 1, 20x4, when it receives the P500,000 payment from Francis Bautista? ADVANCED FINANCIAL ACCOUNTING AND REPORTING PART 1 Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment Illustration: Variable Consideration included in License What journal entry would Juliet Mindanao record on April 1, 20x4, when it receives the P500,000 payment from Francis Bautista? Cash 500,000 License revenue 500,000 Assume on December 31, 20x4, Juliet Mindanao receives P1,000,000 for all sales-based royalties earned from Francis Bautista in 20x4. What journal entry would Juliet Mindanao record on December 31, 20x4, to recognize any revenue that should be recognized in 20x4 with respect to the Francis Bautista license that it has not already recognized? Cash 1,000,000 License revenue 1,000,000 ADVANCED FINANCIAL ACCOUNTING AND REPORTING PART 1 Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment Illustration: Variable Consideration included in License Assume Juliet Mindanao accounts for the Francis Bautista license as a five-year right to access Juliet Mindanao’s intellectual property from April 1, 20x4, though March 31, 20x9. Juliet Mindanao expects that its ongoing marketing efforts will affect the value of the license to Francis Bautista during the five-year license period. Cash 500,000 Deferred Revenue 500,000 Journal Entry on December 31, 20x4 Cash 1,000,000 Deferred Revenue 75,000 Revenue 1,075,000 Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment Franchise ❑ Franchise is contract arrangement with a franchisor to which franchisor permits the franchise to use the franchisor business name, manufacture or sell franchisor products/ services, and/or use franchisor system. ❖ Right to open a business ❖ Use of trade name or other intellectual property. ❖ Continuing services, such as marketing help, training and in some cases supplying inventory and inventory management. ADVANCED FINANCIAL ACCOUNTING AND REPORTING PART 1 Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment Franchise Amount commonly charged by Franchisor; ❖ Initial Franchise Fee – payment for establishing the relationship and providing some initial services. ❖ Continuing Franchise Fee – amount charged in return for continuing rights granted by the agreement & amount charged for providing advertising and other services ➢ Reported as Revenue when the performance obligations related to those fees have satisfied. ADVANCED FINANCIAL ACCOUNTING AND REPORTING PART 1 Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment When to recognize revenue from Initial Franchise Fee? ❑ Franchise granted as right to use: ➢ Revenue is recognized when the right is transferred (Date of Opening of the franchisee ) ➢ If date of opening is not given, presumption is right was transferred at the date of signing. ❑ Franchise granted as right to access: ➢ Revenue is from the date of opening until the end of accounting period. ADVANCED FINANCIAL ACCOUNTING AND REPORTING PART 1 Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment When to recognize revenue from Initial Franchise Fee? ❑ Commingled Revenue – It refers to a single initial franchise fee for rights, initial services & tangible properties. ❖ The portion of the fee applicable to these assets shall be based on the fair values and these assets are recognized upon transfer of ownership. ❖ Allocation of transaction price is based on stand-alone fair values. ADVANCED FINANCIAL ACCOUNTING AND REPORTING PART 1 Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment Illustration: Recognition of Revenue - Franchise Dominador’s Pizza Inc. enters into a franchise agreement on December 31, 20x7, giving Dian Jaycerette the right to operate as a franchisee of Dominador’s Pizza for 5 years. Dominador’s charges Dian Jaycerette an initial franchise fee of P570,000 for the right to operate as a franchisee. Of this amount, P228,000 is payable when Dian Jaycerette signs the agreement, and the balance is payable in five annual payments of P68,400 each on December 31. The credit rating of Dian Jaycerette indicates that money can be borrowed at 8%. Training is completed in February 1, 20x8, the equipment is installed in February 2, 20x8, and Dian Jaycerette holds a grand opening on February 4, 20x8. Dian Jaycerette also promises to pay ongoing or continuing fee (royalty payments) of 1% of its annual sales (payable every January 31 of the following year) and is obliged to purchase products from Dominador’s at its current stand-alone selling prices at the time of purchase. Chapter 11: Revenue Recognition: Licenses & Royalties, Franchises, Non-Refundable Upfront Fee & Consignment Solution.. Transaction price = 228,000 + 68,400 x (3.99) = 500,916 Assumption of allocation for transaction price: Rights to the trade name,. -P228,000 Services – training, etc - 113,316 Machinery and equipments, etc. (costing, P114,000). - 159,600 ADVANCED FINANCIAL ACCOUNTING AND REPORTING PART 1