Question

In: Accounting

Tran Technologies licenses

Tran Technologies licenses its functional intellectual property to Lyon Industries. Terms of the arrangement require Lyon to pay Tran $500,000 on April 1, 2021, when Lyon first obtains access to Tran’s intellectual property, and then in the future to pay Tran a royalty of 4% of future sales of products that utilize that intellectual property. Tran anticipates receiving sales-based royalties of $1,000,000 during 2021 and $1,500,000/year for the years 2022–2026. Assume Tran accounts for the Lyon license as a right of use, because Tran’s actions subsequent to April 1, 2021, will affect the benefits that Lyon receives from access to Tran’s intellectual property.

 

Required:
1. Access the FASB Accounting Standards Codification at the FASB website (www.fasb.org). Identify the specific nine-digit Codification citation (XXX-XX-XX-XX) for accounting for variable consideration arising from sales-based royalties on licenses of intellectual property, and consider the relevant GAAP. When can Tran recognize revenue from sales-based royalties associated with the Lyon license?
2. What journal entry would Tran record on April 1, 2021, when it receives the $500,000 payment from Lyon?
3. Assume on December 31, 2021, Tran receives $1,000,000 for all sales-based royalties from Lyon in 2021. What journal entry would Tran record on December 31, 2021, to recognize any revenue that should be recognized in 2021 with respect to the Lyon license that it has not already recognized?
4. Assume Tran accounts for the Lyon license as a five-year right to access Tran’s symbolic intellectual property from April 1, 2021, through March 31, 2026. Tran expects that its ongoing marketing efforts will affect the value of the license to Lyon during the five-year license period. Repeat requirements 2 and 3.

Solutions

Expert Solution

Requirement 1

The FASB Accounting Standards Codificationrepresents the single source of authoritative U.S. generally accepted accounting principles. Regarding accounting for sales-based royalties from licenses, the appropriate citation is:

 

FASB ASC 606–10–55–65: “Revenue from Contracts with Customers–Overall–Implementation Guidance and Illustrations–Sales-Based or Usage-Based Royalties.”

 

That citation requires that both of the following two events have occurred:

1. The sales that utilize the intellectual property have occurred.

2. The performance obligation to which the royalty has been allocated has been satisfied. 

 

Therefore, Tran can’t recognize revenue for sales-based royalties on the Lyon license until sales have actually occurred. 

 

Requirement 2

If Tran accounts for the Lyon license of functional intellectual property as a right of use that is conveyed on April 1, 2021, Tran can recognize revenue of $500,000 on that date, because that is the date upon which Tran transfers to Lyon the right to use its intellectual property. The journal entry would be:

 

Cash                                                           500,000

    License revenue                                                           500,000

 

Requirement 3

Tran recognizes revenue for sales-based royalties in the period in which uncertainty is resolved. Tran is due $1,000,000of royalties on Lyon’s sales in 2021, so it should recognize revenue in that amount. The journal entry would be:

 

Cash                                                           1,000,000

    License revenue                                                        1,000,000

 

Requirement 4

If Tran accounts for the Lyon license of symbolic intellectual property as an access right for the period from April 1, 2021, through March 31, 2023, Tran cannot recognize any revenue on April 1, 2021, because it fulfills its performance obligation over the access period and no time has yet passed. Instead, Tran must recognize deferred revenue of $500,000. The journal entry would be:

 

Cash                                                           500,000

    Deferred revenue                                                          500,000

 

As of December 31, 2021, Tran has partially fulfilled its performance obligation to provide access to its symbolic intellectual property. Given that the access right covers a five-year period (from April 1, 2021, through March 31, 2026), and Tran provided access for nine months of 2021 (from April 1, 2021, through December 31, 2021), Tran has provided 15% [equal to 9 ÷ (5 × 12)] of the access right during 2021, and should recognize 15% × $500,000 = $75,000 of revenue. Tran also should recognize revenue for the $1,000,000 of royalties arising from Lyon’s sales in 2021. So, total revenue recognized in 2021 is $75,000 + $1,000,000 = $1,075,000. The journal entry would be:

 

Cash                                                           1,000,000

Deferred revenue                                         75,000

        License revenue                                                       1,075,000


Cash                                                           1,000,000

Deferred revenue                                         75,000

        License revenue                                                       1,075,000

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