License Agreement under US GAAP: An Overview

When it comes to accounting for license agreements under US Generally Accepted Accounting Principles (GAAP), the rules can be complex and nuanced. In this article, we’ll take a closer look at how license agreements are accounted for under US GAAP.

What is a License Agreement?

A license agreement is a contract between the licensor (the owner of the intellectual property) and the licensee (the party that is granted the right to use that intellectual property). License agreements are common in the technology sector, where companies allow others to use their patented or copyrighted technology in exchange for compensation.

Accounting for License Agreements

Under US GAAP, license agreements are generally accounted for in one of two ways, depending on the nature of the license agreement: as a sale or as a lease.

Sale Treatment

If a license agreement grants the licensee the right to use the intellectual property in perpetuity, with no ongoing support or other obligations from the licensor, then it may be accounted for as a sale. In this case, the entire amount of revenue from the license agreement is recognized at the time of the sale.

Lease Treatment

If a license agreement grants the licensee a limited right to use the intellectual property, with ongoing support or other obligations from the licensor, then it may be accounted for as a lease. In this case, revenue from the license agreement is recognized over the term of the lease, based on the time periods in which the licensee is able to use the intellectual property.

Key Considerations

There are several key considerations to keep in mind when accounting for license agreements under US GAAP:

– The nature of the license agreement: As noted above, the nature of the license agreement (i.e., whether it’s a sale or a lease) is a critical factor in determining how revenue from the agreement should be recognized.

– Allocation of revenue: In cases where the license agreement includes obligations beyond just the right to use the intellectual property (e.g., ongoing support), it may be necessary to allocate the revenue from the agreement between the intellectual property rights and the other obligations.

– Contingent payments: If there are contingent payments (e.g., royalties) associated with the license agreement, these should be recognized as revenue when the contingency is resolved (e.g., when the licensee exceeds a certain sales threshold).

Conclusion

Accounting for license agreements under US GAAP is a complex process that requires careful consideration of the nature of the license agreement, any obligations beyond just the right to use the intellectual property, and any contingent payments associated with the agreement. By staying abreast of the latest guidance and best practices in this area, companies can ensure that they are properly accounting for license agreements and complying with US GAAP.