Usage-Based Royalty Revenue Under Ind AS 115 Amid Collectability Issues

1. Facts

Enova-tech Limited, hereinafter referred to as “the company”, is engaged in the business of software services. The company entered into a three-year licensing arrangement on 1st April 2020 with Fomato Limited, granting Fomato the right to use the company’s patented manufacturing technology.

Under the agreement, consideration was entirely in the form of a usage-based royalty of ₹50 per unit produced using the patent, payable on a quarterly basis. In the first year of the contract, Fomatoproduced 1,00,000 units and paid the full royalty of ₹50,00,000 on time.

In the second year of the arrangement, although Fomato continued to use the patent and produced approximately 1,00,000 units, its financial position began to deteriorate. While the royalty for the year amounted to ₹50,00,000, Fomatopaid ₹12,50,000 in the first quarter but made only nominal payments totalling₹7,50,000 across the remaining three quarters. The company observed delays, partial settlements, and weakening liquidity indicators, signalling a decline in Fomato’s creditworthiness, even though operations and usage of the patent continued throughout the year.

During the third year of the contract, Fomato continued to use the patented technology and produced around 80,000 units, resulting in contractual royalties of ₹40,00,000. However, during this period,Fomato lost a major customer and completely lost access to external credit, leading to severe financial stress. Based on these facts, the company concluded that it was no longer probable that it would be able to collect any further royalty payments for the ongoing usage of the patent. Accordingly, despite continued use of the licensed intellectual property, the company determined that recognition of royalty income for the third year was not appropriate due to significant uncertainty regarding collectability.

In the year following the end of the licensing term, Fomato won a major new customer, and its financial position improved significantly, restoring its overall credit strength.

Based on the above facts, how should Enova-tech Limitedrecognise usage-based royalty revenue in each year of the licensing arrangement under Ind AS 115, considering the changes in the customer’s creditworthiness and collectability from Year 1 to Year 4?

2. Relevant Provisions

Ind AS 115 – Revenue from Contracts with Customers

Para 9 of Ind AS 115

An entity shall account for a contract with a customer that is within the scope of this Standard only when all of the following criteria are met:

……………

(e) it is probable that the entity will collect the considerationto which it will be entitled in exchange for the goods or services that will be transferred to the customer. In evaluating whether collectability of an amount of consideration is probable, an entity shall consider only the customer’s ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the entity will be entitled may be less than the price stated in the contract if the consideration is variable because the entity may offer the customer a price concession.

Para 31 of Ind AS 115

An entity shall recognise revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (ie an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset.

Para B63 of Ind AS 115

Notwithstanding the requirements in paragraphs 56–59, an entity shall recognise revenue for a sales-based or usage-based royalty promised in exchange for a licence of intellectual property only when (or as) the later of the following events occurs:

a) the subsequent sale or usage occurs

b) the performance obligation to which some or all of the salesbased or usage-based royalty has been allocated has been satisfied (or partially satisfied).

Ind AS 109 – Financial Instruments

Para 5 of Ind AS 109

An entity shall recognise in profit or loss, as an impairment gain or loss, the amount of expected credit losses (or reversal) that is required to adjust the loss allowance at the reporting date to the amount that is required to be recognised.