Revenue recognition for licensors in the record and music industry
For each recording master delivered by a pop group, THRAG, the group (which operates through a service company) receives a payment of €1,000,000. This amount comprises:
- a non-returnable, non-recoupable payment of €100,000;
- a non-returnable but recoupable advance of €600,000; and
- a returnable, recoupable advance of €300,000.
The recoupable advances of €900,000 can be recouped against royalties on net sales earned both on the album concerned and on earlier and subsequent albums. This is achieved by computing the total royalties on net sales on all albums delivered under THRAG” service company” agreement with its recording company, and applying against this total the advances and royalties previously paid on those albums.
It is clear that the non-recoupable advance of €100,000 should be recognised in income when received, since it is not related to any future performance; at the other end of the spectrum, recognition of the returnable advance should be deferred and recognised only when recouped. However, the question arises as to whether the non-returnable but recoupable advance on royalties should be recognised immediately or deferred. If one accepts that revenue may be recognised when it is absolutely assured, there is an argument to justify the immediate recognition of the recoupable advance, since it is non-returnable. Conversely, some might argue that although the advance is non-returnable, it is not earned until it is recouped; furthermore, immediate recognition of royalty advances is likely to lead to a significant distortion of reported income, resulting in there being little correlation between reported income and album sales.
However, in our view, from the perspective of THRAG, the earnings process on the non-returnable but recoupable advance of €600,000 is complete. This is because THRAG has no other service obligation to fulfil, and the fact that the advance is recoupable is a risk of the record company. Consequently, it should be recognised in revenue immediately on delivery of the master.
Similar recognition principles should be applied in the case of advance fees paid on the sale of film/TV rights.