Revenue Recognition for Royalty Payments

Do you receive royalty payments from lessees?

The way you account for these transactions could be changing if you follow U.S. generally accepted accounting principles (GAAP) to prepare your financial statements.

Beginning in 2019, nonpublic businesses will need to implement Accounting Standards Update No. 2014-09 Revenue from Contracts with Customers (Topic 606) and the related updates. Topic 606 introduces a new five-step revenue recognition model in which an entity should recognize revenue based on the transfer of promised goods or services to customers in an amount that reflects the expected consideration to be received. This new guidance does not speak directly to when royalty revenue is recognized if there is a lag between when the royalty is received and when it is earned. You would experience this type of lag with minimum royalty payments. With respect to this specific situation, the Securities and Exchange Commission has taken the position that the sales-and-usage-based royalty guidance should apply and may require an estimation of royalty usage.

What does this mean to you?

Prior to adopting the new revenue recognition standard, revenue from royalties was recognized based on production. The minimums were deferred until recoupment occurred through royalty production or when the recoupment period expired. Under the new revenue recognition standard, the performance obligation for the lease will most likely be defined as providing the lessee the right to mine and sell coal over the lease term.

Revenue under the new standard can be recognized one of two ways ‑ production basis or minimum basis.  Revenue will be recognized on a production basis if the amount of revenue from production royalties is expected to exceed the amount of the revenue received from minimum payments over the lease term. To recognize revenue on a production basis, you will defer the minimums until recoupment occurs through production and recognize the excess royalties when received. If you estimate that minimum payments will exceed the amount of production royalties received over the lease term, you will recognize revenue on the minimum basis. Revenue recognized on the minimum basis is recognized on a straight-line basis over the lease term.

Your lessees will need to assist you in this process by providing you with mine plans and/or forecasts of mine production and coal sales. The decision on how to recognize revenue should be documented at the inception of the lease and reassessed when the lease is renewed or modified.

Don’t worry, we can help!

If you have questions, Suttle & Stalnaker’s energy team can help walk you through the new revenue recognition process. We can assist you in drafting the policies and procedures to fully implement this new standard and keep you GAAP compliant!