In the context of software and intellectual property, a perpetual license is a type of licensing agreement that allows the buyer to use a piece of software indefinitely. Unlike with subscription models, where the right to use the software is tied to regular payments, a perpetual license typically involves a one-time fee. This license doesn’t usually cover future upgrades or support unless these are included as separate agreements. Perpetual licenses are common in industries such as specialized engineering and creative software, where businesses prefer long-term control over their software assets without recurring additional costs.

There are specific rules for recognizing revenue from perpetual licenses. Because software delivery and transfer of control to the buyer occur at the point of sale, businesses often recognize the revenue from the license at that time. This means they reflect immediate income from these sales on their financial statements. Proper revenue recognition is important for ensuring that financial reports accurately represent a company’s earnings and financial health, which helps investors, stakeholders, and management make informed decisions.

Below, we’ll explain what businesses should know about perpetual license revenue recognition and how to apply Accounting Standards Codification (ASC) 606 and International Financial Reporting Standard (IFRS) 15 to perpetual licenses.

What’s in this article?

• What is a perpetual license and who uses it?
  
• Perpetual licenses vs. subscription-based licenses
  
• When is revenue recognized for perpetual licenses?
  
• How to apply ASC 606 and IFRS 15 to perpetual licenses
  
• Challenges in recognizing revenue for perpetual licenses
  

What is a perpetual license and who uses it?

A perpetual license is a type of software licensing agreement that allows the purchaser to use the software indefinitely after a one-time payment. Users who value long-term stability and predictability in software costs favor perpetual licenses, especially when the software is highly important to their operations or projects.

Here are the types of entities that typically use perpetual licenses:

• Large corporations: These businesses often prefer a perpetual license for software because it enables them to control costs in the long term. Once businesses purchase the license, they can use the software without recurring fees, which makes budgeting more predictable.

• Government agencies: Government agencies frequently use perpetual licenses to facilitate budgeting and long-term planning. Perpetual licenses ensure that they can continue using important software without the risk of subscriptions expiring and affecting their operations.

• Educational institutions: Schools, colleges, and universities frequently prefer perpetual licenses for their educational and administrative software. This avoids recurring fees and grants continuous access for students and staff.

• Small and medium-sized enterprises (SMEs): Some SMEs choose perpetual licenses for important software tools to avoid the complications of and potential for rising costs of subscription products.

• Individuals in specialized fields: Professionals such as architects, engineers, and graphic designers who rely heavily on specific tools for their work might purchase perpetual licenses for long-term access without future payment obligations.

Perpetual licenses vs. subscription-based licenses

Perpetual licenses and subscription-based licenses are two common models for acquiring and using software, each of which has distinct characteristics and benefits that fit different needs and preferences. Here’s a quick overview of each license type.

Perpetual licenses

A perpetual license allows the user to pay a one-time fee to use the software indefinitely. After the initial purchase, no additional fees are required to continue using the software. This can be more economical over time, especially for software that doesn’t require frequent updates, and enables stability by maintaining access to the version the buyer purchased, regardless of vendor changes or discontinued product offerings.

Despite these benefits, the higher initial costs of perpetual licenses can be prohibitive for some users or businesses. There’s also the risk that, without regular updates (which often come with a fee), the purchased software can become obsolete. These licenses are also relatively inflexible, and changing or scaling software usage can be more difficult and expensive than doing so with a subscription model.

Perpetual licenses are most suitable for users who need stable, long-term software solutions without the worry of recurring costs. They’re ideal for businesses with predictable software needs and the capital to invest up front.

Subscription-based licenses

Subscription-based licensing involves paying a recurring fee (e.g., monthly, annually) to use the software. This license type comes with lower initial costs, which makes it more accessible for some buyers, and usually includes automatic updates and improvements, which keep the software up-to-date without additional charges. With subscription-based licenses, it’s easier to adjust the number of licenses based on current needs, which is beneficial for fluctuating business conditions.

While the initial costs are lower, ongoing payments can add up and eventually surpass the cost of a perpetual license. Subscription fees can increase, subject to the terms set by the provider, and companies’ recurring payments can become higher than expected. Subscription-based licenses also create a dependence on the vendor, with continued access contingent on the vendor’s stability and policies.

Subscription-based licenses are most suitable for businesses that want flexibility, a minimal initial investment, and access to the latest software updates. They’re ideal for startups, businesses in dynamic industries, and those with changing software needs.

When is revenue recognized for perpetual licenses?

Companies must meet several criteria to recognize revenue from perpetual licenses. The IFRS, the US Generally Accepted Accounting Principles (GAAP), and other accounting standards set these criteria.

Here’s what determines the timing of revenue recognition for perpetual software licenses:

• Software delivery: Businesses recognize revenue from perpetual licenses when the customer receives the software. Delivery occurs when the customer has the ability to download or physically receives the software and the license key. This marks the transfer of control.

• Performance obligations: Under the newer revenue recognition standards (such as ASC 606 and IFRS 15), companies recognize revenue when they satisfy the contract’s performance obligations. In the case of a perpetual license, the primary obligation is typically granting a license to use the software. That means the revenue can be recognized at the point of delivery. But if the seller is required to perform activities after the software delivery (such as providing customization or additional software configuration), it does not recognize revenue until these services are performed.

• Payment terms: Payment terms also dictate the timing of revenue recognition. If payment is contingent on meeting certain conditions, the seller shouldn’t recognize revenue until they are met.

• Collectibility: Revenue should be recognized only if it is highly probable that the seller will collect the payment. If there are doubts about the fee’s collectibility, the seller might postpone revenue recognition.

How to apply ASC 606 and IFRS 15 to perpetual licenses

ASC 606 and IFRS 15 are revenue recognition standards designed to provide a consistent accounting framework across industries, including those that offer perpetual licenses. ASC 606 and IFRS 15 follow a five-step model of revenue recognition. Here’s how to apply this model to perpetual license revenue recognition.

Step 1: Identify the contract with a customer

Identify a customer contract that creates enforceable rights and obligations. For software companies, this is usually a licensing agreement where both parties agree to the terms and conditions of use. Contracts must meet the following criteria:

• The parties have approved the contract (in writing, orally, or in accordance with other business practices).

• Each party’s rights regarding the goods or services to be transferred are identifiable.

• The contract identifies payment terms.

• The contract has commercial substance.

• Collecting payment is probable.

Step 2: Identify the performance obligations in the contract

Next, identify the contract’s performance obligations. A performance obligation is a promise to transfer a distinct good or service to the customer. In the case of perpetual licenses, the performance obligations might include delivering a software license (the core product being sold) or post-contract customer support (PCS) and updates.

Step 3: Determine the transaction price

Determine what the company expects to be entitled to in exchange for transferring the promised goods or services to a customer. Estimate any variable payments and adjust for the effects of time on the transaction value.

Step 4: Allocate the transaction price to the performance obligations

If the contract contains multiple performance obligations, allocate the transaction price to each one in proportion to its stand-alone selling price. For example, a company contracted to deliver both a software license and support services must estimate the stand-alone selling prices of both the license and the services, if sold separately.

Step 5: Recognize revenue when (or as) each performance obligation is satisfied

Recognize revenue when a performance obligation is satisfied by transferring control of a promised good or service to a customer. This might occur over time or at a point in time. For perpetual licenses, businesses typically recognize revenue when the software is made available to the customer. If support services are included in the contract and considered a separate performance obligation, businesses might recognize revenue over time to match the period during which support is provided.

Example

A software company sells a perpetual license for $1,000 and includes one year of support valued at $200, making the total contract price $1,200. Assuming no discounts are applied and these prices reflect the stand-alone selling prices, here’s how the company would handle revenue recognition for this contract:

• It allocates $1,000 to the software license, recognizing this revenue at the point of delivery.

• It allocates $200 to support, recognizing this revenue over the year as services are provided.

Challenges in recognizing revenue for perpetual licenses

Perpetual license revenue recognition presents several accounting challenges. Here’s a closer look at some difficulties businesses might encounter.

Distinguishing when deferred revenue becomes recognized revenue

Distinguishing when deferred revenue becomes recognized revenue can be tricky when the revenue from a particular sale is not recognized all at once. The company needs to carefully manage this transition to accurately reflect its financial performance.

Here’s how this works:

• Deferred revenue: When a company sells a perpetual license, it often receives the payment up front. But it cannot recognize revenue all at once if there are future services or obligations. The company records the portion of the payment related to services or future commitments (e.g., software updates, support, maintenance) as deferred revenue on the balance sheet until the service is delivered or the obligation is fulfilled.

• Recognized revenue: Recognized revenue is the portion of deferred revenue that gets transferred to the income statement as the company fulfills its obligations. For perpetual licenses, the company might recognize the license itself at the time of sale, while it recognizes related services over the period they are provided.

Handling bundled contracts

Bundled contracts often combine different components such as software licenses, support, and maintenance packages. Each component might have a different timeline for revenue recognition, and companies can struggle to allocate revenue across multiple performance obligations, especially when stand-alone selling prices are not readily available.

According to ASC 606, companies must do the following:

• Identify separate performance obligations: For bundled contracts, treat each component (e.g., software, support) as a separate performance obligation if it provides distinct value to the customer.

• Allocate transaction price: Allocate the total contract price among the performance obligations based on their relative stand-alone selling prices. For instance, the company might recognize the license fee up front if it is distinct, while it recognizes support and maintenance fees over the length of the contract.

Managing upgrades or additional services

Perpetual licenses often come with the right to upgrades or the ability to purchase additional services. Assessing whether upgrades and additional services are distinct, whether they represent material rights, and how they impact revenue recognition requires careful contract analysis and professional judgment.

Here’s a closer look at these scenarios:

• Future upgrades: If a company promises future upgrades without additional charge, this promise might be considered a separate performance obligation. This means the company might need to defer a portion of the license fee and recognize it when the upgrades are delivered.

• Optional services: If customers have the option to purchase additional services (e.g., consulting, additional support) at a discount, this option might represent a material right and a separate performance obligation. This affects how the initial license revenue is recognized.