Sales-based royalties

Royalties are the long tail of a successful drug licence: a percentage of every sale for as long as patents last. For many biotechs they are the main source of revenue, and for royalty investors the main asset. This guide explains the royalty exception, how licensors estimate royalties the licensee has not yet reported, how tiered and minimum royalties work, royalty monetisation deals and the payer's side.

By Hamza Fida, Chartered Accountant. Reviewed by Mirza Fahad Baig, Chartered Accountant. 3 minute read.

Short answer

Sales-based royalties on a licence of intellectual property are recognised under IFRS 15's royalty exception: only when the licensee's sales occur, or when the licence performance obligation is satisfied if that is later. The licensor does not estimate future royalties when it grants the licence, however likely they are. Once the sales have happened, it estimates royalties it has earned but not yet been told about, because licensees often report a quarter in arrears. Tiered rates are applied as cumulative sales reach each tier. In this guide's example, a licensee's sales of US$ 1,200 million in a year give the licensor royalties of 110 million, rising from 16 million in the first quarter to 35 million in the fourth as a higher tier applies.

At a glance

Rule
Recognise when the sales occur
No upfront estimate
Exception overrides variable consideration
Unreported sales
Estimated once they have occurred
Tiered rates
Applied as cumulative sales reach tiers
Minimum royalties
Fixed part may be recognised earlier
Selling a stream
Often debt, not revenue
Sales-based royaltiesRule: Recognise when the sales occur; No upfront estimate: Exception overrides variable consideration; Unreported sales: Estimated once they have occurred; Tiered rates: Applied as cumulative sales reach tiers; Minimum royalties: Fixed part may be recognised earlier; Selling a stream: Often debt, not revenue.KEY FACTS AT A GLANCESales-based royaltiesRuleRecognise when the salesoccurNo upfront estimateException overridesvariable considerationUnreported salesEstimated once they haveoccurredTiered ratesApplied as cumulativesales reach tiersMinimum royaltiesFixed part may berecognised earlierSelling a streamOften debt, not revenueTax BakersSales-based royaltiesRule: Recognise when the sales occur; No upfront estimate: Exception overrides variable consideration; Unreported sales: Estimated once they have occurred; Tiered rates: Applied as cumulative sales reach tiers; Minimum royalties: Fixed part may be recognised earlier; Selling a stream: Often debt, not revenue.KEY FACTS AT A GLANCESales-based royaltiesRuleRecognise when the sales occurNo upfront estimateException overrides variable considerationUnreported salesEstimated once they have occurredTiered ratesApplied as cumulative sales reach tiersMinimum royaltiesFixed part may be recognised earlierSelling a streamOften debt, not revenueTax Bakers
Key facts at a glance, as set out in this guide.

What is the royalty exception?

For a licence of intellectual property, IFRS 15 sets aside its usual variable consideration rules for royalties based on the licensee's sales or usage. Such royalties are recognised only when the later of two events happens: the sale or usage occurs, or the performance obligation to which the royalty relates is satisfied. It applies when the royalty relates only to a licence of intellectual property, or the licence is the predominant item it relates to. Sales-based milestones are covered too. See IFRS 15 licences.

Sales-based royalties: a tiered royalty over a year

A licensor earns 8% on its licensee's annual net sales up to US$ 500 million and 10% on sales above that. The licensee's quarterly sales are 200, 300, 350, 350 million.

Royalty revenue by quarter (US$ million)Royalty revenue by quarter (US$ million)16Q124Q235Q335Q4Royalty revenue
Revenue steps up once cumulative sales reach the higher tier.
US$ millionQ1Q2Q3Q4Year
Licensee's net sales2003003503501200
Royalty revenue16243535110

In the second quarter, cumulative sales reach 500 million, so later sales earn 10%. The licensor applies the higher rate only once the sales that reach the tier have occurred; it does not anticipate the tier earlier in the year. If tiers applied retrospectively to all sales in the year once a threshold was crossed, the licensor would still recognise each quarter's royalty as sales occur, adjusting when the threshold is crossed.

How are unreported royalties estimated?

Licensees typically report sales and pay royalties 45 to 60 days after each quarter. At its reporting date, the licensor has earned royalties on sales already made but not yet reported. It estimates them using the licensee's guidance, prescription data, public sales figures and past patterns, and recognises them as revenue and a receivable, truing up when the report arrives. Material differences between estimates and reports are a sign the method needs improving.

How are minimum royalties treated?

A guaranteed minimum annual royalty is fixed consideration, not a sales-based royalty. For a right-to-use licence that has already been transferred, the fixed minimum is recognised when the licence is transferred, discounted if it is significant and payable over many years. Royalties above the minimum are recognised as sales occur. See licensing deals and milestone payments.

What happens when a licensor sells its royalty stream?

Biotechs often sell some or all of their future royalties to royalty investors for cash upfront. If the licensor keeps significant continuing involvement, for example it still receives the royalties and passes them on, or the investor's return is capped or protected, the cash is usually a financial liability under IFRS 9, repaid out of future royalties, and the licensor continues to recognise royalty revenue. Only where it transfers the rights and their risks outright, with no continuing involvement, can the proceeds be recognised as income rather than as a liability, and that analysis needs care. Under US GAAP, sales of future revenue are generally debt under ASC 470 when the seller has significant continuing involvement.

How does the licensee account for royalties it pays?

Royalties payable on sales are expensed as the sales occur, usually in cost of sales. Fixed minimum royalties or upfront licence fees are capitalised as part of the cost of the licence under IAS 38. Variable royalties are generally not included in the cost of an acquired intangible asset until they are incurred. See pharma accounting and IAS 38 intangibles.

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Questions people ask

When are sales-based royalties recognised under IFRS 15?

When the licensee's sales occur, or when the related performance obligation is satisfied if later; they are not estimated upfront.

Can a licensor accrue royalties before the licensee reports them?

Yes. Once the sales have occurred, the licensor estimates royalties earned but not yet reported and trues them up later.

How are tiered royalty rates applied?

As cumulative sales reach each tier; a higher rate is not anticipated before the sales that reach it occur.

Is selling a royalty stream revenue?

Usually not. If the licensor keeps significant continuing involvement, the cash received is a financial liability under IFRS 9.

Sources

Every fee, date and rule on this page was taken from these official and primary sources.

  1. IFRS Foundation: IFRS 15 Revenue from Contracts with Customers
  2. IFRS Foundation: IFRS 9 Financial Instruments

Rules and fees change. If you are reading this long after October 8, 2026, confirm the figures with the source before you rely on them.

PharmaLicensing deals and milestone paymentsIFRS 15Licences of intellectual property under IFRS 15PharmaPharma accounting: the key IFRS issues

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This guide is general information. It is not tax or legal advice for your situation.