Performance obligations are the unit of account for the purposes of applying the revenue standard, and they therefore form the basis for how and when revenue is recognised.

Promises in a contract

A performance obligation is a promise to provide a distinct good or service or a series of distinct goods or services. At contract inception, an entity assesses the goods or services promised to a customer, and identifies each promise to transfer as either:

1. a good or service (or a bundle of goods or services) that is distinct; or
2. a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.

Promises in a contract can be explicit, or implicit if they create a valid expectation that the entity will provide a good or service based on the entity’s customary business practices, published policies or specific statements. Management should consider the entity’s policies and practices, representations made during contract negotiations, marketing materials and business strategies when identifying the promises in an arrangement.

Implied promises in a contract When evaluating whether an implicit promise gives rise to a performance obligation, it’s crucial to consider the customer’s perspective. Customers often base their current purchasing decisions on implied expectations stemming from an entity’s customary business practices or marketing efforts. A performance obligation arises when there’s a valid anticipation of receiving additional goods or services without extra charges. Customer expectations are shaped by various factors, including written contracts, typical business practices of entities, industry norms, marketing strategies, and sales approaches. These customary practices differ across entities, industries, jurisdictions, customer classes, and product/service nature. Hence, management must analyze the specific circumstances of each arrangement to ascertain the existence of implied promises. Implied promises made by the entity to the customer, in exchange for the contractually promised consideration, don’t necessarily need legal enforceability to be regarded as a performance obligation. This differs from contracts granting customers the option to make additional purchases for extra consideration, which aren’t considered performance obligations unless they confer a material right. Implied promises can create performance obligations even without legal assurance because customers expect entity performance. The boards emphasized in the revenue standard’s basis for conclusions that neglecting these implied promises could lead to recognizing all revenue, even if the entity has unfulfilled commitments to the customer.

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Shipment of goods to a customer Arrangements involving the shipment of goods to customers may encompass promises related to shipping services, giving rise to a performance obligation. Management needs to evaluate the explicit shipping terms to ascertain when control of the goods transfers to the customer and whether shipping services constitute a separate performance obligation. Shipping and handling services could be deemed a distinct performance obligation if control of the goods transfers to the customer before shipment, but the entity commits to shipping the goods (or arranging for shipment). However, shipping isn’t a promised service if control of a good doesn’t transfer to the customer before shipment, as shipping then becomes a fulfillment activity, with costs incurred as part of transferring the goods. If shipping is identified as a separate performance obligation, management should determine whether the entity acts as a principal or agent for the shipping service. This assessment dictates whether the entity records the gross revenue amount allocated to shipping or the net amount after paying the shipper. Activity A manufacturer engages in a contract with a customer to supply five flat-screen televisions. The customer specifies that the manufacturer should organize the delivery of the televisions. The terms of delivery stipulate that legal ownership and the risk of loss transfer to the customer upon delivery to the carrier. Control over the televisions shifts to the customer upon shipment, enabling them to sell the televisions to another party. Once the carrier collects the televisions from the manufacturer’s shipping dock, the manufacturer is unable to redirect the shipment to another customer. Question How many performance obligations are in the arrangement? Answer There are two performance obligations: (1) sale of the televisions; and (2) shipping service. The provision of the shipping service, assuming it is distinct, does not impact the moment when the customer gains control over the televisions. The manufacturer will recognize revenue related to the sale of the televisions when control shifts to the customer, which typically occurs upon shipment. Revenue associated with the shipping service will be recognized when the service is performed. Given that the manufacturer is organizing the shipment through a third-party carrier, it should assess whether to record the revenue attributed to the shipping services grossly, as a principal, or on a net basis, as an agent.

Promised goods or services include, but are not limited to:

• Transferring produced goods or reselling purchased goods.
• Arranging for another party to transfer goods or services.
• Standing ready to provide goods or services in the future.
• Building, designing, manufacturing or creating an asset on behalf of a customer.
• Granting a right to use or access to intangible assets, such as intellectual property.
• Granting an option to purchase additional goods or services that provides a material right to the customer.
• Performing contractually agreed-upon tasks.

An entity assesses the goods and services promised in a contract to identify material performance obligations. Management should consider the overall objective of IFRS 15 and materiality to identify the performance obligations. Assessing whether promised goods or services are material in the context of the contract requires judgement.

Should an entity identify immaterial promises? When evaluating whether a promised good or service constitutes a performance obligation, management should analyze the contract’s nature and the importance of that particular promise to the entire arrangement. This assessment should encompass both quantitative and qualitative factors, considering the customer’s viewpoint. For instance, if a promised good or service is prominently highlighted in the entity’s marketing materials, it likely holds significance from the customer’s perspective. Even promises that might seem trivial or routine should be considered as potential performance obligations, as any commitment to provide a distinct good or service meets the criteria for a performance obligation.

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Determining whether unbundling is optional Accurate identification of performance obligations in a contract is essential for adhering to the core principle outlined in IFRS 15. Failing to identify and appropriately account for separate performance obligations could lead to revenue recognition errors. Although the process of identifying performance obligations, often referred to as “unbundling,” is mandatory, there are practical considerations. In some cases, following the Standard’s detailed requirements on unbundling may not be necessary if it doesn’t impact the amounts recognized and disclosed in the financial statements. For instance, if control of multiple goods or services transfers simultaneously or over the same period and there’s no need to separate them for disclosure purposes, then unbundling may not be required. In such scenarios, revenue recognition and disclosure would remain consistent whether the items are unbundled or not.

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Unbundling a sale of inventory with carbon offsets Identifying separate performance obligations is obligatory. However, in this instance, it may not be imperative since both the biofuel and carbon offsets are handed over to the customer simultaneously. Consequently, the total revenue recognized and disclosed in the financial statements will remain consistent, whether or not the sale of the biofuel and associated carbon offsets are treated as distinct performance obligations. Nonetheless, the entity should contemplate breaking down total revenue by the nature of the goods transferred, specifically disclosing revenue from biofuel and carbon offsets (IFRS 15).

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Identification of performance obligations under a contract when ‘free’ goods or services are provided as an incentive In many industries, entities may operate marketing campaigns under which a customer is offered ‘free items’ as an incentive to enter into a contract. When analysing such arrangements in the context of IFRS 15, it is important to focus on when a contract with the customer comes into existence and, accordingly, whether the ‘free items’ form part of the performance obligations under that contract.

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Accounting for free goods or services provided by an entity (bonus items) – example Entity A provides a marketing program where customers have the option to subscribe annually and receive three additional magazines as a bonus. If a customer opts for the subscription, they will receive a total of 15 magazines for an annual fee of CU12. Upon acceptance of the subscription offer, Entity A commits to delivering 15 magazines to the customer for a non-refundable fee of CU12. Entity A divides the transaction price among each magazine (CU0.80 per magazine). Since each magazine is considered a distinct performance obligation fulfilled at a specific point in time, revenue is recognized as each magazine is transferred to the customer.

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Accounting for free goods or services provided by an entity (trial basis) Entity B offers sports magazines for sale through an annual subscription program, which includes a risk-free trial offer allowing subscribers to receive a certain number of magazine issues before committing to the subscription. For instance, Entity B provides 3 trial magazines, and upon acceptance of the subscription offer, a non-refundable fee of CU12 becomes payable. Entity B is not obligated to provide further magazines until the customer accepts the subscription offer. Regardless of when the customer accepts during the trial period, Entity B commits to delivering a total of 15 magazines, including the three trial issues, and the customer pays CU12. When Customer C accepts the subscription offer and pays CU12, Entity B has delivered the first two trial magazines. However, since neither party is obligated to fulfill their obligations until Customer C accepts the subscription offer, no contract exists when the first two magazines are delivered. Upon acceptance of the offer (after receiving two trial magazines), Entity B is then contractually bound to deliver 13 additional magazines to Customer C. The first two trial magazines are considered a marketing incentive rather than promised goods or services. Each magazine is treated as a distinct performance obligation, satisfied at a specific point in time. Therefore, Entity B allocates the CU12 transaction price to the 13 magazines (CU0.92 each) and recognizes revenue as each magazine is transferred to Customer C.

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Application of series guidance may lead to a different accounting result The application of IFRS 15 does not require the same accounting result to be produced as a situation in which each of the underlying distinct goods or services were accounted for as separate performance obligations.

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Mandatory treatment of a series of distinct goods or services as a single performance obligation The series provision in IFRS 15 aims to streamline the application of the revenue model and ensure consistency in identifying performance obligations. When an entity determines that a series of distinct goods or services meets the criteria outlined in IFRS 15, it must treat that series as a single performance obligation. The entity is not allowed to treat the individual goods or services within the series as separate performance obligations. IFRS 15 emphasizes the Board’s decision to enforce this simplification, specifying that a promise to deliver a series of distinct goods or services, which are substantially similar and follow the same pattern of transfer to the customer, constitutes a single performance obligation if two specific criteria are satisfied.

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Applying the series provision when the pattern of transfer is not consecutive To fulfill the series requirement in IFRS 15, particularly regarding the “same pattern of transfer to the customer,” it’s not necessary for goods or services to be transferred consecutively. The criteria outlined in IFRS 15 do not specify consecutive transfer, so the application of the standard isn’t contingent on whether the goods or services will be delivered or performed consecutively. For instance, consider a scenario where an entity agrees to provide a consistent package of cleaning services every week for 52 weeks. Alternatively, the cleaning contract might involve occasional gaps in service delivery, with some services overlapping whereby cleaning starts before the previous week’s work is finished. In both cases, the criteria in IFRS 15 could still be satisfied.

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Determining whether a promise to transfer goods or services constitutes a series of distinct goods or services that are substantially the same In July 2015, the TRG determined that for distinct goods or services to be regarded as substantially the same and thus treated as a series under IFRS 15, it isn’t necessary for the tasks in each increment to be substantially identical. Assessing whether distinct goods or services are substantially the same requires significant judgment based on the specific facts and circumstances of the contract. Initially, an entity should ascertain the nature of the promised goods or services to be provided under the contract by determining whether the arrangement aims to furnish the customer with a specified quantity of distinct goods or services or to be prepared to provide an undefined quantity of goods or services throughout the contract period. If the promise’s nature involves delivering a specified quantity of a service, then the assessment should focus on whether each service is distinct and substantially similar. Conversely, if the entity’s commitment entails standing ready or providing a single service over a period (due to an unspecified quantity to be delivered), the evaluation would center on whether each time increment is distinct and substantially the same, rather than the underlying activities.

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Series of distinct goods or services that are substantially the same – specified quantity of distinct goods or services – example Company A offers Customer Z monthly payroll processing services for a year. After assessing each monthly service, Company A finds them to be distinct, meeting the criteria for revenue recognition over time and employing the same progress measurement method. Moreover, Company A determines that the contract aims to provide Customer Z with a specified quantity of distinct goods or services, specifically 12 instances of payroll processing. Recognizing the arrangement as involving 12 distinct services, Company A notes that while the volume of employee payroll data processed may vary monthly, the benefit received by the customer (i.e., payroll processing for that month) remains substantially consistent across each transaction. Consequently, Company A concludes that the monthly payroll services are substantially similar, satisfying the requirements of IFRS 15 to be treated as a single performance obligation.

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Series of distinct goods or services that are substantially the same – undefined services over the contract period (hotel management services) – example Company B offers Customer Y comprehensive hotel management services, which encompass various tasks such as employee recruitment, procurement, and marketing efforts to enhance hotel occupancy. On any given day, Company B might undertake activities like room cleaning, promotional campaigns, and concierge operations. Company B determines that the essence of the contract lies in delivering integrated hotel management services throughout its duration, rather than fulfilling a specific quantity of designated services (e.g., cleaning 100 guest rooms per day). While the specific activities involved in hotel management may vary widely from day to day, they collectively contribute to Company B’s obligation to provide integrated hotel management services. Therefore, Company B views the service of hotel management transferred to Customer Y as substantially consistent during each period, as the customer receives a similar benefit consistently (i.e., there is a uniform pattern of transfer). Company B concludes that each service increment (e.g., daily or weekly) is distinct, meets the criteria for recognizing revenue over time, and employs the same progress measurement method. As a result, Company B deems the hotel management services compliant with the criteria outlined in IFRS 15 to be treated as a single performance obligation.

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Series of distinct goods or services that are substantially the same – undefined services over the contract period (IT outsourcing services) – example Company C specializes in providing information technology (IT) outsourcing services to Customer X over a five-year term. These services encompass various aspects such as server capacity provision, maintenance of software portfolios, and access to an IT help desk. Upon assessing the commitment to Customer X, Company C determines that its pledge is to ensure continuous access to an integrated outsourced IT solution, rather than delivering a specific quantity of services (e.g., processing a set number of transactions per day). Although the specific tasks involved in IT outsourcing may fluctuate significantly from day to day, they collectively contribute to fulfilling Company C’s integrated IT outsourcing service. Therefore, Company C believes that, for each period, it delivers an integrated IT outsourcing service where the customer continuously receives a consistent benefit, which is distinct (i.e., there is a uniform transfer pattern to the customer). Furthermore, each time increment is deemed substantially similar (i.e., the same integrated IT outsourcing solution is provided in each time period).

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Economic compulsion and optional items Certain business models involve agreements where a seller provides an upfront good or service along with an option for the customer to purchase other distinct goods or services in the future, which are related to the initial offering (e.g., a specialized piece of equipment with an option to acquire specialized consumables for its operation). Such agreements might contain features that create a level of economic compulsion, leading to a high probability that the customer will exercise the option. However, even in cases where it’s highly probable or virtually certain that the customer will exercise the option, the additional goods or services should not be considered performance obligations under the contract. The treatment of customer options is outlined in IFRS 15, which states that “the transaction price does not include estimates of consideration from the future exercise of options for additional goods or services,” without accounting for the likelihood of option exercise. Hence, regardless of the likelihood of a customer choosing to buy additional goods or services, the reporting entity should not recognize those goods or services as performance obligations under the initial contract. Instead, the entity should assess the customer option to determine if it constitutes a material right. This matter was deliberated by the TRG in November 2015.

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Co-branded credit card arrangements A sponsoring entity, such as a retailer or an airline, may engage in a co-branded or private-label credit card arrangement with a financial institution. In these arrangements, the financial institution issues credit cards bearing the entity’s brand name or logo to individual consumers. In both types of arrangements, the financial institution handles credit issuance and card operation independently. In a private-label credit card setup, the card can only be used to buy goods or services from the sponsoring entity. On the other hand, in a co-branded credit card arrangement, the card can be utilized for purchases at any merchant accepting that particular type of credit card, like MasterCard or Visa. When customers use these credit cards, they typically earn loyalty or rewards points that can later be redeemed for complimentary or discounted products or services from the sponsoring entity. The sponsoring entity in a co-branded credit card arrangement generally receives from the financial institution some combination of: an up-front or incentive fee upon executing the credit card arrangement (e.g. a signing bonus); a fee for each new cardholder who signs up for a credit card (sometimes referred to as a ‘bounty fee’); a specified percentage of the cardholders’ annual purchases or programme profits; and reimbursements for certain costs, such as products or services provided under the rewards programme, marketing expenses, or other related expenses (e.g. credit card processing fees). The first step in this evaluation is to identify all of the promised goods or services in the contract. Under co-branded credit card arrangements, the sponsoring entity usually has various obligations to the financial institution that may include: maintaining the loyalty or rewards programme; licensing its brand name (for use on the credit card and marketing materials); providing access to its customer list (for marketing purposes); providing products or services (or discounts on products or services) as part of a loyalty or rewards programme; and marketing the credit card programme. Although the sponsoring entity has an obligation to maintain the loyalty or rewards programme, maintenance activities related to the loyalty or rewards programme generally do not constitute a distinct good or service in the arrangement. This is because the maintenance and administration of the loyalty or rewards programme are typically activities that a sponsoring entity undertakes to fulfil other promises in its contract with the financial institution (specifically, to license its brand name and provide access to its customer list). In other words, having a loyalty or rewards programme makes the sponsoring entity’s brand name more valuable to the financial institution because individuals are more likely to sign up for the credit card when they know that they can earn loyalty or rewards points and redeem them with the sponsoring entity. In addition, sponsoring entities generally maintain a loyalty or rewards programme for purposes other than the fulfilment of their credit card arrangements and therefore would undertake these activities even without entering into a contract with a financial institution. Therefore, it would not generally be the case that these activities transfer a separate good or service to the financial institution. The next step in the evaluation is to identify which of the promised goods or services in the contract represent distinct performance obligations. In general, it might be common that a co-branded credit card arrangement contains at least two performance obligations: a licence bundled with access to the sponsoring entity’s customer list (the ‘brand performance obligation’); and an obligation to provide products or services in the future for free or at a discount (the ‘rewards performance obligation’). Brand performance obligation Typically, in co-branded credit card agreements, the privilege of using an entity’s brand name is not sold separately from obtaining access to the entity’s customer list. However, the licensing of the sponsoring entity’s brand name and access to its customer list are theoretically separable because the financial institution could derive benefits from each independently. In other words, the sponsoring entity could potentially sell each component separately, and the financial institution could leverage other available resources to perform additional activities, such as marketing and supplying products or services, on its own to gain economic advantages from the arrangement. However, the licensing of the brand name and access to the customer list are usually not distinctly identifiable due to their high level of interdependence. Typically, a significant portion of the financial institution’s value in such agreements stems from its ability to market to the sponsoring entity’s loyalty or rewards members, facilitated by access to the customer list. Additionally, the strong brand recognition aims to attract potential customers to engage with the financial institution for the co-branded credit card. As a result, the combined value of the brand and access to the customer list greatly exceeds the sum of their individual values, indicating a high level of interdependence between the two components. Rewards performance obligation The rewards performance obligation signifies the sponsoring entity’s commitment to fulfilling a cardholder’s redemption of loyalty or rewards points for future free or discounted products or services. These rewards are granted to the cardholder as part of their credit card agreement with the financial institution or through the use of the co-branded credit card. Under IFRS 15, the rewards performance obligation may constitute a material right, necessitating its treatment as a distinct performance obligation. Although this obligation technically pertains to the customer’s customer (the cardholder) rather than directly to the customer itself (the financial institution), it is still pertinent to assess whether the obligation constitutes a material right. This is because the sponsoring entity is assuring the financial institution that it will provide and honor the loyalty points. In some scenarios, the sponsoring entity might independently sell loyalty points to the financial institution, while in other cases, it might grant the financial institution the authority to issue loyalty points on its behalf. Regardless of the approach, the sponsoring entity essentially confers upon the financial institution the privilege to offer loyalty or rewards points to cardholders based on their spending behavior. Therefore, it is generally appropriate to recognize this right as a separate performance obligation Marketing activities Many co-branded credit card arrangements involve marketing activities, which may potentially constitute distinct performance obligations. These activities, if carried out by the sponsoring entity, could be considered distinct because similar services are commonly sold by other entities, such as marketing agencies, as stand-alone offerings. Moreover, the financial institution can derive benefits from these services in conjunction with other resources obtained from the sponsoring entity, such as the brand performance obligation. However, a thorough assessment of the nature of the marketing activities is necessary to ascertain whether they represent separate performance obligations. Some marketing activities, like promoting the card by sales personnel during checkout, may be unique to the sponsoring entity and not offered independently. Additionally, these activities might not be distinctly identifiable within the contract, as they could be closely intertwined with other elements, like the brand performance obligation. This interdependency arises because the marketing efforts may be tailored specifically to the co-branded credit card program, thereby enhancing the value of the brand used by the financial institution. In essence, these marketing activities may be integral to the sponsoring entity’s duty to maintain and bolster the value of its brand as utilized by the financial institution. Even if an entity determines that the marketing activities are distinct within the contract and represent a separate performance obligation, they may often be fulfilled over the same duration as the brand performance obligation. Consequently, the timing of revenue recognition might remain consistent regardless of whether the marketing activities are treated as separate obligations or not.

Promise to transfer a distinct good or service

Each distinct good or service that an entity promises to transfer is a performance obligation. Where there are multiple promises in a contract, management will need to determine whether goods or services are distinct, and therefore separate performance obligations.

What activities are not performance obligations – health club? Tasks performed by an entity to fulfill a contract that do not involve the transfer of goods or services to the customer do not constitute performance obligations. Activities such as administrative duties for contract setup or mobilization efforts are not considered performance obligations if they do not result in the delivery of a good or service to the customer. Determining whether an activity results in the transfer of a good or service to the customer may require judgment. Revenue is not recognized when an entity completes an activity that does not qualify as a performance obligation. Activity Entity E operates health clubs. Entity E enters into contracts with customers for one year of access to any of its health clubs for C300. Entity E also charges a C50 non-refundable joining fee to compensate, in part, for the initial activities of registering the customer Question How many performance obligations are in the contract? Answer There is one performance obligation in the contract, which is the right provided to the customer to access the health clubs. Entity E’s activity of registering the customer is not a service to the customer and therefore does not represent satisfaction of a performance obligation. See paragraph 11.225 onwards for considerations related to the treatment of the upfront fee paid by the customer.

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What activities are not performance obligations – licence on cartoon characters? Entity F, the creator of a new animated television show, enters into a three-year term license agreement with a retailer, granting them the right to use the likenesses of the show’s characters on consumer products. The retailer is obligated to use the latest image of the characters from the television show and does not receive any other goods or services in the agreement. Upon entering the license agreement, the retailer anticipates that Entity F will continue to produce the show, develop the characters further, and engage in marketing activities to promote awareness of the characters. The retailer is permitted to commence selling consumer products featuring the characters’ likenesses once the television show airs for the first time. Question How many performance obligations are in the arrangement? Answer The licence is the only performance obligation in the arrangement. Entity F’s continued production, internal development of the characters, and marketing of the show are not performance obligations, because such additional activities do not directly transfer a good or service to the retailer.

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Product liability and patent infringement protection An entity may face a legal obligation, such as through legal mandates or court orders, to compensate for damages resulting from the use of its products causing harm or damage to others as intended. However, such compensation obligations do not constitute separate performance obligations. Instead, they should be handled following provisions guidance. Similarly, compensations offered to customers due to contract breaches or to address customer grievances are typically treated as consideration payable to the customer, leading to a reduction in revenue. Furthermore, promises to indemnify customers against claims of patent, copyright, or trademark infringements are not considered separate performance obligations, unless the entity’s core business involves providing such protection. These indemnification commitments resemble warranties ensuring the proper functioning of goods or services and are managed according to provisions outlined in IAS 37.

Goods and services that are not distinct are bundled with other goods or services in the contract until a bundle of goods or services that is distinct is identified. The bundle of goods or services, in that case, is a single performance obligation.

Promise to transfer a series of distinct goods or services

A series of distinct goods or services provided over a period of time is a single performance obligation if the distinct goods or services are substantially the same and have the same pattern of transfer to the customer. A series of distinct goods or services has the ‘same pattern of transfer’ if both of the following criteria are met:

• each distinct good or service meets the criteria to be a performance obligation satisfied over time; and
• the same measure of progress towards complete satisfaction of the performance obligation is used.

Substantially the same and consecutive Substantially the same Management should assess the series requirement considering the nature of its commitment to the customer. For instance, a pledge to deliver hotel management services over a defined contract duration might fulfill the series criteria. In this scenario, the entity consistently provides the service of “hotel management” each period, despite potential variations in underlying activities on a daily basis. These underlying activities, such as reservation services or property maintenance, are part of fulfilling the overall hotel management service rather than separate commitments. The distinct service within the series constitutes each time period of performing the service, such as each day or month of service. Consecutive The interpretation also hinges on the specific circumstances. There’s no mandate for goods or services to be provided consecutively to be classified as a series of distinct goods or services. The series guidance might be applicable even if there are breaks in performance or simultaneous transfer of individual distinct goods or services within the series, as long as the criteria are satisfied.

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Series of distinct services A series can encompass distinct intervals of service, such as daily or monthly services. Examples of commitments to provide a series of distinct services might include specific maintenance services, software-as-a-service (SaaS), transaction processing, IT outsourcing, licenses granting access to intellectual property (IP), and asset management services, provided the service rendered each time period remains substantially similar. Conversely, a service where each day’s work builds on the previous day’s efforts toward achieving an ultimate outcome would typically not qualify as a series of distinct services, as the service rendered each time period is not substantially identical. Examples of such services could include certain consulting services, engineering services, and research and development (R&D) endeavors. Although the examples mentioned primarily pertain to services, the series concept extends to goods as well, as long as the criteria for being a performance obligation satisfied over time are met for the individual distinct goods within the series.

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Series of distinct goods A contract manufacturer has secured an agreement to supply 50 units of product A over a span of 36 months. Product A is already fully developed, so design services are not part of the contract. Upon assessment, the contract manufacturer has determined that each unit qualifies as a distinct good. These individual units meet the criteria for recognition over time because they lack alternative uses, and the manufacturer holds the right to payment for work completed to date, meaning payment is due as the goods are manufactured. Question How many performance obligations are in the contract? Answer The promise to provide 50 units of product A is a single performance obligation. The contract is a series of distinct goods because (a) each unit is substantially the same, (b) each unit would meet the criteria to be a performance obligation satisfied over time, and (c) the same method would be used to measure the entity’s progress to depict the transfer of each unit. If any of these criteria were not met, each unit would be a separate performance obligation.

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Is a promise to stand ready to provide goods or services (that is, a ‘stand-ready obligation’) a series of distinct goods or services? Indeed, a stand-ready obligation typically fulfills the requirements to be recognized as a series of distinct goods or services, thereby constituting a single performance obligation. Determining whether an entity’s commitment involves standing ready to provide goods or services, as opposed to promising specified goods or services, requires managerial discretion.

When the series criteria are satisfied, management will adhere to the principles for the single performance obligation as a whole, rather than focusing on individual goods or services within it. However, there’s an exception: when dealing with contract modifications and allocating variable consideration, management should evaluate each distinct good or service in the series separately, rather than the single performance obligation.

Is the series guidance optional? The series guidance must be applied and is mandatory. Assessing whether a contract constitutes a series could affect both revenue allocation and recognition timing. This is because the guidance mandates that goods and services within the series be treated as a single performance obligation. Consequently, revenue isn’t distributed to each distinct good or service based on its individual stand-alone selling price. Instead, management will determine a measure of progress for the single performance obligation that most accurately reflects the transfer of goods or services to the customer.

Assessing whether a good or service is ‘distinct’

A good or service that is promised to a customer is distinct if:

1. the customer can benefit from the good or service, either on its own or together with other resources that are readily available to the customer (that is, the good or service is capable of being distinct); and
2. the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (that is, the promise to transfer the contract). Therefore, the assessment of whether a good or service is distinct has two elements; the good or service must be both:

(a) capable of being distinct; and

(b) separately identifiable.

Capable of being distinct

A good or service is capable of being distinct if the customer can benefit from that good or service on its own or with other resources that are readily available. A customer can benefit from a good or service if it can be used, consumed or sold (for an amount greater than scrap value) to generate economic benefits. A good or service is also usually capable of being distinct if an entity regularly sells that good or service on a stand-alone basis. A good or service that cannot be used on its own, but can be used with readily available resources, also meets this criterion, since the customer has the ability to benefit from it. Readily available resources are goods or services that are sold separately, either by the entity or by others in the market. Readily available resources include resources that the customer has already obtained, either from the entity or through other means. As a result, the timing of delivery of goods or services (that is, whether a necessary resource is delivered before or after another good or service) can impact the assessment of whether the customer can benefit from the good or service.

Separately identifiable

It is necessary to understand what a customer expects to receive as a final product in order to assess whether a good or service is separately identifiable or whether it should be combined with other goods or services into a single performance obligation. Management needs to consider the terms of the contract and all other relevant facts, including the economic substance of the transaction, to make this assessment.

The objective of assessing whether an entity’s promise to transfer goods or services to the customer is separately identifiable is to determine whether the nature of the promise, within the context of the contract, is to transfer each of those goods or services individually or, instead, to transfer a combined item or items to which the promised goods or services are inputs. Factors that help an entity to determine whether two or more promises to transfer goods or services to a customer are not a separate performance obligation include the following:

1. The entity provides a significant service of integrating the goods or services with other goods or services promised in the contract into a bundle of goods or services that represent the combined output or outputs for which the customer has contracted (that is, the entity is using the goods or services as inputs to produce or deliver the combined output or outputs specified by the customer). A combined output or outputs might include more than one phase, element, or unit.
2. One or more of the goods or services significantly modifies or customises, or is significantly modified or customised by, one or more of the other goods or services promised in the contract.
3. The goods or services are highly interdependent or highly interrelated. In other words, each of the goods or services is significantly affected by one or more of the other goods or services in the contract. For example, two or more goods or services are significantly affected by each other because the entity cannot fulfil its promise to transfer each of the goods or services independently.

The agenda decision ‘Revenue recognition in a real estate contract that includes the transfer of land’ illustrates the application of the principles to the assessment of whether a promise to transfer land and construct a building are separately identifiable. This concept is also illustrated in examples 10 and 11 of the revenue standard

How should an entity apply the factors described to determine whether its performance in transferring multiple goods or services in a contract is fulfilling a single promise to a customer? The factors mentioned are not an exhaustive checklist but rather considerations for management to assess. These include: Examining whether the combined item resulting from the goods or services is substantially different from the sum of its individual components. This involves determining if there’s a transformative relationship during fulfillment. For instance, constructing a wall involves labor, lumber, and sheetrock, which together create a unique entity—the wall. Thus, the promise to construct the wall constitutes a single performance obligation. Evaluating the degree of integration, interrelation, and interdependence among the promises to transfer goods or services. Mere dependency of one item on another doesn’t automatically imply a single performance obligation. For example, a contract providing equipment and installation separately isn’t necessarily a single performance obligation, even if the installation relies on the equipment purchase. Considering whether the entity could fulfill its obligation to provide a good or service without delivering others specified in the contract. If the entity’s performance significantly changes without providing certain goods or services, it suggests a high level of interdependency or interrelation, indicating they are not separately identifiable.

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Contract to build a house A contractor enters into a contract to build a house for a new homeowner. The contractor is responsible for the overall management of the project and identifies various goods and services that are provided, including architectural design, site preparation, construction of the home, plumbing and electrical services, and finish carpentry. The contractor regularly sells these goods and services individually to customers. Question How many performance obligations are in the contract? Answer In this scenario, the bundle of goods and services should be consolidated into a single performance obligation. While the promised goods and services can be distinct, as the homeowner could derive benefit from them individually, they are not separable from other promises in the contract. The contractor’s overarching commitment is to deliver a unified product (the house), with the individual goods and services serving as inputs. This determination is reinforced by the contractor’s substantial service of integrating these components into the home, which the homeowner has agreed to purchase.

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Bundle of standard software and service Entity G engages in a contractual agreement with a customer, offering a perpetual software license along with installation services and three years of post-contract customer support, including unspecified future upgrades and telephone assistance. The installation services involve configuring specific software aspects but do not substantially alter the software. These services do not demand specialized expertise, and other skilled software technicians could perform comparable tasks. The upgrades and telephone support provided do not markedly impact the software’s benefit or worth to the customer. Question How many performance obligations are in the contract? Answer There are four distinct performance obligations outlined in this scenario: (1) the software license; (2) the installation services; (3) the unspecified future upgrades; and (4) the telephone support. The customer derives benefit from the software upon delivery, as it is functional even without the subsequent installation services, unspecified future upgrades, or telephone support. However, the customer can benefit from the installation services, unspecified future upgrades, and telephone support in conjunction with the software it has already received. Entity G determines that each of these goods and services is identifiable separately. This determination stems from the fact that the software license, installation services, unspecified future upgrades, and telephone support are not contributing to a combined item that the customer has contracted to receive. Additionally, Entity G can fulfill its commitment to deliver each of these goods or services individually, without providing any substantial integration, modification, or customization services.

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Contractual requirement to use the vendor’s service Entity G enters into a contract with a customer to provide a perpetual software licence, installation services, and three years of post-contract customer support (unspecified future upgrades and telephone support). The installation services require the entity to configure certain aspects of the software, but they do not significantly modify the software. These services do not require specialised knowledge, and other sophisticated software technicians could perform similar services. The upgrades and telephone support do not significantly affect the software’s benefit or value to the customer. The customer is contractually required to use entity G’s installation services. Question How many performance obligations are in the contract? Answer The requirement for the customer to utilize Entity G’s installation services does not alter the assessment of whether the goods and services are distinct. Entity G determines that there are four distinct performance obligations: (1) the software license; (2) the installation services; (3) the unspecified future upgrades; and (4) the telephone support. The customer can derive benefit from the software independently, as it is functional without relying on the subsequent installation services, unspecified future upgrades, or telephone support. However, the customer can also benefit from these additional services when used in conjunction with the software it has already received. Entity G concludes that each of these goods and services can be identified separately. This conclusion is reached because the software license, installation services, unspecified future upgrades, and telephone support are not contributing to a combined item that the customer has agreed to obtain. Additionally, Entity G is capable of fulfilling its commitment to provide each of these goods or services independently, without engaging in significant integration, modification, or customization services.

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Bundle of customised software and service Entity G enters into a contract with a customer to provide a perpetual software licence, installation services and three years of post-contract customer support (unspecified future upgrades and telephone support). The installation services require entity G to substantially customise the software by adding significant new functionality, thereby enabling the software to function with other computer systems owned by the customer. The upgrades and telephone support do not significantly affect the software’s benefit or value to the customer. Question How many performance obligations are in the contract? Answer There are three distinct performance obligations identified by Entity G: (1) a license for customized software; (2) unspecified future upgrades; and (3) telephone support. Entity G determines that its commitment to the customer revolves around providing a tailored software solution. The software and customization services are integral components contributing to the combined item contracted by the customer. Consequently, the software license and installation services are not individually identifiable and should be amalgamated into a singular performance obligation. This conclusion is reinforced by the substantial service rendered by Entity G in integrating the licensed software with the customer’s existing computer systems. Furthermore, the nature of the installation services results in significant modifications and customizations being applied to the software. In contrast, the unspecified future upgrades and telephone support stand as separate performance obligations since they do not contribute to a combined item specified in the customer contract. Entity G is capable of fulfilling its commitment to provide each of these goods or services separately, and it does not engage in substantial integration, modification, or customization services.

Other considerations when identifying performance obligations

Performance obligations can result from other contractual terms or promises implied by an entity’s customary business practices.

Options to acquire additional goods or services

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Contracts frequently include options for customers to purchase additional goods or services in the future. Customer options that provide a material right to the customer (such as a free or discounted good or service) give rise to a separate performance obligation. The performance obligation is the option itself, rather than the underlying goods or services. Management will allocate a portion of the transaction price to such options, and recognise revenue allocated to the option when the additional goods or services are transferred to the customer, or when the option expires

Distinction between optional goods or services and variable consideration An entity may need to exercise judgment in distinguishing between optional goods or services and promises to provide goods or services in exchange for a variable fee. For instance, consider a contract wherein a photocopy machine is delivered to a customer in exchange for a fee based on the number of copies made. In this scenario, the promise to the customer pertains to transferring the machine. Although the quantity of photocopies is unknown at contract initiation, the customer’s subsequent actions (creating photocopies) do not constitute a distinct decision to purchase additional goods or services. The fee represents variable consideration. In contrast, envision a contract for delivering a photocopy machine with an option for the customer to purchase replacement ink cartridges in the future. These future ink cartridge purchases represent options to buy goods later and should not be considered promises in the current contract. Nevertheless, the entity should evaluate whether the customer option constitutes a material right. The determination of whether future purchases are optional can significantly affect contract accounting, especially when allocating the transaction price to multiple performance obligations. It also impacts disclosures. For instance, optional goods or services would not be included in disclosures of the remaining transaction price for a contract and the expected periods of recognition.

The additional consideration that would result from a customer exercising an option in the future is not included in the transaction price for the current contract. This is the case even if management concludes it is probable, or even virtually certain, that the customer will purchase additional goods or services. For example, customers could be economically compelled to make additional purchases due to exclusivity clauses or other circumstances. Management should not include an estimate of future purchases as a promise in the current contract unless those purchases are enforceable by law regardless of the probability that the customer will make additional purchases. Judgement might be required to identify the enforceable rights and obligations in a contract, as well as the existence of implied or explicit contracts that should be combined with the present contract.

Sale of equipment and consumables Entity H, a medical device company, markets a sophisticated surgical instrument along with consumables intended for use alongside the instrument. The instrument is priced at C100,000, while the consumables are individually priced at C100 per unit. A customer buys the instrument but doesn’t commit to a predetermined quantity of consumables. However, the customer can’t utilize the instrument without the consumables and is restricted from sourcing them from alternative suppliers. Entity H anticipates the customer will acquire 1,000 consumables annually for the projected lifespan of the instrument. Entity H determines that both the instrument and the consumables constitute distinct entities. Question Should entity H include the estimated consumable purchases as a performance obligation in the current contract? Answer Entity H should exclude the projected consumable purchases from the current contract, as they represent optional acquisitions. Despite the customer’s reliance on the consumables for instrument operation, there exists no legally binding commitment for the customer to procure them. Each time the customer places an order for consumables, it makes an independent decision to acquire additional distinct goods. Moreover, Entity H must assess whether the option for future consumable purchases confers a significant benefit to the customer, such as a discount on subsequent consumable acquisitions that exceeds typical discount ranges offered to other customers upon entering into the present contract. Such a significant benefit qualifies as a performance obligation, as elaborated earlier.