1.5 Step 2: Identify the Performance Obligations in the Contract (Chapter 5 of the Roadmap)
Step 2 requires an entity to
identify the distinct goods or services promised in the contract. Distinct
goods and services should be accounted for as separate units of account (this
process is sometimes called “unbundling”). These distinct goods or services are
referred to as “performance obligations.”
The guidance in ASC 606-10-25-14 requires an entity to evaluate the promised
“goods or services” in a contract to determine each performance obligation (i.e.,
the unit of account). A performance obligation is a promise to transfer either of
the following to a customer:
-
“A good or service (or a bundle of goods or services) that is distinct.”
-
“A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.”
The guidance addresses the identification of distinct performance obligations in
contracts involving the following:
-
Warranties (see Section 5.5).
-
Customer options to acquire additional free or discounted goods or services (see Chapter 11).
-
Nonrefundable up-front fees (see Section 5.6).
The decision tree below illustrates the process for identifying performance
obligations in a contract.
A promised good or service is distinct (and therefore a performance obligation)
if both of the following criteria in ASC 606-10-25-19 are met:
-
Capable of being distinct — “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.”
-
Distinct within the context of the contract — “The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract.”
ASC 606-10-25-20 defines a readily available resource as “a good or service that
is sold separately (by the entity or another entity) or a resource that the customer
has already obtained from the entity.” If an entity regularly sells a good or
service on a stand-alone basis, the customer can benefit from that good or service
on its own and, therefore, the first criterion above is met.
The objective of the second criterion above is to determine whether the nature
of the promise is to transfer each good or service individually or, instead, to
transfer a combined item or items to which the promised goods or services are
inputs. The guidance in ASC 606-10-25-21 provides the following indicators that two
or more promises are not separately identifiable:
-
“The entity provides a significant service of integrating goods or services with other goods or services promised in the contract . . . . In other words, the entity is using the goods or services as inputs to produce or deliver the combined output or outputs specified by the customer.”
-
“One or more of the goods or services significantly modifies or customizes, or are significantly modified or customized by, one or more of the other goods or services promised in the contract.”
-
“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, in some cases, two or more goods or services are significantly affected by each other because the entity would not be able to fulfill its promise by transferring each of the goods or services independently.”
Entities may need to use significant judgment when determining whether the goods
or services in a contract are significantly integrated, are highly interdependent or
highly interrelated, or significantly modify or customize one another.