Identify Equipment and consumables industry obligations – This is an example in a small series for illustrating the concepts in What is a good or service that is distinct?
In the Basis for Conclusions to IFRS 15 the Board also makes it clear that an important consideration is whether one promise in a contract has a transformative effect on another promise. The principle is whether two or more goods or services that might be capable of being distinct are used as inputs that are used to produce one single item.
In contrast, if a vendor’s promise to its customer contains two or more goods or services that depend on each other, such as equipment and related consumables that are needed to operate the equipment, these would be distinct in the context of the contract because the supply of the consumables does not change the machine. Identify Equipment and consumables industry obligations
A vendor enters into a contract to supply a customer with an item of equipment and consumables that are required to operate the equipment. The contract also requires the vendor to provide replacement consumables on specified dates over the next three years. The consumables are specific to the equipment and only produced by the vendor, although they are sold separately to customers who have bought the equipment second hand. Identify Equipment and consumables industry obligations
The item of equipment and the consumables are both capable of being distinct, because each of them are regularly sold separately by the vendor. The customer can benefit from the consumables that will be delivered under the contract together with the item of equipment. Identify Equipment and consumables industry obligations
The item of equipment and the consumables are also distinct in the context of the contract. This conclusion is based on the following: Identify Equipment and consumables industry obligations
- There is no service being provided that integrates and transforms the equipment and consumables into a single combined output; Identify Equipment and consumables industry obligations
- Neither the equipment nor the consumables are significantly customised or modified by the other; Identify Equipment and consumables industry obligations
- The equipment and consumables are not highly inter-related because they do not significantly affect each other. Identify Equipment and consumables industry obligations
Consequently, although there is a functional relationship between the equipment and the consumables because the consumables are needed in order to make the equipment work, the absence of any transformation (or integration) of the two components means that they represent separate performance obligations. Identify Equipment and consumables industry obligations
The vendor would be able to fulfill each of its promises in the contract independently of each other; it could transfer the equipment to the customer even if the customer did not purchase any consumables, and could transfer consumables to the customer separately if the customer had acquired the equipment from another third party. Identify Equipment and consumables industry obligations
Distinct within the context of the contract (Agenda Paper 9; October 2014)
It was generally agreed that various factors will often influence the analysis of whether a promise is distinct within the context of the contract, such as a learning curve, a customer’s motivation or contractual restrictions, with none in isolation being determinative.
While TRG members expressed varying levels of support for each, they said that all facts and circumstances would need to be considered.
The IASB and the FASB subsequently made amendments to IFRS 15, including the Illustrative Examples, to clarify the application of the concept of ‘distinct’.
Identifying promised goods or services (Agenda Paper 12; January 2015) Identify Equipment and consumables industry obligations
The TRG discussed an implementation question about whether an entity should identify items or activities as promised goods or services that are not identified as deliverables or components under previous revenue standards. A specific concern was raised about the decision not to exempt an entity from accounting for performance obligations that the entity might regard as being ‘perfunctory or inconsequential’. Some stakeholders held a view that IFRS 15 might require an entity to identify significantly more performance obligations than would be the case under previous revenue standards. Identify Equipment and consumables industry obligations
As a consequence of this, the FASB amended Topic 606 to permit an entity not to identify promised goods or services that are immaterial in the context of the contract. This was to ensure consistency with guidance that was previously included in US GAAP, which was deleted when Topic 606 was issued. However, the IASB decided not to propose incorporating similar guidance into IFRS 15 as its view is that this issue relates to the application of the materiality concept more generally, rather than the application of the requirements in IFRS 15. In addition, unlike under US GAAP, this issue was not previously addressed in IFRS.