Performance obligation

Performance obligation – [IFRS 15 Appendix A – Defined terms]

Such an obligation is a promise in a contract with a customer to transfer to the customer 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.

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Context

For revenue to be recognized, the following conditions must be satisfied:

1. Risks and rewards have been transferred from the seller to the buyer.
2. The seller does not have control over the goods sold.
3. The collection of payment from goods or services is reasonably assured.
4. The amount of revenue can be reasonably measured.
5. Costs of revenue can be reasonably measured.

Conditions (1) and (2) are referred to as performance. Regarding performance, it occurs when the seller has done what is to be expected to be entitled to payment. This means the performance obligation has been fulfilled.

Condition (3) is referred to as collectability. The seller must have a reasonable expectation that he or she will be paid for the performance.

Conditions (4) and (5) are referred to as measurability. Due to the accounting guideline of the matching principle, the seller must be able to match the revenues to the expenses. Hence, both revenues and expenses should be able to be reasonably measured.

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Performance obligations in contracts

In many revenue transactions, the performance obligation (or promise) is explicitly stated as either a good or a service. For example, retailer A agrees to sell customer Jones a new television. The performance obligation, embodied in the customer invoice, is delivering the television into the hands of Jones in exchange for the stated consideration. In another scenario, garage B agrees to change the oil in Smith’s vehicle in exchange for the stated consideration. Here again the customer invoice is the contract. There are countless numbers of such transactions happening daily. They are straightforward and IFRS 15 is generally easily applied. However, there are many more contracts which contain multiple performance obligations. For these, careful analysis and judgment are required.

Some contracts may involve more than one performance obligation. For example, the sale of a car with a complementary driving lesson would be considered as two performance obligations. The first being the car itself and the second being the driving lesson.

Performance obligations must be distinct from each other. The following conditions must be satisfied for a good or service to be distinct (or separable):

• 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, and
• The entity’s performance obligation (or promise) to transfer the good or service to the customer is separately identifiable from other performance obligation (or promise)s in the contract.

In assessing whether an entity’s performance obligations (or promises) to transfer goods or services to the customer are separately identifiable, the objective is to determine whether the nature of the performance obligation (or promise) in the contract is to transfer each of those goods or services individually or, instead, to transfer a combined item or (bundle of) items to which the promised goods or services are inputs.  This assessment is done from the perspective of the customer.

If a promised good or service is not distinct, the entity must combine that good or service with other promised goods or services until it identifies a bundle of goods and/or services that is distinct.  Performance obligations (or promises) are not separately identifiable (i.e. they must be bundled) if any of the following circumstances exist:

• The seller performs a significant amount of work to integrate the good or service with other goods or services promised in the contract
• Goods or services provided are highly interdependent or interrelated, or
• One or more of the goods or services provided by the seller significantly modifies or customises, or is significantly modified or customised by, other goods or services promised in the contract.

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Examples of performance obligations

Depending on the contract, these obligations (or promised goods or services) may include, but are not limited to, the following:

• Sale of goods produced by an entity (for example, inventory of a manufacturer)
• Resale of goods purchased by an entity (for example, merchandise of a retailer)
• Resale of rights to goods or services purchased by an entity (for example, a ticket resold by an entity acting as a principal)
• Performing a contractually agreed-upon task (or tasks) for a customer
• Providing a service of standing ready to provide goods or services (for example, unspecified updates to software that are provided on a when-and-if-available basis) or of making goods or services available for a customer to use as and when the customer decides
• Providing a service of arranging for another party to transfer goods or services to a customer (for example, acting as an agent of another party)
• Granting rights to goods or services to be provided in the future that a customer can resell or provide to its customer (for example, an entity selling a product to a retailer performance obligation (or promise)s to transfer an additional good or service to an individual who purchases the product from the retailer)
• Constructing, manufacturing, or developing an asset on behalf of a customer
• Granting options to purchase additional goods or services

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Real-life example

An auto dealer sells a car to a customer for an all-inclusive price that includes the car and three years of free oil changes. This contract would include two performance obligations. The first performance obligation would be for the sale of the car. The second performance obligation would be for the oil changes. The car performance obligation revenue would be recognized upon delivery to the customer. The oil change performance obligation would be recognized over the three-year oil change obligation.

Performance obligation