Performance obligations satisfied over time
and Performance obligations satisfied at a point in time are the two choices in IFRS 15. IFRS 15 Revenue from Contracts with Customers (contents page is here) introduced a single and comprehensive framework which sets out how much revenue is to be recognised, and when. The core principle is that a vendor should recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the vendor expects to be entitled in exchange for those goods or services. See a summary of IFRS 15 here. Performance obligations satisfied over time
This section is part of step 5 Recognise revenue as or when each performance obligation is satisfied.
Determine if performance obligation is satisfied over time
To determine whether revenue allocated to a performance obligation should be recognised over time, IFRS 15 requires an entity to consider three criteria. If any one of them is met, this means that control is transferred to the customer over time, and thus revenue shall likewise be recognised over time. The entity shall assess this at contract inception.
In summary:
These criteria shall be applied to all goods and services sold by the entity, irrespective of sector.
However, the Basis for Conclusions suggests that these criteria are likely to be more relevant in certain situations (cf. IFRS 15.BC125, IFRS 15.BC129 and IFRS 15.BC132):
- “typical” (i.e. relatively simple) service provisions should generally be accounted for over time under criterion IFRS 16.35(a);
- the second criterion (IFRS 15.35(b)) applies when the customer clearly controls work in progress;
- the last criterion (IFRS 15.35(c)) should be considered, by default, when the two previous criteria are not met (for example, services tailored to a customer that ultimately result in the delivery of a report, or the construction of a complex industrial asset on the entity’s premises).
If a performance obligation is not satisfied over time, then an entity recognises revenue at the point in time at which it transfers control of the good or service to the customer.
So as per the picture above, for each performance obligation in a contract, an entity first determines whether the performance obligation is satisfied over time – i.e. control of the good or service transfers to the customer over time. It does this using the following criteria and examples (a different approach applies if the performance obligation is a licence of IP – see Licensing) (IFRS 15.32, IFRS 15.35)
| # | Criterion Performance obligations satisfied over time |
Example |
| 1 | The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs | Routine or recurring services – e.g. cleaning services |
| 2 | The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced | Building an asset on a customer’s site |
| 3 | The entity’s performance does not create an asset with an alternative use to the entity (see below ‘Performance does not create an asset with an alternative use‘) and the entity has an enforceable right to payment for performance completed to date (see below ‘The entity has an enforceable right to payment for performance completed to date‘) | Building a specialised asset that only the customer can use or building an asset to a customer’s specifications |
If one or more of these criteria are met, then the entity recognises revenue over time, using a method that depicts its performance – i.e. the pattern of transfer of control of the good or service to the customer. If none of the criteria is met, then control transfers to the customer at a point in time and the entity recognises revenue at that point in time (see ‘Performance obligations satisfied at a point in time‘) (IFRS 15.35, IFRS 38–39).
| # | Explanations Performance obligations satisfied over time |
| 1 | A customer simultaneously receives and consumes the benefits of the entity’s performance as the entity performs and another entity would not need to substantially re-perform the work that the entity has completed to date.
When determining whether another party would not need to substantially re-perform, the entity also presumes that another party would not have the benefit of any asset that the entity presently controls and would continue to control if that other party took over the performance obligation. Performance obligations satisfied over time IFRS 15.B3–B4, IFRS 15.BC125–BC128 Performance obligations satisfied over time |
| 2 | In evaluating whether a customer controls an asset as it is created or enhanced, an entity considers the guidance on control in the standard, including the indicators of the transfer of control (see ‘Performance obligations satisfied at a point in time‘).
In evaluating Criterion 2 for sales of real estate, an entity focuses on the real estate unit itself, rather than on the right to sell or pledge a right to obtain the real estate in the future. This is because the latter does not provide evidence of control of the real estate unit. IFRS 15.B5 Performance obligations satisfied over time |
| 3 | In assessing whether an asset has an alternative use, at contract inception an entity considers its ability to readily direct that asset in its completed state for another use – e.g. selling it to a different customer.
IFRS 15.36 Performance obligations satisfied over time |
Applying Criteria 1 and 3
Potential contractual restrictions or practical limitations may prevent the entity from transferring the remaining performance obligation to another entity (Criterion 1) or directing the asset for another use (Criterion 3). The standard provides guidance on whether these facts or possible termination affect the assessment of those criteria. It provides the following guidance on the assumptions that an entity should make when applying Criteria 1 and 3. Performance obligations satisfied over time
Worked example – Assessing whether another entity would need to re-perform the work completed |
| Company M enters into a contract to transport equipment from Los Angeles to New York City. If M delivers the equipment to Denver – i.e. only part of the way – then another entity could transport the equipment the remainder of the way to New York City without reperforming M’s performance to date. The other entity would not need to take the goods back to Los Angeles to deliver them to New York City. Criterion 1 is met and transportation of the equipment is a performance obligation that is satisfied over time.
IFRS 15.BC126 |
Performance obligations satisfied over time
Food for thought – Differences in assumptions used when applying Criteria 1 and 3 |
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The consideration of contractual restrictions and practical limitations differs for the assessment of Criteria 1 and 3 because they are designed to apply to different scenarios. Criterion 1 involves a hypothetical assessment of what another entity would need to do if it took over the remaining performance obligation. Contractual restrictions or practical limitations, which would otherwise prevent the entity from transferring the performance obligation to another entity, are not relevant when assessing whether the entity has transferred control of the goods or services provided to date. By contrast, Criterion 3 focuses on the entity’s ability to direct the completed asset for an alternative use, assuming that the contract is fulfilled. This ability is directly affected by the existence of contractual restrictions and practical limitations. However, the entity’s rights on contract termination are considered when evaluating whether the entity has a right to payment under Criterion 3. IFRS 15.BC139 |
Food for thought – Determining whether a commodity transfers over time may depend on Criterion 1 |
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An entity that agrees to deliver a commodity considers the nature of its promise to determine whether to recognise revenue over time or at a point in time. In many contracts to deliver commodities, an entity has promised to transfer a good and will consider the point-in-time guidance to determine when control transfers. However, there may be scenarios in which an entity has promised to provide a service of delivering a commodity that the customer immediately consumes and therefore immediately receives the benefits. For example, a contract to deliver natural gas to temporary storage may represent a promise to deliver a good, whereas a contract to provide natural gas to the customer for on-demand consumption may represent a service that meets Criterion 1 for over-time recognition. To determine whether the customer immediately consumes the assets and receives the benefits as the performance obligation is satisfied, the entity evaluates the:
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Food for thought – Application to service concession arrangements |
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The interpretation on service concession arrangements specifies that an operator in a service concession arrangement accounts for construction and upgrade services under the revenue standard. Therefore, the operator applies the criteria in the standard to determine whether construction and upgrade services are separate performance obligations and recognises revenue as it satisfies the performance obligations over time or at a point in time. In many situations, revenue from construction and upgrade services under service concession arrangements will be recognised over time because Criterion 2 and/or Criterion 3 will be met. |
Performance does not create an asset with an alternative use
For an asset to have no alternative use to an entity, a contractual restriction on the ability to direct its use has to be substantive – i.e. an enforceable right. If an asset is largely interchangeable with other assets and could be transferred to another customer without breaching the contract or incurring significant incremental costs, then the restriction is not substantive (IFRS 15.B7).
A practical limitation on an entity’s ability to direct an asset for another use – e.g. design specifications that are unique to a customer – exists if the entity would: Performance obligations satisfied over time
- incur significant costs to rework the asset; or
- be able to sell the asset only at a significant loss (IFRS 15.B8).
The assessment of whether an asset has an alternative use is made at contract inception and is not subsequently updated, unless a contract modification substantially changes the performance obligation (see ‘Contract modifications‘) (IFRS 15.36).
Worked example – Applying the guidance on alternative use |
| Manufacturer Y enters into a contract with a customer to build a specialised satellite. Y builds satellites for various customers; however, the design and construction of each satellite differs substantially on the basis of each customer’s needs and the type of technology that is incorporated into the satellite.
At contract inception, Y assesses whether the satellite, in its completed state, will have an alternative use. Although the contract does not preclude Y from directing the completed satellite to another customer, Y would incur significant costs to rework the design and function of the satellite. In this example, the customer-specific design of the satellite restricts Y’s practical ability to readily direct the satellite to another customer. Therefore, the satellite does not have an alternative use to Y. |
Worked example – Applying the guidance on alternative use: Automotive supplier |
| Automotive Supplier S enters into a contract with Carmaker W to build 100 steering wheels.
S builds steering wheels for various carmakers. However, the design of some of the components of W’s steering wheel is W’s IP. Therefore, S is not allowed to sell completed steering wheels to other carmakers. W enforces this contractual restriction by performing periodic inspections in S’s warehouses. In addition, S would incur significant costs to rework the design of the steering wheel in its completed state if it replaced W’s unique components with other carmakers’ components. On contract inception, S assesses whether each completed steering wheel will have an alternative use. S concludes that there are significant contractual and practical restrictions that limit its ability to direct the completed steering wheels to another carmaker. Therefore, S concludes that the steering wheels manufactured for W have no alternative use. |
Performance obligations satisfied over time
Food for thought – Many factors to consider when evaluating alternative use |
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Under the standard, an asset may not have an alternative use due to contractual restrictions. For example, units constructed for a multi-unit residential complex may be standardised; however, an entity’s contract with a customer may preclude it from transferring a specific unit to another customer. Protective rights – e.g. a customer having legal title to the goods in a contract – may not limit the entity’s practical ability to physically substitute or redirect an asset, and therefore on their own are not sufficient to establish that an asset has no alternative use to the entity. In the absence of a contractual restriction, an entity considers:
The focus is not on whether the asset can be redirected to another customer or for another purpose during a portion of the production process – e.g. up until the point at which significant customisation begins to occur. For example, in some manufacturing contracts the basic design of an asset may be the same across many contracts, but the customisation of the finished good may be substantial. Consequently, redirecting the asset in its completed state to another customer would require significant rework. IFRS 15.BC136–BC139 |
Food for thought – Evaluating whether costs of rework are significant |
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The standard does not provide guidance to help evaluate whether the cost to rework an asset for an alternative use is significant. Therefore, judgement is required in making the evaluation and consideration is given to both quantitative and qualitative factors. The following are some factors that an entity may consider when making this determination.
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The entity has an enforceable right to payment for performance completed to date
An entity that is constructing an asset with no alternative use is effectively constructing the asset at the direction of the customer. The contract will often contain provisions providing some economic protection against the risk of the customer terminating the contract and leaving the entity with an asset of little or no value. Therefore, to demonstrate that a customer controls an asset that has no alternative use as it is being created, an entity evaluates whether it has an enforceable right to payment for the performance completed to date (IFRS 15.37).
In performing this evaluation, the entity considers whether, throughout the contract, it is entitled to compensation for performance completed to date if the contract is terminated by the customer or another party for reasons other than the entity’s failure to perform as promised.
The likelihood that the customer would terminate the contract or that the entity would exercise its right to payment are not relevant in making this assessment. Performance obligations satisfied over time
To meet this part of Criterion 3, the entity’s right to payment has to be for an amount that approximates the selling price of the goods or services transferred – e.g. a right to recover costs incurred plus a reasonable profit margin. The amount to which the entity is entitled does not need to equal the contract margin, but has to be based on either a reasonable proportion of the entity’s expected profit margin or a reasonable return on the entity’s cost of capital. However, if an entity would only recover its costs, then it would not have the right to payment for performance completed to date and this part of Criterion 3 would not be met (IFRS 15.B9–B13).
In some cases, an entity may enter into a contract with a customer that is expected to be loss-making from the outset. This usually happens when an entity pursues a specific economic objective – e.g. to enter into a new market, an entity agrees to sell a product in that market for a price that is below cost. It appears that a contract with a negative margin may still meet Criterion 3 if the amount to which the entity is entitled from the customer on termination is reasonable in proportion to the expected margin for the contract and the performance completed to date.
Other factors to consider include the following (IFRS 15.B11). Performance obligations satisfied over time
Worked example – Applying the over time criteria: Consulting contract |
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Consulting Firm B enters into a contract to provide a professional opinion to Customer C based on C’s specific facts and circumstances. If C terminates the consulting contract for reasons other than B’s failure to perform as promised, then the contract requires C to compensate B for its costs incurred plus a 15% margin. The 15% margin is approximately the profit margin that B earns from similar contracts. B assesses the contract against the over time criteria and reaches the following conclusions.
Because one of the three criteria is met, B recognises revenue relating to the consulting services over time. Conversely, if B determined that it did not have a legally enforceable right to payment if C terminated the consulting contract for reasons other than B’s failure to perform as promised, then none of the three criteria would be met. In that situation, the revenue from the consulting service would be recognised at a point in time – probably on completion of the engagement and delivery of the professional opinion. |
Performance obligations satisfied over time
Worked example – Applying the over-time criteria: Sales of real estate: No alternative use and enforceable right to payment |
Developer D is developing a multi-unit residential complex. Customer Y enters into a binding sales contract with D for Unit X, which is under construction. Each unit has a similar floor plan and is a similar size. The following facts are relevant.
At contract inception, D determines that because it is contractually prevented from transferring X to another customer, X does not have an alternative use. In addition, if Y were to default on its obligations then D would have an enforceable right to all of the consideration promised under the contract. Consequently, Criterion 3 is met and D recognises revenue from the construction of Unit X over time. |
Performance obligations satisfied over time
Food for thought – A right to payment may be established by relevant laws and regulations |
| When a right to payment on termination is not specified in the contract with the customer, an entity may still have a right to payment under relevant laws or regulations.
The fact that the entity may sue a customer that defaults or cancels a contract for convenience does not in itself demonstrate that the entity has an enforceable right to payment. Generally, a right to payment exists only if taking legal action entitles the entity to a payment for the cost incurred plus a reasonable profit margin for the performance completed to date. Factors to consider when determining whether an entity has a right to payment include:
Each individual factor may not be determinative on its own. An entity needs to determine which factors are relevant for its specific set of circumstances. In cases of uncertainty – e.g. when the above factors are inconclusive or provide contradictory evidence about the existence of a right to payment – an entity considers all relevant factors and applies judgement in reaching its conclusion. IFRS 15.B11–B12, BC147 |
Food for thought – Use of legal opinion when assessing enforceability of right to payment |
| In some cases, an entity may have an apparent right to payment described in its contract with the customer, or under a relevant law or regulation, but there may be uncertainty over whether the right is enforceable. This may be the case when there is no legal precedent for the enforceability of the entity’s right.
For example, in a rising property market an entity may choose not to enforce its right to payment in the event of customer default, because it prefers to recover the property and resell it at a higher price. A practice of not enforcing an apparent right to payment may result in uncertainty over whether the contractual right remains enforceable (IFRS 15.B12) In these cases, an entity may need a legal opinion to help it assess whether it has an enforceable right to payment. However, all facts and circumstances need to be considered in assessing how much weight (if any) to place on the legal opinion. This may include an assessment of:
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Food for thought – Agreements for the construction of real estate may have different patterns of transfer of control |
| Applying the criteria to real estate contracts may result in different conclusions on the pattern of transfer of control, depending on the relevant facts and circumstances of each contract. For example, the terms of some real estate contracts may prohibit an entity from transferring an asset to another customer and require the customer to pay for performance completed to date (therefore meeting Criterion 3). However, other real estate contracts that create an asset with no alternative use may only require a customer to make an up-front deposit, and therefore would not provide the entity with an enforceable right to payment for its performance completed to date (therefore failing to meet Criterion 3).
In practice, a detailed understanding of the terms of the contract and local laws may be required to assess whether an entity has a right to payment for performance to date. For example, in some jurisdictions customer default may be infrequent and contracts may not include extensive detail on the rights and obligations that arise in the event of termination. In these cases, expert opinion may be required to establish the legal position. In other jurisdictions, real estate developers may have a practice of not enforcing their contractual rights if a customer defaults, preferring instead to take possession of the property so that they can sell it to a new customer. Again, evaluation of the specific facts and circumstances, including appropriate legal consultation, may be required to establish whether the contractual rights remain enforceable given an established pattern of non-enforcement. IFRS 15.BC150 |
Food for thought – Enforceable right to payment for standard materials used as inputs |
| Contracts with customers to manufacture or construct goods with no alternative use to the entity may require the use of standard raw materials or components as inputs into the product being manufactured or constructed. In many cases, these inputs (including work in progress) remain interchangeable with other products until they are integrated into the customer’s product – i.e. they have an alternative use. The entity will often not have an enforceable right to payment for these standard inputs until they are integrated into the customer’s product.
In these circumstances, the entity treats the raw materials or work in progress as inventory until they are incorporated into the customer’s product. The fact that the entity does not have an enforceable right to payment for standard materials until they are integrated into the product being manufactured does not result in the arrangement failing to meet Criterion 3. An entity’s right to payment is assessed for performance completed. Standard materials are not considered completed performance until they are integrated into the production process. The assessment of an entity’s right to payment is for the standard materials once they are integrated. IFRS 15.BC142 |
Food for thought – Termination of an over time contract |
| In some cases, an entity that has a contract meeting Criterion 3 for recognition of revenue over time may choose not to enforce its right to payment. For example, an entity may permit a customer to terminate a contract when no termination right exists. In these cases, an entity needs to consider carefully whether its right to payment remains enforceable such that Criterion 3 is met at contract inception for similar contracts.
If an entity chooses to waive its enforceable right to payment, then a question arises about how it should account for the termination – in particular, the revenue that has been recognised over time under Criterion 3. It appears that in these circumstances it is generally appropriate to reverse the revenue previously recognised for which the right to payment has been waived. For example, Developer D enters into a contract to sell an apartment to Customer C for 100. The expected construction cost is 60. C is required to make an up-front payment of 30, with the remaining 70 due on completion of the apartment. C cannot terminate the contract and D has the right to complete the apartment and require C to pay the promised consideration. D has determined that this right is enforceable in its jurisdiction. D determines that its contract with C meets Criterion 3 for the recognition of revenue over time and that a cost-to-cost input measure of progress is appropriate. When the apartment is 80% complete, C approaches D with a request to terminate the contract. Considering C’s circumstances, as an exception to its customary business practice D agrees to terminate the contract, thereby waiving its right to complete the apartment and enforce payment of 100 in cash from C. D also agrees to refund the up-front payment of 30 to C. At the time of the termination, D had recorded the following journal entries to recognise revenue and costs over time as the apartment was constructed.
It is generally considered appropriate for D to reverse the previously recognised revenue and cost of sales.Therefore, D should record the following entries.
D carefully considers whether its right to payment remains enforceable such that Criterion 3 is met at contract inception for similar contracts. Modifying the example, D agrees to terminate the contract with C but retains the up-front payment of 30. In this case, we believe that it is generally appropriate for D to reverse the previously recognised revenue for which it has waived payment – i.e. 50 – and cost of sales. Therefore, D should record the following entries.
D carefully considers whether its right to payment remains enforceable such that Criterion 3 is met at contract inception for similar contracts. IFRS 15.BC142 |
See also: Performance obligations over time
Performance obligations satisfied over time
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