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.
Determining a distinct good or service is part of identifying separate performance obligations. An important item to look at is whether a ‘promise to’ in a contract (established to be a contract for accounting purposes in Step 1) is a distinct good or service, and as a result thereof is a performance obligation.
Entity XYZ has contractually agreed to build a fence at the home of a customer. From an operational perspective, there are likely three stages to the contract:
- Purchase the timber, nails, concrete and other required building supplies,
- Deliver the required building supplies to the customer’s home, and
- Build the fence.
However, from the perspective of the customer, a completed fence has been promised. In addition:
- Entity XYZ performs a significant amount of work to integrate the goods (building materials) and services (building of the fence) provided under the contract,
- The goods (building materials) and service (building of the fence) are highly interrelated, and
- The service (building of the fence) provided by Entity XYZ significantly modifies the goods (building materials) promised in the contract.
Given the above there is only one performance obligation in the contract and that is the provision of a completed fence.
The two criteria that need to be met in order for a good or service to be distinct are set out in more detail below (see performance obligation):
‘Promise to’ 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 (i.e. the good or service is capable of being distinct).
A customer can benefit from a good or service if the good or service can be used, consumed, or sold (other than for scrap value), or it can be held in a way that generates economic benefits. A customer may benefit from some goods or services on her/his own, while for others a customer may only be able to obtain benefits from them in conjunction with other readily available resources.
A readily available resource is either a good or service that is sold separately (either by the vendor or another vendor), or a resource that the customer has already obtained from the vendor (this includes goods or services that the vendor has already transferred to the customer under the contract) or from other transactions or events.
If the vendor regularly sells a good or service separately, this indicates that a customer can benefit from it (either on its own, or in conjunction with other resources).
‘Promise to’ 2
The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (i.e. the good or service is distinct within the context of the contract).
IFRS 15.29 includes indicators that a vendor’s promise to transfer two or more goods or services to the customer are not distinct within the context of the contract. The guidance is explicit that these are not the only circumstances in which two or more promised goods or services are not distinct:
- The vendor provides a significant service of integrating one good or service with other goods or services promised in the contract into a bundle, which represents a combined output for which the customer has contracted (i.e. the vendor is using one good or service as an input to produce the combined output specified by the customer);
- One good or service significantly modifies or customises other goods or services promised in the contract;
- One good or service is highly dependent on (or highly interrelated with) other promised goods or services. That is, if the customer decides not to purchase the good or service it would not significantly affect any of the other promised goods or services in the contract.
To determine whether the vendor’s promise to transfer a good or service is separately identifiable from other promised goods or services in the contract (i.e. distinct within the context of the contract) requires judgment in light of all relevant facts and circumstances. In summary: