What is a good or service that is distinct?

What is a good or service that is distinct?

– 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. What is a good or service that is distinct?

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.

Example distinct goods or services construction of a fence

 

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:What is a good or service that is distinct

  • Purchase the timber, nails, concrete and other required building supplies, What is a good or service that is distinct?
  • Deliver the required building supplies to the customer’s home, and What is a good or service that is distinct?
  • Build the fence. What is a good or service that is distinct?

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.

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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: highly dependent or highly interrelated

  • 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 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. highly dependent or highly interrelated

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 judgement in light of all relevant facts and circumstances.

This is evident from the Basis for Conclusions to IFRS 15, which explains that the notion of two or more promises being ‘separately identifiable’ (i.e. distinct within the context of the contract) is in turn based on the notion that the risks assumed in one promise are separable from the risks assumed in another.

The three factors included in IFRS 15.29 are therefore intended to assist entities in making that judgement. Further, the three factors are not mutually exclusive, because they are based on the same underlying principle of inseparable risks. highly dependent or highly interrelated

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 then combined to produce one single identifiable item.

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In contrast, if a vendor’s promise to its customer contains two or more goods or services that depend on each other (that is, they have a functional relationship), 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 make any changes to the machine.

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.

Distinct decision tree

In summary:

What is a good or service that is distinct

Performance obligation unit of account

Consider this!

The identification of each of the distinct goods or services in contracts may require a detailed analysis of contractual terms, and linkage to IFRS 15’s requirements on whether a promise in a contract is a distinct good or service (and hence constitutes a performance obligation), or needs to be combined (’bundled’) with other promises in the contract to create a single performance obligation. Subtle differences in contractual terms and conditions, as well as individual facts and circumstances, can impact the analysis.

The importance of appropriately identifying the performance obligations in a contract cannot be underestimated as they each form a separate ‘unit of account’ for the purposes of determining how much revenue should be recognised and when revenue should be recognised. The conclusions reached in Step 2 could also bring substantial changes to the amount and timing of revenue recognition in comparison with the old Revenue/Construction standards.

Example distinct goods or services Telecom industry

A telecom company enters into a contract for the sale of a mobile device and connection to its mobile network. The Old telephonecontract, which lasts for 2 years, gives the customer:

  • X minutes of calls per month;
  • Y gigabytes of data per month; and
  • Z texts per month.

The telecom company frequently sells mobile devices without connecting them to the network. Although different combinations of minute, data and texts are available, it is not possible to buy only minutes, only data or only texts.

The telecom company concludes that although the customer can benefit from the minutes, data and texts independently from one another (i.e. they are capable of being distinct), they are interrelated with each other because the risks associated with the promise to transfer of minutes, texts and data are not separable as part of the network connection. Therefore, 2 performance obligations are identified

  • The sale of a mobile phone; and
  • Network services.

Example distinct goods or services Equipment and consumables

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.

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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.

The item of equipment and the consumables are also distinct in the context of the contract. This conclusion is based on the following:

  • There is no service being provided that integrates and transforms the equipment and consumables into a single combined output
  • Neither the equipment nor the consumables are significantly customised or modified by the other
  • The equipment and consumables are not highly inter-related because they do not significantly affect each other

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.

The vendor would be able to fulfil 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.

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What is a good or service that is distinct

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