Identifying performance obligations is critical to revenue recognition under IFRS 15In our April 2018 edition of Accounting News we discussed the five step model for revenue recognition introduced by IFRS 15 Revenue from Contracts with Customers (IFRS 15): Show
In the May and June 2018 editions we examined the first step of this five step process in greater depth. In this article, we look at the complexities of the second step in the IFRS 15 revenue recognition model. Step two requires the entity to identify the performance obligations in the contract with a customer. This is a critical step in the revenue recognition process because revenue is recognised when (or in some instances as) a performance obligation is satisfied. Failing to correctly identify performance obligations may therefore result in the timing of revenue recognition not complying with the requirements of IFRS 15, and revenue being recognised in the incorrect reporting period. What is a performance obligation?A contract with a customer includes promises to transfer goods or services to the customer. If those goods or services are distinct, the promises are performance obligations and must be accounted for separately. Examples of goods or services that may be promised in a contract with a customer include:
What are ‘distinct’ goods and services?A good or service that is promised to a customer is ‘distinct’ if both of the following criteria are met:
When is the entity’s promise to transfer goods and services ‘separately identifiable’?In assessing whether an entity’s promises to transfer goods or services to the customer are separately identifiable, the objective is to determine whether the nature of the promise in the contract is to transfer each of those goods or services individually or, instead, to transfer a combined item or 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. Promises are not separately identifiable (i.e. they must be bundled) if any of the following circumstances exist:
The following decision tree summarises the process discussed above and will assist in determining whether goods and services promised in a contract are ‘distinct’: ExampleEntity 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:
However, from the perspective of the customer, a completed fence has been promised. In addition:
Given the above there is only one performance obligation in the contract and that is the provision of a completed fence. In future editions of Accounting News, we will examine some real life situations in which the identification of performance obligations can be difficult. Concluding thoughtsThe concept of performance obligations is new, but it is central to ensuring that the timing of revenue recognition is correct. For that reason, it is important that finance teams become familiar with the concept and correctly identify the performance obligations within their company’s contracts with its customers. This will require the finance team to have a much greater understanding of the particular terms and conditions of contracts with customers than has been required in the past. What is the first step in the process for revenue recognition?Step 1: Identify the contract with the customer. ... . Step 2: Identify the performance obligations in the contract. ... . Step 3: Determine the transaction price. ... . Step 4: Allocate the transaction price to the performance obligations in the contract. ... . Step 5: Recognize revenue when, or as, the entity satisfies a performance obligation.. What are the five step revenue recognition standards?Step 1: Identify the contract with a customer. Step 2: Identify the performance obligations in the contract. Step 3: Determine the transaction price. Step 4: Allocate the transaction price to the performance obligations in the contract.
What is revenue recognition quizlet?Revenue (GAAP Definition) Increasing an asset or decreasing a liability (or combination of both) by producing or delivering goods, or rendering services that are the entity's ongoing major or central operations. Revenue Recognition (GAAP) Revenue is recognized when it realized or realizable and earned.
Which of the following is the fourth step in the process for revenue recognition?Step 4 – Allocating the transaction price. The objective of Step 4 is to allocate the transaction price identified in Step 3 to the performance obligations identified in Step 2. Step 4 is not applicable to contracts with a single performance obligation.
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