to be accrued.
Knowledge check
1 Which statement best describes an implied promise in a contract with a customer?It needs to be explicitly stated in the contract.May be part of an entity’s customary business practice.May be part of an entity’s competitor’s customary business practice.Creates an unreasonable expectation of the customer.
2 An entity may elect to not account for shipping and handling activities as a separate performance obligation providing:The shipping and handling activities occurred before the customer obtains control of the goods.The shipping and handling activities occurred after the customer obtained control of the good.The shipping and handling activities were an established customary business practice by the entity.The shipping and handling activities were explicitly stated in the contract with the customer.
Determining when a good or service has been identified as distinct
When goods and services are distinct
In order to determine whether a promised good or service in a contract is a separate performance obligation, an entity will need to assess whether that good or service is distinct. Therefore, FASB ASC 606 explains that a good or service promised to a customer is distinct if both of the following criteria are met:
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 (that is, the good or service is capable of being distinct).
The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises
A series of distinct goods or services has the same transfer pattern to the customer if both of the following criteria are met:
Each distinct good or service in the series that the entity promises to transfer to the customer would meet the criteria to be a performance obligation satisfied over time.
The same method would be used to measure the entity’s progress toward complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer.
In assessing whether an entity’s promises to transfer goods or services to the customer are separately identifiable at the inception of the contract, an entity will need to determine the following:
Whether a customer can benefit from the good or service if the good or service could be used, consumed, sold for an amount that is greater than scrap value, or otherwise held in a way that could generate economic benefits. Keep in mind that with some goods or services a customer may be able to benefit from a good or service on its own.
Whether a customer is able to benefit from the good or service only in conjunction with other readily available resources. A readily available resource is a good or service that is sold separately (by the entity or another entity) or a resource that the customer has already obtained from the entity (including goods or services that the entity will have already transferred to the customer under the contract) or from other transactions or events. Various factors may provide evidence that the customer can benefit from a good or service either on its own or in conjunction with other readily available resources. For example, if an entity regularly sells a good or service separately indicates that a customer can benefit from the good or service on its own or with other readily available resources.
The contract
Ace Partners, a software developer, enters into a contract with a customer, Jones Inc., to transfer a software license, perform an installation service, and provide unspecified software updates and technical support (online and telephone) for a two-year period. ACE Partners sells the license, installation service, and technical support separately. The installation service includes changing the web screen for each type of user (for example, marketing, inventory management, and information technology). The installation service is routinely performed by other software developers and does not significantly modify the software. The software remains functional without the updates and the technical support.
Assessment considerations
Ace Partners assesses the goods and services promised to the customer Jones Inc. and observes that the software is delivered before the other goods and services and remains functional without the updates and the technical support.
Ace Partners took into consideration the fact that, although they integrate their software into the system of Jones Inc., the installation services do not significantly affect their customer’s ability to use and benefit from the software license because the installation services are routine and can be obtained from alternate software providers.
The software updates do not significantly affect Jones Inc.’s ability to use and benefit from the software license because the software updates in this contract are not necessary to ensure that the software maintains a high level of utility to Jones Inc. during the license period.
Ace Partners observes that none of the promised goods or services significantly modifies or customizes one another and that they are not providing a significant service of integrating the software and the services into a combined output.
Conclusion
Based on Ace Partners’ assessment, the following four performance obligations have been identified in the contract with Jones Inc.:
The software license
An installation service
Software updates
Technical support
Ace Partners reached the above conclusion because of the following
Jones Inc. can benefit from the updates together with the software license transferred at the outset of the contract. Thus, Ace Partners concludes that its customer, Jones Inc., can benefit from each of the goods and services either on its own or together with the other goods and services that are readily available.
The software and the services do not significantly affect each other and, therefore, are not highly interdependent or highly interrelated because Ace Partners would be able to fulfill its promise to transfer the initial software license independent from its promise to subsequently provide the installation service, software updates, or technical support.
When goods and services are not distinct
When identifying performance obligations, FASB ASC 606-10-25-21 states that the objective is to determine whether an entity’s promises to transfer goods or services to the customer are separately identifiable within the context of the contract or are instead a combined item or items to which the promised goods or services are inputs. Some factors that would indicate that two or more promises to transfer goods or services to a customer would not be considered as separately identifiable include the following:
When an entity is using the goods or services as inputs to produce or deliver the combined output or outputs specified by the customer. A combined output or outputs might include more than one phase, element, or unit.
When one or more of the goods or services significantly modifies or customizes, or are significantly modified or customized by, one or more of the other goods or services promised in the contract.
When each of the goods or services is significantly affected by one or more of the other goods or services in the contract. For example, in some cases an entity would not be able to fulfill their promise by transferring each of the goods or services independently.