Proposed changes to IFRS 15 – identifying the performance obligations

As we discussed here, the IASB has issued its exposure draft of clarifications to IFRS 15, with comments to be received by October 28, 2015.

The standard is built around a five-step framework, including the key step of identifying the performance obligations in a contract. You’ll recall the definition of a performance obligation:

  • A promise in a contract with a customer to transfer to the customer either:
  • (a) a good or service (or a bundle of goods or services) that is distinct; or
  • (b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.

In many situations, of course, it’s easy to identify the promises made to a customer. For example, in an everyday retail transaction, the promise is to transfer a particular item to the customer in return for receiving payment, and this promise can be rapidly fulfilled once the customer initiates the transaction. In other cases, a contract may encompass a number of different goods and services: some of them delivered at or near to the time of intercepting the contract, others in the future, or over time.

A good or service that’s promised to a customer is distinct if the customer can benefit from the good or service either on its own or together with other resources that are readily available to it (i.e. the good or service is capable of being distinct); and 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). This assessment will clearly often be key to determining whether a particular aspect of a contract can be regarded as a separate performance obligation. IFRS 15.29(c) sets out some factors indicating that an entity’s promise to transfer a good or service to a customer is separately identifiable, including that the good or service isn’t highly dependent on, or highly interrelated with, other goods or services promised in the contract.

The IASB has now identified a risk of this concept “being applied more broadly than intended, resulting in items being inappropriately combined as a single performance obligation. Stakeholders asked about the application of this factor to scenarios in which one of the promised goods or services is dependent on the transfer of the other, such as a contract for equipment and related consumables that are required for the equipment to function. Some stakeholders suggested that, although the promised goods or services may be capable of being distinct, if one of the goods or services was dependent on the other, the promised goods or services would not be distinct within the context of the contract.” To clarify this, the new exposure draft proposes adding some new illustrative examples and amending some of the existing ones. It doesn’t propose amending the basic requirements of the standard, seeing this as an example of satisfying “educational needs.”

So, for example, the exposure draft considers a case where “An entity enters into a contract with a customer to provide an item of equipment as well as to provide installation services. The equipment is functional without any customization or modification and the installation required is capable of being performed by other service providers.” In those circumstances, the installation services constitute a separate performance obligation – among other things, “the entity has promised to deliver the equipment and then install it; it has not promised to combine the equipment and the installation services in a way that would transform them into a different, combined output.” This conclusion is unchanged even if the customer is contractually required to use the entity’s installation services: “the contractual requirement to use the entity’s installation services does not change the characteristics of the goods or services themselves, nor does it change the entity’s promises to the customer.”

These cases differ from one where “as part of the installation service, the software is to be substantially customized to add significant new functionality to enable the software to interface with other customized software applications used by the customer.” That is: “an entity should not merely evaluate whether one item, by its nature, depends on the other (i.e. whether two items have a functional relationship). Instead, an entity should evaluate whether there is a transformative relationship between the two items in the process of fulfilling the contract.” To take the simplest of all examples: “in a contract to build a wall, the promise to provide bricks and the promise to provide labour are not separately identifiable from each other within the context of the contract because those promises together comprise the promise to the customer to build the wall.”

On a final note: in its corresponding exposure draft, the FASB is proposing to specify that an entity needn’t identify promised goods or services that are immaterial in the context of the contract. The IASB isn’t making that proposal, taking the view that any concerns raised in this regard apply to materiality concepts, rather than to the requirements of IFRS 15. More to come on other aspects of the exposure draft…

The opinions expressed are solely those of the author

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