International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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incentive in practice under legacy IFRS. However, entities would consider materiality
in determining whether items are promised goods or services.28
The Board subsequently considered the TRG members’ discussion and agreed that it
does not expect entities to identify significantly more performance obligations than the
deliverables that were identified under legacy IFRS.
The FASB’s standard allows entities to disregard promises that are deemed to be
immaterial in the context of a contract. That is, ASC 606 permits entities to disregard
items that are immaterial at the contract level and does not require that the items be
aggregated and assessed for materiality at the entity level. However, ASC 606 also
emphasises that entities still need to evaluate whether customer options for additional
goods or services are materials rights to be accounted for in accordance with the related
requirements (see 5.6 below).
IFRS 15 does not include explicit language to indicate an entity can disregard promised
goods or services that are immaterial in the context of the contract. However, in the
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Basis for Conclusions, the IASB noted that it did not intend for entities to identify every
possible promised good or services in a contract and that entities should consider
materiality and the overall objective of IFRS 15 when assessing promised goods or
services and identifying performance obligations. [IFRS 15.BC116D].
The IASB also noted that revenue standards under legacy IFRS did not contain similar
language to the guidance that was issued by the staff of the US SEC on inconsequential
or perfunctory performance obligations under legacy US GAAP. [IFRS 15.BC116E]. The
TRG’s discussion highlighted that the concerns raised about identifying performance
obligations that are not identified as deliverables under legacy requirements primarily
relate to potential changes in practice under US GAAP when comparing the legacy
US SEC guidance to ASC 606. [IFRS 15.BC116C].
5.1.2
Implementation questions on identifying promised goods or services
5.1.2.A
Assessing whether pre-production activities are a promised good or
service
Manufacturing and production entities in various industries had asked the TRG how
they should account for activities and costs incurred prior to the production of goods
under a long-term supply arrangement when they adopt IFRS 15. The questions arose
because some long-term supply arrangements require an entity to incur upfront
engineering and design costs to create new technology or adapt existing technology to
the needs of the customer.
These pre-production activities are often a prerequisite to delivering any units under a
production contract. For example, a manufacturer may incur costs to perform certain
services related to the design and development of products it will sell under long-term
supply arrangements. It may also incur costs to design and develop moulds, dies and
other tools that will be used to produce those products. A contract may require the
customer to reimburse the manufacturer for these costs. Alternatively, reimbursement
may be implicitly guaranteed as part of the price of the product or by other means.
At the meeting on 9 November 2015, the TRG members generally agreed that the
determination of whether pre-production activities are a promised good or service or
fulfilment activities requires judgement and consideration of the facts and
circumstances. When making this evaluation, entities need to determine whether the
activity transfers a good or service to a customer. If an entity determines that these
activities are promised goods or services, it applies the requirements in IFRS 15 to those
goods or services.
The TRG members generally agreed that if an entity is having difficulty determining
whether a pre-production activity is a promised good or service in a contract, the entity
should consider whether control of that good or service transfers to the customer. For
example, if an entity is performing engineering and development services as part of
developing a new product for a customer and the customer will own the resulting
intellectual property (e.g. patents), the entity would likely conclude that it is transferring
control of the intellectual property and that the engineering and development activities
are a promised good or service in the contract.
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The TRG members noted that assessing whether control transfers in such arrangements
may be challenging. In some arrangements, legal title of the good or service created from
the pre-production activity is transferred to the customer. However, the TRG members
generally agreed that an entity has to consider all indicators of control transfer under
IFRS 15 and that the transfer of legal title is not a presumptive indicator.
If a pre-production activity is determined to be a promised good or service, an entity
allocates a portion of the transaction price to that good or service (as a single performance
obligation or as part of a combined performance obligation that includes the pre-
production activities along with other goods or services). If the pre-production activities
are included in a performance obligation satisfied over time, they are considered when
measuring progress toward satisfaction of that performance obligation (see 8.2 below).29
If a pre-production activity does not result in the transfer of control of a good or service
to a customer, an entity should consider other requirements that may be applicable
(e.g. IAS 16, IAS 38 – Intangible Assets, paragraphs 95-98 of IFRS 15 on costs to fulfil a
contract with a customer).
5.1.2.B
The nature of the promise in a typical stand-ready obligation
Stakeholders raised questions about the nature of the promise in a ‘typical’ stand-
ready obligation.
At the January 2015 TRG meeting, the TRG members discussed numerous examples of
stand-ready obligations and generally agreed that the nature of the promise in a stand-
ready obligation is the promise that the customer will have access to a good or service, not
the delivery of the underlying good or service.30 The standard describes a stand-ready
obligation as a promised service that consists of standing ready to provide goods or services
or making goods or services available for a customer to use as and when it decides to do
so. Stand-ready obligations are common in the software industry (e.g. unspecified updates
to software on a when-and-if-available basis) and may be present in other industries.
The TRG agenda paper included the following types of promises to a customer that could
be considered stand-ready obligations, depending on the facts and circumstances:31
• obligations for which the delivery of the good, service or intellectual property is
within the control of the entity, but is still being developed (e.g. a software vendor’s
promise to transfer unspecified software upgrades at its discretion);
• obligations for which the delivery of the underlying good or service is outside the
control of the entity and the customer (e.g. an entity’s promise to remove snow
from an airport runway in exchange for a fixed fee for the year);
/> • obligations for which the delivery of the underlying good or service is within the
control of the customer (e.g. an entity’s promise to provide periodic maintenance
on a when-and-if needed basis on a customer’s equipment after a pre-established
amount of usage by the customer); and
• obligations to make a good or service available to a customer continuously (e.g. a
gym membership that provides unlimited access to a customer for a specified
period of time).
An entity needs to carefully evaluate the facts and circumstances of its contracts to
appropriately identify whether the nature of a promise to a customer is the delivery of
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the underlying good(s) or service(s) or the service of standing ready to provide goods or
services. Entities also have to consider other promises in a contract that includes a
stand-ready obligation to appropriately identify the performance obligations in the
contract. The TRG members generally agreed that all contracts with a stand-ready
element do not necessarily include a single performance obligation (see 5.1.2.C below).32
At the TRG meeting, a FASB staff member also indicated that the staff does not believe
that the FASB intended to change previous practice under US GAAP for determining
when software or technology transactions include specified upgrade rights (i.e. a
separate performance obligation) or unspecified upgrade rights (i.e. a stand-ready
obligation).33 For details of TRG members’ discussion on measuring progress toward
satisfaction for a stand-ready obligation that is satisfied over time see 8.2.4.A below.
5.1.2.C Considering
whether
contracts
with a stand-ready element include a
single performance obligation that is satisfied over time
At the November 2015 TRG meeting, the TRG members considered whether all
contracts with a stand-ready element include a single performance obligation that is
satisfied over time.
The TRG members generally agreed that the stand-ready element in a contract does
not always represent a single performance obligation satisfied over time. This
conclusion is consistent with the discussion in 5.1.2.B above that, when identifying the
nature of a promise to a customer, an entity may determine that a stand-ready element
exists, but it is not the promised good or service for revenue recognition purposes.
Instead, the underlying goods or services are the goods or services promised to the
customer and accounted for by the entity.
Consider the following example in the TRG agenda paper: An entity is required to stand
ready to produce a part for a customer under an MSA. The customer is not obligated to
purchase any parts (i.e. there is no minimum guaranteed volume). However, it is highly
likely the customer will purchase parts because the part is required to manufacture the
customer’s product and it is not practical for the customer to buy parts from multiple
suppliers. The TRG members generally agreed that the nature of the promise in this
example is the delivery of the parts, rather than a service of standing ready. When the
customer submits a purchase order under the master supply arrangement, it is
contracting for a specific number of distinct goods and the purchase order creates new
performance obligations for the entity. However, if the entity determined that the
nature of the promise is a service of standing ready, the contract would be accounted
for as a single performance obligation satisfied over time. In that situation, the entity
may be required to estimate the number of purchases to be made throughout the
contract term (i.e. make an estimate of variable consideration and apply the constraint
on variable consideration) and continually update the transaction price and its allocation
among the transferred goods or services.
The TRG agenda paper also noted that, in this example, the entity is not obligated to
transfer any parts until the customer submits a purchase order (i.e. the customer makes
a separate purchasing decision). This contrasts with a stand-ready obligation, which
requires the entity to make a promised service available to the customer and does not
require the customer to make any additional purchasing decisions.34
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See 5.6.1.C below for further discussion on determining whether a contract involving
variable quantities of goods or services should be accounted for as variable
consideration (i.e. if the nature of the promise is to transfer one overall service to the
customer, such as a stand-ready obligation) or a contract containing customer options
(i.e. if the nature of the promise is to transfer the underlying distinct goods or services).
5.2
Determining when promises are performance obligations
After identifying the promised goods or services within a contract, an entity determines
which of those goods or services will be treated as separate performance obligations.
That is, the entity identifies the individual units of account. Promised goods or services
represent separate performance obligations if the goods or services are distinct (by
themselves, or as part of a bundle of goods or services) (see 5.2.1 below) or if the goods
or services are part of a series of distinct goods or services that are substantially the
same and have the same pattern of transfer to the customer (see 5.2.2 below).
If a promised good or service is not distinct, an entity is required to combine that good
or service with other promised goods or services until it identifies a bundle of goods or
services that, together, is distinct. [IFRS 15.30].
An entity is required to account for all the goods or services promised in a contract as a
single performance obligation if the entire bundle of promised goods or services is the
only performance obligation identified. See 5.3 below for further discussion. Figure 28.6
illustrates these requirements:
Figure 28.6:
Determining when promises are performance obligations
Combine with other promised
Is the promised good or service
No
goods or services until distinct
capable of being distinct?
bundle exists
(see 5.2.1.A below)
(see 5.3 below)
Yes
Is the promised good or service
distinct in the context of the
No
contract?
(see 5.2.1.B below)
Yes
Promised good or service is a
performance obligation (i.e.
separate unit of account)
(see 5.2.1 below)
Consider whether series
requirement applies
(see 5.2.2 below)
A single performance obligation may include a licence of intellectual property and other
promised goods or services. IFRS 15 identifies two examples of licences of intellectual
property that are not distinct from other promised goods or services in a contract:
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(1) a licence that is a component of a tangible good and that is integral to the functionality
of the tangible good; and (2) a licence that the customer can benefit from only in
conjunction with a related service (e.g. an online hosting service that en
ables a customer
to access the content provided by the licence of intellectual property). [IFRS 15.B54].
See 9.1.2 below for further discussion on these two examples.
The standard also specifies that the following items are performance obligations:
• Customer options for additional goods or services that provide material rights to
customers (see 5.6 below). [IFRS 15.B39-B43].
• Service-type warranties (see 10.1 below). [IFRS 15.B28-B33].
Entities do not apply the general model to determine whether these goods or services
are performance obligations because the Board deemed them to be performance
obligations if they are identified as promises in a contract.
5.2.1
Determination of ‘distinct’
IFRS 15 outlines a two-step process for determining whether a promised good or service
(or a bundle of goods or services) is distinct:
• Consideration at the level of the individual good or service (i.e. the good or service
is capable of being distinct).
• Consideration of whether the good or service is separable from other promises in
the contract (i.e. the good or service is distinct within the context of the contract).
Both of these criteria must be met to conclude that the good or service is distinct. If
these criteria are met, the individual good or service must be accounted for as a separate
unit of account (i.e. a performance obligation).
The Board concluded that both steps are important in determining whether a promised
good or service should be accounted for separately. The first criterion (i.e. capable of being
distinct) establishes the minimum characteristics for a good or service to be accounted for
separately. However, even if the individual goods or services promised in a contract may be
capable of being distinct, it may not be appropriate to account for each of them separately
because doing so would not result in a faithful depiction of the entity’s performance in that
contract or appropriately represent the nature of an entity’s promise to the customer.
[IFRS 15.BC102]. Therefore, an entity also needs to consider the interrelationship of those
goods or services to apply the second criterion (i.e. distinct within the context of the
contract) and determine the performance obligations within a contract.
The IFRS Interpretations Committee received a request about the identification of