Identification of separate performance obligations

Continuing the previous days' discussion on how to identify separate performance obligations, the staffs provided the Boards with two additional alternatives in additional to the proposal discussed yesterday.

The first alternative would account for a good or service, or a bundle of goods or services, as a separate performance obligation if 1) the good or service is distinct and 2) the good or service has a different pattern of transfer to the customer. This alternative would provide a list of indicators of when a good or service may be distinct including 1) the entity regularly sells the good or service separately, 2) the customer can use the good or service either on its own or together with resources that are readily available to the customer, 3) the entity and the customer negotiated the sale of goods or services separately, or the entity is not providing a significant service of integrating the promised goods or services into a single item that the entity provides to the customer.

The second alternative would account for a good or service, or a bundle of goods or services, as a separate performance obligation if 1) the good or service has a different pattern of transfer to the customer and 2) the customer can use the good or service either on its own or together with resources that are readily available to the customer. However, one would account for a bundle of promised goods or services as one performance obligation if the entity provides a service of integrating those goods or services into a single item that the entity provides to the customer.

The Boards generally viewed the two alternatives as more favourable to the original staff proposals (only one FASB member expressed support for the original staff proposals). However, several members from each Board preferred certain aspects from each of the models rather than one model in its entirety. Specifically mentioned was the overriding requirement from the second alternative that one would account for a bundle of promised goods or services as one performance obligation if the entity provides a service of integrating those goods or services into a single item that the entity provides to the customer rather than having a similar criteria as only an indicator in the first alternative. However, there was support for the first alternative because it incorporated the concept of distinct which many felt preparers could understand and apply.

The Boards tentatively agreed to incorporate aspects of both alternatives into the model for identifying a separate performance obligation. The model would first consider if the entity provides a service of integrating a bundle of goods or services into a single item that the entity provides to the customer. If so, the entity would account for the bundle as a single performance obligation. If not, the entity would account for a promised good or service as a separate performance obligation if 1) the good or service is distinct and 2) the good or service has a different pattern of transfer to the customer. The model would also include indicators of what would be considered distinct, including 1) the entity regularly sells the good or service separately, 2) the customer can use the good or service either on its own or together with resources that are readily available to the customer, and 3) the entity is not providing a significant service of integrating the promised goods or services into a single item that the entity provides to the customer.

Existence of a contract and definition of a performance obligation

The revenue recognition exposure draft defined a performance obligation as "an enforceable promise (whether explicit or implicit) in a contract with a customer to transfer a good or service to the customer". Certain comment letter respondents questioned the inclusion of the term 'enforceable promise' as that could result in an entity not accounting for promised goods or services that the customer reasonably expects to receive. They recommended expanding the definition of a performance obligation to include constructive obligations where an entity's specific statements or past practices establish a valid expectation that performance will occur.

The Boards discussed the example of as software provider who provides both 'bug' fixes as well as software updates to its customers. One IASB member mentioned that the 'bug' fixes would only be bringing the product back to its original specification and therefore would not be a separate performance obligation. However, other Board members acknowledged that the providing of 'updates' could be viewed as delivery of a separate performance obligation even though no contractual requirement may be in place.

The Boards tentatively agreed to remove the term enforceable from the definition of a performance obligation to provide clarity that other non-contractual arrangements could be identified as performance obligations.

Breakage on prepayments

The Boards also discussed the topic of breakage on prepayments (i.e. how to recognise revenue for unused gift cards or other prepaid services). The revenue recognition exposure draft provided that an entity would recognise a contract liability upon receipt of any prepayment from a customer for its performance obligation to provide goods or services in the future and derecognise the liability (and recognise revenue) when the good or service is transferred.

While, the exposure draft did not specifically address how to recognise revenue for breakage on prepayment, the staffs believe the accounting is similar to the proposals for contract options for additional goods or services. Under those proposals, an option is accounted for a separate performance obligation only if the option provides the customer with a material right that the customer would not receive without entering into that contract. If the option provided a material right, then the entity recognises revenue when it transfers those future goods or services or when the option expires. The exposure draft also included an example (example 26) that illustrated the guidance in the context of a customer loyalty programme and how an entity would recognise revenue based on a pattern of redemption of the loyalty points.

The staffs proposed that revenue for breakage should be recognised in proportion to the pattern of rights being exercised by the customer (the proportional model), but if an entity cannot reasonably estimate breakage then revenue should be recognised when the likelihood of the customer exercising their right becomes remote (the remote model). The staffs believe this is consistent with the guidance on options already included in the exposure draft.

The Boards discussion on breakage began with most Board members seemingly opposed to the staffs' recommendation. Some preferred only permitting the remote method while others preferred recognising immediately if an amount can be reasonably estimated and utilising the remote method when an estimate cannot be reasonably estimated. Some also preferred that recognition of breakage be classified as a 'gain' rather than as revenue.

The staffs reiterated their position that the proposal is consistent with the Boards position on the accounting for options. They also commented that classification as a 'gain' would result in reporting that is significantly more difficult that what is included in the exposure draft and over current practice.

The Boards were ultimately swayed by the staffs' arguments. The IASB tentatively agreed with 10 Board members supporting the proposal for the proportional method when a pattern can be estimated but the remote model in other instances. The FASB did not reach a majority supporting the proposal (2 votes) but 4 Board members agreed "not to object".

Onerous performance obligations

The Boards also began discussions on onerous performance obligations. Because of time limitations, the Boards were only able to address the first topic of whether the onerous test should be performed at the contract of performance obligation level. The Boards were not able to discuss the topics of whether subsequent contracts should be linked in determining whether to recognise an onerous liability and what costs should be included in the onerous test. Both of these issues will be addressed at a future joint board meeting.

The revenue recognition exposure draft proposed that an onerous liability be recognised when the present value of the probability weighted costs that relate directly to satisfying that performance obligation exceeds the amount of the transaction price allocated to that performance obligation. The Boards proposed that the onerous test be performed at the performance obligation level in order to provide transparency for margins on each performance obligation and to provide timely information by recognising changes in circumstances impacting a performance obligation at the time it becomes loss-making.

Almost all comment letter respondents who commented on the onerous test opposed the proposals in the exposure draft that the test be performed at the performance obligation level. They cited various reasons for performing the test at a higher level unit of account than the performance obligation, including that items are often not priced at the performance obligation level, it is misleading to recognise a loss on a part of the contract when the overall contract is profitable, and that costs are not necessarily tracked at the performance obligation level which would make the test difficult to apply.

The staffs believe that some of these issues may be addressed through other changes to the revenue recognition proposals currently under discussion. However, they also acknowledged the issues identified by comment letter respondents. The staffs proposed that the onerous test be performed at the contract level and clarify that would be the remaining performance obligations in the contract.

A few members from each Board opposed the staff recommendation but the majority of both Boards seemed supportive of the proposals. One IASB member asked the staff what disclosures were planned to supplement the decision to apply the onerous test at the contract level. The staff responded that the exposure draft included disclosures for onerous contracts but that all disclosures would be reassessed as part of the current discussions.

The Boards tentatively decided that the onerous test would be performed at the contract level rather than the performance obligation level as was proposed in the exposure draft (twelve IASB members and three FASB members supported the decision).