IFRS 15, the new accounting guidelines aim to simplify and

harmonize revenue recognition  practices. The new standards are

based on one overarching principle: Companies must recognize
revenue when goods and services are transferred to the customer, in
an amount that is proportionate to what has been delivered at that
point.

While this sounds reasonable, it can complicate matters for your

business, especially your finance department. Let’s look at contract
changes for example.

CONTRACT COMBINATIONS
UNDER IFRS 15
IFRS 15.17 outlines the criteria for determining when an entity
combines two or more contracts and accounts for them as a single
contract. The key criteria being “Are the contracts entered into at or
near the same time with the same customer or related parties of the
customer?”

IFRS 15 is broadly similar to the requirements of IAS 11 and IAS 18.

However, IAS 11 requires an entity to consider combining a group of
contracts as a single contract when the contracts are performed
concurrently or in a continuous sequence. In contrast, IFRS 15 states
that contracts are combined when the goods or services promised in
the contract are a single performance obligation. In addition, IFRS 15
provides more specific guidance on when to combine contracts than
IAS 18, and combining of contracts is required when those conditions
are met.

CONTRACT MODIFICATIONS
UNDER IFRS 15
Under IFRS 15.18, contract modification is a change in the scope or
price of a contract, or both. This may be described as a change order,
a variation, or an amendment. When a contract modification is
approved, it creates or changes the enforceable rights and obligations
of the parties to the contract. There is currently guidance in both IFRS
and US GAAP on contract modifications for industries that have
construction- and production-type contracts. However, neither revenue
recognition framework includes a general framework for accounting for
contract modifications.

Under the new standard, the guidance on contract modifications

applies to all contracts with customers and may therefore result in a
change in practice for entities in industries without construction- and
production-type contracts – and even for industries with such contracts,
depending on the type of modification.

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THE ACCOUNTING PROCESS

Some entities will need to develop new processes – with appropriate
internal controls – to identify and account for contract modifications on
an ongoing basis under the new guidance.

Let’s discuss with an example: Your company enters into two contracts,
A & B, with the same customer within 15 days of each other. Your
company policy considers 30 days as “near the same time”, hence
these two contracts will form a Contract Combination and will need to
be accounted for (allocations made) as a single contract. Now 90 days
later another contract C is sold to the same customer which adds more
products to contract A. This is not within the 30-day policy so doesn’t
need to be combined, however if contract C is not sold at SSP then it
forms a Contract Modification. This modification requires to be
accounted along with the prior two combined contracts and allocations
changed accordingly. This would not have been the case prior to IFRS
15. Hence there is a clear impact on revenue recognized.

Let’s also consider that contract C was sold at SSP so it did not form a
Contract Modification and was accounted simply as a separate
contract. But 10 days after contract C, contract D is sold to the same
customer further adding more products to contract A. Now this contract
needs to be combined to contract C as its within 30 days. Further
contract D is not sold at SSP, so now the combination of contract C &
D needs to be considered a Contract Modification of the previously
combined contract A&B and accounted for as a Single Contract.

Imagine tracking and doing all these changes for multiple contracts,
over different contract periods and we haven’t even touched on the
requirement of considering entering into contracts with “related
parties”!

It’s time for all companies to rethink how they compute their revenue
and whether it’s time to automate the process.

For more on how Zuora RevPro can help, click  here.

Article: 

Contract modifications and IFRS 15

20 September 2017

In all businesses, sales contracts are extended, adapted or modified on a regular basis as
client’s needs develop. Accounting for those changes so that revenues are correctly recognised
can be a challenging task.
Currently, when a construction contract is changed, companies must use the rules set out in IAS
11 to decide if the modified contract should be accounted for as a separate contract. This will
change for annual reporting periods beginning on or after 1 January 2018: IFRS 15 introduces
three different approaches to recognising revenue when any contracts are modified. However,
let’s start with the basics.
 

Has there been a modification?

A contract modification exists when the parties to a contract approve a change that either:

 Changes existing enforceable rights and obligations of the parties, or

 Creates new enforceable rights and obligations of the parties.

You have to consider all relevant facts and circumstances (eg external evidence as well as the
terms of the contract) to determine enforceability. A contract modification may exist even though
the parties:

 Have a dispute about the scope and/or price (or both) of the modification or
 They have approved a change in the scope of the contract but have not yet determined
the corresponding change in price.

If a change in price has not been agreed, for accounting purposes businesses must use the rules
for estimating variable consideration (see – Sale with a right of return).
 

How do I account for it?

IFRS 15 sets out three different approaches to accounting for a contract modification. To
determine which approach is required you have to ask:

 Are the additional goods or services distinct from those in the original contract?  and
 Does the modification reflect the standalone selling price of the additional goods or
services?

Different combinations of answers to the question can result in the change being treated as
either:

a. A separate contract in addition to the original contract,

b. The termination of the original contract and the creation of a new contract (which will
include the unsatisfied performance obligations from the original terminated contract) or
c. As part of the original contract.

IFRS 15 example – sale of a product

A company enters into a contract to sell 200 units of a product for £16,000 (£80 each) and will
supply 50 units per month over a four month period (control over each unit passes to the
customer on delivery). After 150 units have been delivered, the contract is modified to require the
delivery of an additional 50 units (ie 250 in total). At the modification date, the stand-alone selling
price of one unit of the product has fallen to £75.
The additional units are distinct from those in the original contract under IFRS 15. Consequently,
the subsequent accounting will depend on whether or not the sales price for the additional units
reflects the stand-alone selling price at the date of contract modification (£75). This is illustrated
below.

Stand-alone
Modified Unit Price Seller’s recognises
unit price at Accounting
contract of extra
date contract treatment revenue of
example units
changes
£80 per unit for the original
contract (including the
1. Treat extra units as
remaining 50 units to be
being sold under a
50 extra £75 £75 delivered)
new and separate
units contract  
£75 per unit for extra 50 units
2. £60* (ie £65 £75 Recognise discount Recognise the £5 per unit
agreed unit on first contract discount (£250 in total) as an
50 extra
price less £5 immediate reduction in
units with  
per unit in revenue of £250 for the first 50
discount
respect of   units delivered that were
because
faults on defective.
of faults  
first 50) *
in units  
  
Revenue before change is a
Treat original
proportion of total contracts
contract as
value (see below)
terminated at date of
change  
already
delivered    
Treat all subsequent Use weighted average to
deliveries as under a determine deemed new
new contract ( ie contract revenue to be
remaining 50 plus recognised (see below)
extra 50)
* This reflects an agreed price of £65 per unit less a credit of £250 for poor service as some of
the first 50 units that had been delivered were faulty and the vendor had been slow in rectifying
the position.
 

Revenue calculations in 2
Use a weighted average to establish the amount of revenue recognised for each of the units
delivered after the contract change, calculate as:
((50 x £80) + (50 x£65)) = £7,250          (100 units weighted average £72.50 each)
Therefore, revenue to be recognised for deliveries before the contract change is calculated as:
Total revenue of £16,000 (200 x £80) + £3,000 (50 x £60) = £19,000 less £7,250 recognised
after the contract change = £11,750# (150*£80-£250).
#
 including the £250 credit
 
Read more on revenue recognition under IFRS15:
Significant financing components in contracts
To bundle or not to bundle, that is the question
Sale with a right of return
IFRS 15 in the spotlight: Accounting for vouchers
 

Identifying performance obligations is critical to revenue

recognition under IFRS 15
In the May 2018 edition of Accounting Alert we discussed the five step model for revenue
recognition introduced by IFRS 15 Revenue from Contracts with Customers (“IFRS 15”):
In the early June and late June 2018 editions of Accounting Alert 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:

 The sale of goods produced by an entity (for example, a manufacturer selling its
inventory)
 The resale of goods purchased by an entity (for example, a retailer selling its inventory)
 Performing a contractually agreed-upon task for a customer
 Providing a service of standing ready to provide goods or services to a customer (such
as software updates that are provided on a when-and-if-available basis)
 Providing a service of arranging for another party to transfer goods or services to a
customer (i.e. acting as an agent of another party)
 Constructing, manufacturing or developing an asset on behalf of a customer
 Granting licences.

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:

 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, and
 The entity’s promise to transfer the good or service to the customer is separately
identifiable from other promises in the contract. 

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 seller performs a significant amount of work to integrate the good or service with
other goods or services promised in the contract
 Goods or services provided are highly interdependent or interrelated, or
 One or more of the goods or services provided by the seller significantly modifies or
customises, or is significantly modified or customised by, other goods or services
promised in the contract.

The following decision tree summarises the process discussed above and will assist in
determining whether goods and services promised in a contract are distinct:

Example
Entity 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:

 Purchase the timber, nails, concrete and other required building supplies
 Deliver the required building supplies to the customer’s home, and
 Build the fence.

However, from the perspective of the customer, a completed fence has been promised.  In
addition:

 Entity XYZ performs a significant amount of work to integrate the goods (building
materials) and services (building of the fence) provided under the contract
 The goods (building materials) and service (building of the fence) are highly interrelated,
and
  The service (building of the fence) provided by Entity XYZ significantly modifies the
goods (building materials) promised in the contract.  

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 Alert we will examine some real life situations in which the
identification of performance obligations can be difficult. 
Concluding thoughts
The 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. 
For more on the above, please contact  your local BDO representative.

Question RR 3-1
Could a continuous service (for example, hotel management services) qualify as a
series of distinct services if the underlying activities performed by the reporting
entity vary from day to day (for example, employee management, accounting,
procurement, etc.)?
PwC response
Possibly. The series guidance requires each distinct good or service to be
“substantially the same.” Management should evaluate this requirement based on
the nature of its promise to the customer. For example, a promise to provide hotel
management services for a specified contract term could meet the series criteria.
This is because the reporting entity is providing the same service of “hotel
management” each period, even though some of the underlying activities may vary
each day. The underlying activities (for example, reservation services, property
maintenance) are activities to fulfill the hotel management service rather than
separate promises. The distinct service within the series is each time increment of
performing the service (for example, each day or month of service). Example 12A
in ASC 606-10-55-157B through ASC 606-10-55-158 illustrates this concept. Also refer
to Revenue TRG Memo No. 39 and the related meeting minutes in Revenue TRG Memo
No. 44 for further discussion.

Question RR 3-2
Is a promise to stand ready to provide goods or services (that is, a "stand-ready
obligation") a series of distinct goods or services?
PwC response
Yes. A stand-ready obligation will typically meet the criteria to be accounted for as
a series of distinct goods or services because each time interval during which the
reporting entity provides a service of standing ready is distinct from and
substantially similar to all of the time intervals during the contract. Management
will need to apply judgment to determine whether the nature of a reporting entity’s
promise is to stand ready to provide goods or services or a promise to provide
specified goods or services. Refer to RR 3.2.3 and RR 6.4.3.
Question RR 3-3
Is it always acceptable to use a time-based measure of progress (that is, straight-
line recognition) for a performance obligation that is a series of distinct goods or
services?
PwC response
No. It is not appropriate to default to a time-based measure of progress for a series;
however, straight-line recognition over the contract period will be reasonable in
many cases. Management should select the method that best depicts the reporting
entity’s progress in transferring control of the goods or services. Refer to RR 6.4.
Question RR 3-4
Do goods and services need to be delivered consecutively to qualify as a series of
distinct goods or services?
PwC response
No. There is no requirement to deliver goods or services consecutively to qualify
as a series of distinct goods or services. The series guidance could apply despite
gaps in performance or concurrent transfer of individual distinct goods or services
within the series. Refer to Revenue TRG Memo No. 27 and the related meeting
minutes in Revenue TRG Memo No. 34 for further discussion of this topic.

Example RR 3-1 illustrates a contract that includes a series of distinct goods.

See Examples 7 and 31 in the revenue standard (ASC 606-10-55-125 through ASC 606-
10-55-128 and ASC 606-10-55-248 through ASC 606-10-55-250) for additional illustration
of a series of distinct goods or services.
EXAMPLE RR 3-1
Series of distinct goods – a single performance obligation
Contract Manufacturer has a contract to provide 50 units of Product A over a 36-
month period. Product A is fully developed such that design services are not
included in the contract.
Contract Manufacturer has concluded that each unit is a distinct good. An
individual unit meets the criteria to be recognized over time because it has no
alternative use and Contract Manufacturer has the right to payment for its
performance as the goods are manufactured (refer to RR 6.3).
How many performance obligations are in the contract?
Analysis
The promise to provide 50 units of Product A is a single performance obligation.
The contract is a series of distinct goods because (a) each unit is substantially the
same, (b) each unit would meet the criteria to be a performance obligation satisfied
over time, and (c) the same method would be used to measure the reporting entity’s
progress to depict the transfer of each unit. If any of these criteria were not met,
each unit would be a separate performance obligation.

EXAMPLE: IDENTIFYING DISTINCT GOODS

A bus manufacturer offers for sale both fully manufactured buses and spare parts. When a customer
purchases a fully manufactured bus, it is made up of many inputs (e.g., engine, tires, frame, etc.);
however, the customer is not receiving these individual inputs (e.g., the engine in isolation). Rather,
these inputs are used to produce a combined output to the customer (i.e., a bus). Although engines
may be sold separately as a spare part, which would indicate that it meets the first criterion of being
a distinct good (i.e., capable of being distinct), in the context of a contract for a fully manufactured
bus the engine is not considered distinct because it is an input and the entity is providing a
significant service by integrating the engine with other goods and services in the contract (i.e., the
engine is not distinct within the context of the contract). Therefore in this type of contract, the
engine is not considered to be a distinct good or service, and is not a separate performance
obligation.

EXAMPLE: SERIES OF DISTINCT GOODS

A manufacturer enters into a contract with a customer to provide a series of similar customized
goods in a large quantity that will be delivered consecutively over time. Based on the contract, the
customer has title to and controls the work in progress as the products are being manufactured. The
manufacturer has determined an expected average cost for manufacturing the product and has also
determined that using an input method based on costs (for this particular contract) is an appropriate
method because it represents the manufacturer’s performance when transferring control of the
goods. This contract is determined to be for a series of distinct goods that are effectively one
performance obligation because of the following: • The goods are similar in nature and are
transferred consecutively over time (i.e., over a period of XX years). • The contract is satisfied over
time because the customer has title to and controls the work in progress while the products are
being manufactured and therefore meets the criterion for over-time recognition. • The same
method (i.e., cost to cost) is used to measure progress toward the satisfaction of the performance
obligation of each individual product.

EXAMPLE: SUBCONTRACTING SERVICES

A building contractor enters into a contract with a customer to build a residential home. Various
goods and services are required throughout the construction process. As is typical with construction
projects,12 the various goods and services are subject to significant integration such that the
customer is in effect getting a single output and the entire contract is viewed as one performance
obligation. Assume in this particular case, the builder is not completing all the required services
needed for the combined output to satisfy the customer on its own. The building contractor sub-
contracts out the electrical and plumbing work to an external, independent contractor. Does
contracting out some of the services change the assessment such that the contract is no longer one
performance obligation? Does the ability to sub-contract services mean the services are distinct
performance obligations? In this case, although the electrical and plumbing services are being
obtained elsewhere (i.e., capable of being distinct), the building contractor is still providing a level of
integration as the nature of the promise is to produce a combined output (i.e., a residential home).
The sub-contracting of services would not result in a change in the assessment of whether a good or
service is distinct. As both criteria (i.e., capable of being distinct and distinct within the context of the
contract) for identifying a good or service as distinct were not met, the entire contract remains as
one-performance obligation.

EXAMPLE RR 3-2
Distinct goods or services — bundle of goods or services are combined
Contractor enters into a contract to build a house for a new homeowner. Contractor
is responsible for the overall management of the project and identifies various
goods and services that are provided, including architectural design, site
preparation, construction of the home, plumbing and electrical services, and finish
carpentry. Contractor regularly sells these goods and services individually to
customers.
How many performance obligations are in the contract?
Analysis
The bundle of goods and services should be combined into a single performance
obligation in this fact pattern. The promised goods and services are capable of
being distinct because the homeowner could benefit from the goods or services
either on their own or together with other readily available resources. This is
because Contractor regularly sells the goods or services separately to other
homeowners and the homeowner could generate economic benefit from the
individual goods and services by using, consuming, or selling them.
However, the goods and services are not separately identifiable from other
promises in the contract. Contractor’s overall promise in the contract is to transfer
a combined item (the house) to which the individual goods or services are inputs.
This conclusion is supported by the fact that Contractor provides a significant
service of integrating the various goods and services into the home that the
homeowner has contracted to purchase.
EXAMPLE RR 3-3
Distinct goods or services — bundle of goods or services are not combined
SoftwareCo enters into a contract with a customer to provide a perpetual software
license, installation services, and three years of postcontract customer support
(unspecified future upgrades and telephone support). The installation services
require the reporting entity to configure certain aspects of the software, but do not
significantly modify the software. These services do not require specialized
knowledge, and other sophisticated software technicians could perform similar
services. The upgrades and telephone support do not significantly affect the
software’s benefit or value to the customer.
How many performance obligations are in the contract?
Analysis
There are four performance obligations: (1) software license, (2) installation
services, (3) unspecified future upgrades, and (4) telephone support.
The customer can benefit from the software (delivered first) because it is functional
without the installation services, unspecified future upgrades, or the telephone
support. The customer can benefit from the subsequent installation services,
unspecified future upgrades, and telephone support together with the software,
which it has already obtained.
SoftwareCo concludes that each good and service is separately identifiable because
the software license, installation services, unspecified future upgrades, and
telephone support are not inputs into a combined item the customer has contracted
to receive. SoftwareCo can fulfill its promise to transfer each of the goods or
services separately and does not provide any significant integration, modification,
or customization services.
EXAMPLE RR 3-4
Distinct goods or services — contractual requirement to use the vendor’s service
SoftwareCo enters into a contract with a customer to provide a perpetual software
license, installation services, and three years of postcontract customer support
(unspecified future upgrades and telephone support). The installation services
require the reporting entity to configure certain aspects of the software, but do not
significantly modify the software. These services do not require specialized
knowledge, and other sophisticated software technicians could perform similar
services. The upgrades and telephone support do not significantly affect the
software’s benefit or value to the customer. The customer is contractually required
to use SoftwareCo’s installation services.
How many performance obligations are in the contract?
Analysis
The contractual requirement to use SoftwareCo’s installation services does not
change the evaluation of whether the goods and services are distinct. SoftwareCo
concludes that there are four performance obligations: (1) software license, (2)
installation services, (3) unspecified future upgrades, and (4) telephone support.
The customer can benefit from the software (delivered first) because it is functional
without the installation services, unspecified future upgrades, or the telephone
support. The customer can benefit from the subsequent installation services,
unspecified future upgrades, and telephone support together with the software,
which it has already obtained.
SoftwareCo concludes that each good and service is separately identifiable because
the software license, installation services, unspecified future upgrades, and
telephone support are not inputs into a combined item the customer has contracted
to receive. SoftwareCo can fulfill its promise to transfer each of the goods or
services separately and does not provide any significant integration, modification,
or customization services.
EXAMPLE RR 3-5
Distinct goods or services — bundle of goods or services are combined
SoftwareCo enters into a contract with a customer to provide a perpetual software
license, installation services, and three years of postcontract customer support
(unspecified future upgrades and telephone support). The installation services
require SoftwareCo to substantially customize the software by adding significant
new functionality enabling the software to function with other computer systems
owned by the customer. The upgrades and telephone support do not significantly
affect the software’s benefit or value to the customer.
How many performance obligations are in the contract?
Analysis
There are three performance obligations: (1) license to customized software, (2)
unspecified future upgrades, and (3) telephone support.
SoftwareCo determines that the promise to the customer is to provide a customized
software solution. The software and customization services are inputs into the
combined item for which customer has contracted and, as a result, the software
license and installation services are not separately identifiable and should be
combined into a single performance obligation. This conclusion is further
supported by the fact that SoftwareCo is performing a significant service of
integrating the licensed software with the customer’s other computer systems. The
nature of the installation services also results in the software being significantly
modified and customized by the service.
The unspecified future upgrades and telephone support are separate performance
obligations because they are not inputs into a combined item the customer has
contracted to receive. SoftwareCo can fulfill its promise to transfer each of the
goods or services separately and does not provide any significant integration,
modification, or customization services.
3.6.1 Activities that do not transfer a good or service
Activities that a reporting entity undertakes to fulfill a contract that do not transfer
goods or services to the customer are not performance obligations. For example,
administrative tasks to set up a contract or mobilization efforts are not performance
obligations if those activities do not transfer a good or service to the customer.
Judgment may be required to determine whether an activity transfers a good or
service to the customer. Figure RR 3-1 illustrates the assessment of whether
activities, such as set-up or mobilization, are separate performance obligations.
Figure RR 3-1
Assessing activities undertaken to fulfill a contract
EXAMPLE RR 3-7
Identifying performance obligations — activities
FitCo operates health clubs. FitCo enters into contracts with customers for one year
of access to any of its health clubs for $300. FitCo also charges a $50
nonrefundable joining fee to compensate, in part, for the initial activities of
registering the customer.
How many performance obligations are in the contract?
Analysis
There is one performance obligation in the contract, which is the right provided to
the customer to access the health clubs. FitCo’s activity of registering the customer
is not a service to the customer and therefore does not represent satisfaction of a
performance obligation. Refer to RR 8.4 for considerations related to the treatment
of the upfront fee paid by the customer.
EXAMPLE RR 3-8
Identifying performance obligations — activities
CartoonCo is the creator of a new animated television show. It grants a three-year
term license to RetailCo for use of the characters’ likenesses on consumer
products. RetailCo is required to use the latest image of the characters from the
television show. There are no other goods or services provided to RetailCo in the
arrangement. When entering into the license agreement, RetailCo reasonably
expects CartoonCo to continue to produce the show, develop the characters, and
perform marketing to enhance awareness of the characters. RetailCo may start
selling consumer products with the characters’ likenesses once the show first airs
on television.
How many performance obligations are in the arrangement?
Analysis
The license is the only performance obligation in the arrangement. CartoonCo’s
continued production, internal development of the characters, and marketing of the
show are not performance obligations as such additional activities do not directly
transfer a good or service to RetailCo. Refer to RR 9 for other considerations related
to this example, such as the timing of revenue recognition for the license.

EXAMPLE RR 3-9
Identifying performance obligations — shipping and handling services
Manufacturer enters into a contract with a customer to sell five flat screen
televisions. The customer requests that Manufacturer arrange for delivery of the
televisions. The delivery terms state that legal title and risk of loss pass to the
customer when the televisions are given to the carrier.
The customer obtains control of the televisions at the time they are shipped and can
sell them to another party. Manufacturer is precluded from selling the televisions to
another customer (for example, redirecting the shipment) once the televisions are
picked up by the carrier at Manufacturer’s shipping dock. Manufacturer does not
elect to treat shipping and handling activities as a fulfillment cost.
How many performance obligations are in the arrangement?
Analysis
There are two performance obligations: (1) sale of the televisions and (2) shipping
service. The shipping service does not affect when the customer obtains control of
the televisions, assuming the shipping service is distinct. Manufacturer will
recognize revenue allocated to the sale of the televisions when control transfers to
the customer (that is, upon shipment) and recognize revenue allocated to the
shipping service when performance occurs.
Since Manufacturer is arranging for the shipment to be performed by another party
(that is, a third-party carrier), it must also evaluate whether to record the revenue
allocated to the shipping services on a gross basis as principal or on a net basis as
agent. Refer to RR 10 for further discussion of the principal versus agent
assessment.
EXAMPLE RR 3-10
Identifying performance obligations — shipping and handling accounting election
Manufacturer enters into a contract with a customer to sell five flat screen
televisions. The customer requests that Manufacturer arrange for delivery of the
televisions. The delivery terms state that legal title and risk of loss pass to the
customer when the televisions are given to the carrier.
The customer obtains control of the televisions at the time they are shipped and can
sell them to another party. Manufacturer is precluded from selling the televisions to
another customer (for example, redirecting the shipment) once the televisions are
picked up by the carrier at Manufacturer’s shipping dock. Manufacturer elects to
account for shipping and handling activities as a fulfillment cost.
How many performance obligations are in the arrangement?
Analysis
There is one performance obligation in the arrangement because Manufacturer has
elected to account for shipping and handling activities as a fulfillment
cost. Manufacturer will recognize revenue and accrue the shipping and handling
costs when control of the televisions transfers to the customer upon shipment.
Manufacturer does not need to assess whether it is the principal or agent for the
shipping service since the shipping service is not accounted for as a promise in the
contract. Manufacturer should disclose its election with its accounting policy
disclosures.