The second step of the new revenue recognition standard is to identify the performance obligation in the contract. In this step, an entity will evaluate the goods and services offered and determine which are distinct and should be accounted for as separate performance obligations. The key determinant for identifying a separate performance obligation is whether the good or service is distinct.
A good or service is distinct if both of the following criteria are met:
- Capable of being distinct. This means a customer can benefit from a good or service if the good or service can be used, consumed, sold for an amount that is greater than scrap value or otherwise held in a way that generates economic benefits.
- Distinct within the context of the contract. Factors that indicate that an entity’s promise to transfer a good or service to a customer is separately identifiable include, but are not limited to, the following:
- The organization is not using the good or service as an input to produce or deliver the combined output specified by the customer.
- The good or service does not significantly modify or customize another good or service promised in the contract.
- The good or service is not highly dependent on, or highly interrelated with, other goods or services promised in the contract.
Each distinct good or service is separately identified from other promises in the contract and represents a separate performance obligation.
Stay tuned for our next post, which will cover transaction pricing.
Read other articles in our “Revenue Recognition” Series: