Question

Determine how many separate performance obligations are included in the following separate contract examples, and make simple explanation.

a. A retailer enters into a contract with a customer to sell an electric toothbrush, bundled with the replacement parts for the toothbrush. The retailer also sells the replacement parts and toothbrushes separately. The customer can use the toothbrush without the replacement parts, but the replacement parts have no use without the toothbrush. How many performance obligations exist in the bundling of the toothbrush and the replacement parts?

b. A contractor enters into a revenue contract to build a house for a customer. The 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, painting, and carpentry. The contractor regularly sells these goods and services individually to customers. For example, the contractor can be contracted to paint a home. How many performance obligations are included in the contract to build the home assuming that the goods and services provided are limited to the descriptive list provided above?

c. Gateway Inc. enters into a contract with a customer to provide a license for use of new accounting software, installation services, and three years of subsequent customer support. The customer purchased the accounting software, scheduled installation services one week later, and is guaranteed customer support for three years beyond the software purchase date. The installation services require some configuration but no serious modifications. External consultants would have the knowledge to perform similar services (installation and customer support). The subsequent customer support does not significantly affect the software’s benefit or value to the customer. How many performance obligations are included in this revenue contract?

d. Assume the same circumstances in part c above except that Gateway Inc. is supplying highly customized software, where the customer has a number of requests for changes to the standard software to accommodate industry specific reporting requirements. The customization affects both the software product and the installation process. How many performance obligations are included in this revenue contract?

Answer 1

ASC 606 defines a performance obligation as a promise to transfer goods or services (or a bundle of products or services) to a customer that are either:

1. Distinct in featuring unique requirements for the provider of goods and services to customers; or
2. A collection of distinct goods or services with the same pattern of transfer to the customer. The same pattern of transfer occurs if:

• Each distinct product or service would constitute a performance obligation over time;
• Progress towards complete satisfaction of the performance obligation to transfer each distinct product or service would be evaluated using the same method

If a promised good or service is not distinct, it should be considered with other products or services to make it distinct.

a.Below are the Performance Obligations

1.Electric Toothbrush and Replacement Parts

2.Electric Toothbrush

Customer has no use only with Replacement Parts without Electric Toothbrush.

b.All the promised goods and services are capable of being distinct as other entities can also provide the same. However, the goods and services are not distinct in the context of the contract, as the entity provides significant services in integrating to all the promises to deliver a newly constructed wing, that the home had contracted for. Since both the above criteria are not being met, the contract contains one single performance obligation, that is, to construct the entire new extension as per the promise!

c.Let us analyze the promises other than that of the software license: Other entities working within the same industry also routinely provide installation services which does not significantly modify the software originally provided. Therefore, the customer can benefit from the service on its own by adding other readily obtained resources, i.e. the software license.

The software license is a separately delivered item and can function without the frequent updates or the technical support. Thus, the customer can benefit from the license on its own. The updates and technical support are also separately available as the entity sells the products separately.

The contract thus has three performance obligations:

• Software license
• Installation services
• Customer support

d.Considering the same facts in the above example of IT company, consider that the software requires significant customization as per the customer’s requirements. In this situation, since the customer cannot obtain the special customizations from another entity, the customer cannot obtain the benefit of the software license from readily obtained resources. The software license and custom installation services are thus clubbed into one performance obligation. Hence, here the contract has two performance obligations:

• Software license and custom installation
• Customer support