Identifying performance obligations (IFRS 15)

Second step of the five step model introduced by IFRS 15 is identifying performance obligations. Promises made by an entity in a contract to transfer goods or services to the customer are performance obligations. These promises can be explicit as well as implicit.

Generally a contract explicitly states what goods and services are to be transferred by the entity to its customer. This is an explicit promise. However, the performance obligations may not be limited to explicit promises. There is a possibility that a contract may contain implicit promises as well. An entity’s published statements, policies and its customary business practices may create a valid expectation to the customer that the entity will transfer goods or services other than those explicitly stated in the contract.

An entity shall, at the inception of the contract, identify each explicit and implicit promise as a performance obligation to either:

  • transfer a distinct good or service to the customer; OR
  • transfer a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.

What is meant by distinct good or service? A good or service 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 readily available resources; AND
  • the entity’s promise to transfer the good or service is separately identifiable.

Example

An entity enters into a contract with a customer to deliver an IT device, install its operating system and provide technical support for one year. Identify the performance obligations in the following two scenarios:

  1. The IT device can be used by the customer by installing other operating systems readily available in the market.
  2. The IT device can only be used with the operating system the entity has promised to provide.

Answer

Scenario (1)

The entity should evaluate the criteria defined by IFRS 15 to evaluate whether goods and services promised are distinct or not. In scenario A, as the entity can use the IT device by installing any other operating system from the market, it means that the entity can benefit from that device together with readily available resources. Furthermore, goods and services are separately identifiable, as two or more goods are not required to be integrated into a combined output in this case. Therefore there are three performance obligations:

  • Delivering the IT device
  • Installing the operating system
  • Providing technical support for one year

Scenario (2)

In scenario B, as the entity cannot use the IT device by installing any other operating system, it means that the entity cannot benefit from that device on its own or together with readily available resources. Furthermore, IT device and operating system are not separately identifiable, as operating system is required to be integrated into the IT device to make it operational (combined output). Therefore there are two performance obligations:

  • Delivering the IT device with installed operating system
  • Providing technical support for one year