Although not all inclusive, the following are some examples of when an entity should possibly consider combining separate contract with the same customer, keeping in mind that judgment is required because additional facts or different circumstances could result in a different conclusion.
Entities that provide engineering and construction services in separate contracts with the same customer, whose contracts are issued at or near the same time, may need to combine these separate contracts if the two contracts are for the design and building of a single capital asset and would be deemed a single performance obligation had they been in a single contract; therefore, these contracts should likely should be combined.
Educational institutions will need to determine if tuition and housing (or any other contracts entered into with the student) are contracted together in a single contract or in separate contracts. If entered into at or near the same time with the same student, specifically, if the contracts are negotiated as a package with a single commercial objective, the amount of consideration to be paid in one contract depends on the price or performance of the other contract, or if the services promised in the contracts are a single performance obligation, then the educational institution would combine the contracts. When making the determination of whether to combine contracts for tuition and housing, the educational institution would need to consider whether a discount (for example, financial aid) has been provided in a bundled arrangement. If the single commercial objective criterion has not been met, then the educational institution would treat the contracts as separate contracts and apply the guidance in FASB ASC 606 to each separate contract.
Knowledge check
1 Indicators of a combined contract include:The contracts are entered into at or near the same time and have a single commercial objective.The contracts have different commercial objectives.The amounts of consideration in the two contracts are independent of each other.The customer receives a discount as a result of an existing relationship.
The following are few considerations for management when identifying a contract with a customer:
Is there a formal or informal policy in place to approve and modify contracts with customers? Does that policy differ based on contract types?
Are there controls around both the approval and modification of contracts with customers?
Is there a need to engage expert legal advice to determine whether a contract with a customer is legally enforceable and/or has commercial substance?
At the inception of the contract, how has management determined that they will collect substantially all of the consideration they are entitled to?
How does management identify contracts that should be combined?
Has management elected the use of the portfolio approach? If so, how did management determine which contracts with customers have similar characteristics?
Can the judgments and assumptions used when identifying a contract with a customer be supported and are they documented? Is that documentation and support sufficient enough for the company’s auditors?
Unlike larger companies, many private companies do not have the staff nor do the resources to tackle FASB ASC 606. Those private companies should consider reaching out to their auditors to learn if their auditors can provide non-attest services, providing those services do not impair their auditors’ independence, or seek the help of third parties skilled in the application of FASB ASC 606.
Notes
1 1 Exercise fact pattern originated from paragraphs 95–98 of FASB ASC 606-10-55.
2 2 Exercise fact pattern originated from FASB ASC 606-10-55-98.
3 3 Exercise fact pattern originated from paragraphs 99–101 of FASB ASC 606-10-55.
4 4 Example fact pattern originated from paragraphs 106–109 of FASB ASC 606-10-55.
Chapter 3 Identifying The Performance Obligations in the Contract
Learning objectives
Identify the definition of a performance obligation.
Identify promises of goods or services in a contract with a customer.
Identify when a good or service is distinct within the context of a contract with a customer.
Overview
The core principle of the revenue recognition standard is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
In order to achieve the core principle of the revenue standard, an entity should be able to perform the following five steps:
Step 1: Identify the contract with a customer
Step 2: Identify the performance obligations in the contract
Step 3: Determine the transaction price
Step 4: Allocate the transaction price
Step 5: Recognize revenue when or as the entity satisfies a performance obligation
In this chapter, we will focus primarily on concepts involving step 2, identifying the performance obligations in a contract.
Identifying the performance obligations in the contract
After an entity has determined that it has a contract with a customer, thereby meaning that the criterion in step 1 has been achieved, they will turn their attention to step 2. This is performed by assessing, at the inception of the contract, the types of goods or services, or both, promised in the contract with the customer. The entity will need to determine whether each of these goods or services, or both, meet the definition of a separate performance obligation. Therefore, it is important to understand the definition of a performance obligation, which is given in the FASB Accounting Standards Codification® (ASC) master glossary as:
Performance Obligation: A promise in a contract with a customer to transfer to the customer either:
1 A good or service (or a bundle of goods or services) that is distinct
2 A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.
Promised
