AASB 15 Revenue from Contracts with Customers is now applicable. Our series of articles explore some of the issues you should be considering as part of your implementation project. This article looks at when goods and services should be considered separate performance obligations (POs) in a contract.
Appropriately identifying POs is a fundamental step in the new revenue model. Getting this right is critical as the amount and timing of revenue recognition is determined on a PO by PO basis. Identifying the wrong POs could impact when and how you recognise revenue.
Typically, a company performs various activities when providing a service to a customer. Take for example roadside assistance - should each one of the activities performed, such as operating a call centre, changing a tyre or towing a car be a separate PO? If those tasks are so interrelated and necessary for an entity to deliver its promise to help drivers when their vehicle breaks down, then they are possibly a single PO.
Considering each activity as separate POs could result in lumpy revenue recognition and may not necessarily reflect the substance of the obligation to the customer.
Maintenance services could be an example of a stand-ready obligation: waiting for repair calls and providing the service anytime throughout the contract period. These contracts can also include major overhauls.
Whether these types of services are stand-ready POs as opposed to multiple POs can be a fine line. It is important to understand what promises have been made, and whether the quantity of services promised to the customer diminishes with each use.
Where a specific number of overhauls are promised (let’s say two per year over three years), then overhauls are likely a separate PO to general maintenance. Whereas with general maintenance, all maintenance tasks are likely considered one stand-ready PO, as the number of tasks the customer could receive does not diminish when each task is performed. In such an example, there would be a single PO for three years of general maintenance and six POs for each major overhaul.
Identification of POs is key, as revenue for each overhaul would be recognised as it was performed and revenue for the general maintenance is likely to be recognised on a straight-line basis over the three years.
Do contractual restrictions impact the number of POs identified? While contractual restrictions can affect a customer’s ability to use a good or service, restrictions are generally not determinative when identifying POs. If an entity sells a printer and requires its customers to use its installation services, the contractual restriction does not change the characteristics of the goods and services in the contract. The customer is able to benefit from the printer and the installation services separately and there is no significant service of integration. The installation services do not customise the printer and they are not highly interrelated, thereby resulting in separate POs.
It’s also important to not assume because goods and services are functionally dependent upon each other they would be combined as a single PO. The question is do they transform, significantly modify or customise the other? If no, they are likely separate POs. Take a printer that only takes specific ink cartridges. The printer and cartridges are functionally dependent upon each other to print. As a customer can benefit from each of them individually (as cartridges are sold separately to the printer) and they do not transform each other, they would be separate POs.
Working out whether a promise is a single or multiple POs can be tricky. Ensure you are across these common pitfalls to appropriately identify the POs in your customer contracts and apply the rest of the standard on a sound basis.
If you wish to discuss this further, or any other aspects of implementing AASB 15, please contact your usual KPMG contact or the contacts on this page.