By: Nicholas Lombardi Jr., CPA
Blog Series: Revenue from Contracts with Customers
Post 3 of 6
As this is only my second blog post for NCACPA, I am thankful that I’m not too constrained by the usual rules of maturity and decorum which typically govern the writing of official documents, reports, and communications because, really—a 700-plus page update? I had no idea that the IASB and FASB were such chatty groups. Maybe the next oversized ASU can be released as a “book on tape.” I’m thinking ASU 2049-12, “Leases on Audiobook”, as read by a character such as Frasier Crane or maybe Ellis Boyd Redding from the Shawshank Redemption as portrayed by Morgan Freeman.
This is the third in a series of six posts on ASU 2014-09. The ASU’s core principle is that revenue should be recognized to depict the transfer of goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled to, in exchange for those goods and services. Today’s topic is the second step in the five step process to achieve the core principle and involves identifying the performance obligations in the contract.
What is a performance obligation? It is simply a promise to transfer to the customer either a distinct good or service, or a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer. Key to this discussion is the word distinct. A promised good or service is distinct if both of the following criteria are met: (1) the customer can benefit from a good or service either on its own or together with other resources available to the customer—e.g. the good or service is capable of being distinct— and (2) the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract. Contracts can be explicitly stated or they can be implied—e.g. by customary business practices.
An entity shall recognize revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service to a customer.
As a real world example —at least in my mind—I’ve entered into a contract with a rather eccentric customer, Dr. Emmett Brown, to build and deliver a flux capacitor. When completed and transferred, can the customer benefit from this product on its own? Of course not. Everyone knows that a flux capacitor by itself does nothing but glow in the dark. However, is it a distinct product? Yes, because the product is specifically identified in the contract and Dr. Brown happens to have a DeLorean lying around that when combined with a flux capacitor creates a perfectly functional time machine. So the flux capacitor was the only item contracted to be built and the customer has the resources available to use the completed flux capacitor, as he is the owner of the DeLorean.
Something to consider however, I did have to obtain a significant number of permits to build the flux capacitor. This type of setup or administrative activity is valuable to the process but does not transfer goods or services to the customer. Therefore set up activities are not considered a performance obligation.
Lastly, if a good or service is not distinct then it should be combined with other goods and services until a bundle of goods or services are distinct.
Now it’s on to step three—determining the transaction price!
Nicholas Lombardi, Jr., CPA joined the Stancil & Company team in 1994 after working in the banking industry for over ten years. Nick serves clients in the firm’s accounting and auditing, taxation, and small business consulting practice areas. He works extensively with both for-profit and not-for-profit entities including foundations, associations, medical and dental practices, construction contractors, and other closely-held businesses.
Nick is a member of the North Carolina Association of Certified Public Accountant’s Accounting and Attestation Committee and a former member and past chairman of the NCACPA’s Not-For-Profit Committee. In addition, Nick is a frequent speaker for SCORE (Service Corps of Retired Executives) and a contributing author for the NCACPA’s magazine Interim Report and the North Carolina Center for Nonprofit’s quarterly newsletter Common Ground.
Nick is a graduate of the University of North Carolina at Chapel Hill and is a member of both the American Institute of Certified Public Accountants and the North Carolina Association of Certified Public Accountants. He and his wife Kate, and their daughter Jessica, are members of St. Francis of Assisi Catholic Church.