Measuring Progress with Multiple Goods or Services in a Single Performance Obligation

Accounting Standards Codification (ASC) 606 requires entities to evaluate if promised goods or services in a contract are capable of being distinct and separately identifiable. In step two, identify the performance obligations in the contract, promised goods or services deemed not distinct are combined into a single performance obligation. When the single performance obligation meets the criteria for over-time recognition, the combination of non-distinct goods or services complicates the application of step five of the revenue model, recognize revenue when or as performance obligations are satisfied. Therefore, entities must appropriately measure progress for bundled goods or services for which control is transferred to the customer at different rates.

How To

Measuring progress of a performance obligation composed of non-distinct goods and services with different patterns of transfer is not explicitly addressed in ASC 606. As a result, the Financial Accounting Standards Board (FASB) Transition Resource Group for Revenue Recognition (TRG) addressed related issues in its July 2015 meeting. Determining appropriate measurement of progress in these situations will require significant judgment. The following provides restrictions and principles to assist in determining the appropriate measure of progress:

Restrictions

Entities must select a single method of measuring progress that faithfully depicts performance in transferring control of goods or services, as required in ASC 606-10-25-31 to 25-32. In other words, applying multiple methods of measuring progress, whether input methods, output methods, or a combination of both, is not permissible. The FASB notes that using multiple methods of measuring progress inherently circumvents the distinct analysis performed within step two of the revenue model.

Additionally, the TRG believes entities should not default to common methods used under ASC 605 for measuring progress for bundled performance obligations. These common methods include recognizing revenue over the performance period of the final deliverable in the bundle (“final deliverable method”) and using the recognition pattern of the predominant good or service in the bundle (“predominant deliverable method”).

Principles

Given the restrictions above, some stakeholders argue that using a single method of measuring progress that considers all non-distinct goods or services may not be operationally possible or faithfully depict the economics of the arrangement. However, consistent with the need to exercise significant judgment, entities should assess the nature of the overall promise to transfer non-distinct goods or services. The TRG notes that the reasons for which goods or services were combined into a single performance obligation are important in making this assessment. The TRG states that if the use of a single measure of progress truly does not reflect the economics of an arrangement, this may indicate that the goods or services were incorrectly combined as part of step two of the revenue recognition model. However, this is not a definitive conclusion for all similar arrangements.

Illustrative Examples

Example 1

Flare-for-Solar Co. (“Flare”), a commercial solar provider, recently contracted with Burst Biometrics (“Burst”) for the delivery and installation of solar panels on Burst’s large office complex. The project is scheduled for completion in four weeks and will require a significantly customized installation. During its analysis of this contract, Flare has determined that, due to the required customization of the solar panel equipment as part of the installation, the equipment and installation are not separately identifiable in accordance with ASC 606-10-25-19 to 25-22. Further, the combined performance obligation meets the criteria to be recognized over time as the customized panels cannot be utilized on another project and Burst is obligated to pay for work completed to date. Flare must determine the appropriate method for measuring progress for the combined performance obligation.

Analysis: Although the promised goods and services in the contract appear to be transferred at separate rates (i.e. the panels may be delivered to the office complex at one rate and subsequently installed at another rate), it would be inappropriate to use different methods of measuring progress or to default to a common method used under ASC 605. Rather, Flare considers the overall nature of the promise to deliver the combined performance obligation (to provide an integrated and customized solar panel system), and concludes that the revenue should follow the performance of the installation service over time. Flare determines that the input method of hours incurred faithfully depicts performance of the transfer of control of the combined performance obligation.

Example 2

MacroHard (“Macro”) is a successful video game developer that frequently licenses its intellectual property to third-parties. Common licenses include Macro’s logo or images of its iconic video game characters. Recently, Macro entered into a licensing agreement with Hopper LLC. The agreement gives Hopper LLC the rights to the image of Parkis Lenicks, a popular video game character of the Years of Yore game series, for a 24-month term. In addition to the license of intellectual property, the agreement includes consulting services provided in the first six months of the license term aimed to improve Hopper LLC’s use of the license.

During its analysis of this contract, Macro has determined that the license and consulting are capable of being distinct, but not separately identifiable in accordance with ASC 606-10-25-19 to 25-22 because the two services significantly affect one another such that they are highly interdependent. Further, the combined performance obligation meets the criteria to be recognized over time (and the nature of the license is to provide a right to access intellectual property). Macro must determine the appropriate method for measuring progress for the combined performance obligation.

Analysis: Macro cannot use multiple methods of measuring progress (e.g. time-based for the license and input hours for the consulting) or default to a common ASC 605 method. Macro must consider the overall nature of the combined performance obligation. In this case, the consulting services are meant to enhance the benefit received from the license. Therefore, the nature of the bundle is for the effective use of rights to access the intellectual property. Macro concludes that the appropriate method of measuring progress will follow the license over time using a time elapsed output method as the license is for symbolic IP and performance occurs evenly throughout the license period.

Comparison to 605

Due to a lack of specific ASC 605 guidance for situations discussed above, practitioners use certain common methods for measuring progress toward completion of combined deliverables including the predominant deliverable, final deliverable, and various other methods. Under ASC 606, entities must consider the overall nature of the performance obligation. This approach avoids defaulting to a method that may not represent the nature of the combined items; however, it appears that conclusions reached by considering the overall nature may be similar to those reached using the predominant deliverable method. On the other hand, conclusions will most likely be different from those reached using the final deliverable method or other methods referred to in TRG Memo 41, paragraph 7. As such, revenue recognition patterns may be different under ASC 606 for entities using other methods that exist in practice under ASC 605.

Conclusion

When multiple promised goods or services are deemed not to be distinct during step two of the revenue recognition model, entities must use significant judgment in step five to determine a single method of measuring progress for the transfer of control of the combined performance obligation. In these cases, entities must follow certain restrictions and consider the overall nature of the performance obligation. Revenue recognition under ASC 606 is likely to be different for entities applying common methods used in practice under ASC 605.

Resources Consulted

ASC 606
ASU 2014-09: "Revenue from Contracts with Customers." BC159-BC162.
FASB TRG Memo 41: "Measuring progress when multiple goods or services are included in a single performance obligation." 13 July 2015.