What Are Performance Obligations and Contract Assets?
Under IFRS 15 (and ASC 606), companies recognize revenue by identifying each promise in a contract — a performance obligation — and tracking the resulting contract assets or liabilities. Getting this right determines when and how much revenue a business reports.
A performance obligation is a promise in a contract to transfer a distinct good or service to a customer; a contract asset is the entity's right to consideration for work already performed that isn't yet unconditional (not just a passage-of-time receivable).
- 1↓Identify the contractConfirm an agreement with enforceable rights and obligations exists.
- 2↓Identify performance obligationsSeparate the contract into each distinct promised good or service.
- 3↓Determine the transaction priceEstimate the total consideration the entity expects to receive.
- 4↓Allocate the transaction priceSplit the price across obligations using relative standalone selling prices.
- 5Recognize revenueRecord revenue as (or when) each performance obligation is satisfied.
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Step-by-step worked examples
A software company sells a license bundled with 2 years of support for $50,000 total. The license's standalone selling price (SSP) is $32,000 and the support's SSP is $24,000. How much revenue is allocated to the license?
Sum of SSPs = 32,000 + 24,000 = $56,000 License share = 32,000 / 56,000 = 57.14% Allocated to license = 50,000 × 0.5714 ≈ $28,571
A construction company recognizes $500,000 of revenue to date on a long-term contract (satisfied over time) but has only billed the customer $420,000 so far. Is there a contract asset, and how much?
Contract asset = Revenue recognized − Amount billed Contract asset = 500,000 − 420,000 = $80,000 (The right to the extra $80,000 is conditional on further billing milestones, so it's a contract asset, not a receivable.)
A bundle of equipment, installation and 1-year training sells for $200,000. Standalone selling prices are $90,000, $60,000 and $50,000 (sum = $200,000, no discount). Allocate the transaction price.
Sum of SSPs = 90,000 + 60,000 + 50,000 = $200,000 (equals the bundle price, so no discount to allocate) Equipment = 200,000 × (90,000/200,000) = $90,000 Installation = 200,000 × (60,000/200,000) = $60,000 Training = 200,000 × (50,000/200,000) = $50,000
Flashcards
Quick quiz
Q1.Which of these best defines a performance obligation?
Q2.A contract asset arises when...?
Q3.A bundle sells for $90,000; equipment SSP is $70,000 and installation SSP is $30,000. Revenue allocated to equipment?
Q4.What is the correct order of the first two steps in the 5-step revenue model?
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Common mistakes
Treating every line item in a contract as a separate performance obligation. — Correct: Only distinct promises — ones the customer can benefit from on their own and that are separately identifiable — count as performance obligations.
Confusing a contract asset with accounts receivable. — Correct: A contract asset's right to payment is still conditional (e.g., on further performance); a receivable is unconditional — only time must pass.
Allocating a bundle discount equally across all obligations. — Correct: Discounts are allocated proportionally based on relative standalone selling prices, not evenly.
Recognizing revenue as soon as a contract is signed. — Correct: Revenue is recognized only when (or as) the performance obligation is actually satisfied — goods delivered or services rendered.
FAQ
What is a performance obligation under IFRS 15 / ASC 606?
It's a promise in a contract to transfer a distinct good or service (or a series of similar ones) to a customer; each one is accounted for and recognized as revenue separately.
How do you allocate transaction price to performance obligations?
Using the relative standalone selling price method: the total price is split across obligations in proportion to what each would sell for on its own.
What is the difference between a contract asset and a receivable?
A receivable is an unconditional right to payment (only time needs to pass); a contract asset's right is still conditional on future performance.
What are some examples of performance obligations?
Delivering a product, providing installation, granting a software license, and providing ongoing support are each a separate performance obligation if they are distinct.