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Question 18: In order to apply the series provision, how should an entity consider whether the performance obligation consists of distinct goods or services that are substantially the same?
Publication date: 31 Jan 2020
us FASB Staff Q&A Revenue 18
Reference(s): Section 606-10-25
In order to be considered a series, there must be two or more goods or services that are distinct, and each distinct good or service must also be considered substantially the same.
The staff thinks the first step is to determine the nature of the entity’s promise in providing the services to the customer. In some cases, an entity would need to determine if the nature of the promise is the actual delivery of a specified quantity of service or the act of standing ready to perform. If the nature of the promise is the delivery of a specified quantity of a service, then the evaluation should consider whether each service is distinct and substantially the same. If the nature of the entity’s promise is the act of standing ready or providing a single service for a period of time (that is, because there is an unspecified quantity to be delivered), the evaluation would likely focus on whether each time increment, rather than the underlying activities, are distinct and substantially the same. This evaluation will require judgment.
The staff thinks that making this evaluation based on the nature of the promise is consistent with the examples throughout Topic 606. That is, the Board intended that a series could consist of distinct time increments (an hour of cleaning) or the good or service delivered (each unit of electricity), depending on the nature of the promise. For example, paragraph BC285, of Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), discusses a hotel management performance obligation that is a series of distinct days of service. In that example, the nature of the promise is to provide a daily management service, and not a specified amount of services, which could include management of the hotel employees, accounting services, training, procurement, etc. The staff notes that the underlying activities could significantly vary within a day and from day to day; however, that would not be relevant to the evaluation of the nature of the promise. In contrast, Example 13 (paragraph 606-10-55-160) describes an annual contract to provide monthly payroll processing services that is considered a series. In this contract, the nature of the promise is to deliver twelve distinct instances of the service, rather than a promise to stand ready to perform an undefined number of tasks.
When considering the nature of the entity’s promise and the applicability of the series guidance, the staff also thinks it could be helpful to consider the reason why the entity concluded that a performance obligation is satisfied over time. If a performance obligation is satisfied over time because the customer simultaneously receives and consumes the benefits provided by its services as it performs (paragraph 606-10-25-27(a)), that might indicate that each increment of service being performed is capable of being distinct (paragraph 606-10-25-19(a)). That is because the customer can benefit on its own from each increment of service. The entity would then need to evaluate whether each increment was separately identifiable (paragraph 606-10-25-19(b)) and substantially the same, as described above.
If a promise is satisfied over time based on the other criteria in paragraph 606-10-25-27, the nature of that promise might be the delivery of a single specified good or service. For example, a contract to construct a single piece of equipment might meet the criteria to be recognized over time in paragraph 606-10-25-27(b). The nature of the promise is to provide the piece of equipment and not a daily construction or manufacturing service. As such, the staff does not think this performance obligation is a series because the individual goods or services within that performance obligation are not distinct, and the evaluation of a time increment is not relevant due to the nature of the promise. However, a contract for two pieces of equipment that each meet the criteria to be recognized over time could be a series comprised of two pieces of equipment if they are substantially the same.
A contract to provide professional services that results in a professional opinion might be recognized over time if it meets the criteria in paragraph 606-10-25-27(c). In this arrangement, the nature of the promise is providing the professional opinion and not a daily service. As such, the staff does not think this service would be a series. That is because there is no increment of the service that could be a separate performance obligation because each of the activities are inputs to provide the combined output of the professional opinion and, therefore, are not distinct within the context of the contract. Similarly, due to the nature of the promise, a time-based increment of the service would not be relevant.
Consider the following examples:
Example A:
Information technology (IT) Seller and IT Buyer execute a 10-year IT Outsourcing arrangement in which IT Seller provides continuous delivery of outsourced activities over the contract term. For example, the vendor will provide server capacity, manage the customer’s software portfolio, and run an IT help desk. The total monthly invoice is calculated based on different units consumed for the respective activities. For example, the billings might be based on millions of instructions per second of computing power (MIPs), number of software applications used, or number of employees supported, and the price per unit differs for each type of activity. Before the delivery of the service, IT Seller performs certain initial set-up activities to be in a position to provide the other services in the contract. IT Seller charges the IT Buyer a nonrefundable up-front fee related to the transition activities. IT Seller concludes that the set-up activities do not transfer services to the customer.
The per unit price charged by IT Seller declines over the life of the contract. The agreed upon pricing at the onset of the contract is considered to reflect market pricing. The pricing decreases to reflect the associated costs decreasing over the term of the contract as the level of effort to complete the tasks decreases. Initially, the tasks are performed by more expensive personnel for activities that require more effort.
Later in the contract, the level of effort for the activities decreases, and the tasks are performed by less expensive personnel. The contract includes a price benchmarking clause whereby the IT Buyer engages a third-party benchmarking firm to compare the contract pricing to current market rates at certain points in the contract term. There is an automatic prospective price adjustment if the benchmark is significantly below IT
Seller’s price. Assume IT Seller concludes that there is a single performance obligation that is satisfied over time because the customer simultaneously receives and consumes the benefits provided by its services as it performs.
The entity first considers the nature of its promise to the customer in this contract (that is, whether the entity’s promise is to provide an integrated outsourcing service or, instead, to provide defined items or activities that are distinct from each other). Because IT Seller has promised to provide an unspecified quantity of activities, rather than a defined number of services, the staff thinks it would be reasonable to conclude that the nature of the promise is an obligation to stand ready to provide the integrated outsourcing service each day.
If the nature of the entity’s promise is the overall IT outsourcing service, the staff thinks that each day of service could be considered distinct because the customer can benefit from each day of service on its own and each day of service is separately identifiable. Put another way, each day could be separately identifiable because the entity does not provide an integration service between the days (that is, while the activities are generally coordinated and inputs to the combined service, each day those combined activities are provided is not an input to a combined output), each day does not modify or customize another day, and the days of service are generally not highly interdependent or interrelated because the entity can fulfil its obligations each day independent of fulfilling its obligations for the other days.
If IT Seller concluded that the nature of its promise is one overall service, the staff also thinks it would be reasonable to conclude each day of service is substantially the same. That is, even if the individual activities that comprise the performance obligation vary from day to day, the nature of the overall promise is the same from day to day. Therefore, the entity has promised the daily IT outsourcing service.
The staff would not consider the set-up activities in the assessment of whether or not the distinct services are the same. That is because those activities do not transfer goods or services to the customer and would not be considered part of the performance obligation, as stated in paragraph 606-10-25-17.
Example B:
Transaction Processer (TP) enters into a 10-year agreement with a customer. Over the 10-year period, TP will provide continuous access to its system and process all transactions on behalf of the customer. The customer is obligated to use TP’s system to process all of its transactions; however, the ultimate quantity of transactions is not known. TP concludes that the customer simultaneously receives and consumes the benefits as it performs. TP charges the customer on a per transaction basis. For each transaction, the customer is charged a contractual rate per transaction and a percentage of the total dollars processed. TP also charges the customer a fixed upfront fee at the beginning of the contract.
If TP concludes that the nature of its promise to the customer is one of providing continuous access to its system, rather than one of processing a particular quantity of transactions, then TP might conclude that there is a single performance obligation to stand ready to process as many transactions as the customer requires. If that is the case, the staff thinks it would be reasonable to determine if there are multiple distinct time increments of that service. The staff thinks that each day of service could be considered distinct because the customer benefits each day from the access to its system (capable of being distinct) and each day is separately identifiable. That is, each day of service could be separately identifiable because there is no significant integration service, each day does not modify or customize another day, and each day is not highly interdependent or interrelated.
The staff thinks that each day of access (the distinct service) provided to the customer could be considered substantially the same because the customer is deriving a consistent benefit from the access over each day of the service period even if the number of transactions processed in a given day differs from the next. That is, if the nature of what could be considered daily performance obligations is the stand-ready service to provide access, the nature of each day would be similar.
If TP concludes that the nature of the promise is the processing of each transaction, then TP would need to evaluate whether a series of distinct transactions was present. The staff notes that this view of the performance obligation raises additional questions when there is an undefined quantity of transactions and if each transaction should be considered an optional purchase that is accounted for separately. Regardless, the staff thinks each transaction processed could be considered substantially the same even if there are multiple types of transactions that generate different payments. Furthermore, the staff thinks that each transaction could be a distinct service because the customer benefits from each transaction and each transaction could be distinct in the context of the contract.
Example C:
Hotel manager (HM) enters into a 20-year agreement to manage properties on the behalf of the customer. HM receives monthly consideration based on 1 percent of monthly rental revenue, reimbursement of labor costs incurred to perform the service, and an annual incentive payment based upon 8 percent of gross operating profit. HM concludes that the customer simultaneously receives and consumes the benefits provided by its services as it performs.
HM must first consider the nature of its promise to the customer in this contract (that is, whether the entity’s promise is to provide a single integrated management service or, instead, to provide defined items or activities that are distinct from each other). If the nature of HM’s promise is the overall management service because the underlying activities are not distinct from each other, the staff thinks that each day of service could be considered distinct because the customer can benefit from each day of service on its own and each day of service is separately identifiable.
Example C is similar to the hotel management example in paragraph BC285 of Update 2014-09 where the Board concluded that each time increment of service is distinct and substantially the same. Therefore, assuming the nature of the promise is the overall management service, the staff thinks the service performed each day could be considered distinct and substantially the same.
Example D:
Franchisor grants franchisee a license that provides franchisee with the right to use franchisor’s trade name and sell its products for 10 years. Franchisor will receive a sales-based royalty of 5 percent of the franchisee’s sales for the term of the license as well as a fixed fee. Franchisor concludes that the nature of its promise is to provide a right to access the intellectual property throughout the license period, and the performance obligation is satisfied over time because franchisee simultaneously will receive and consume the benefit from franchisor’s performance of providing access to its intellectual property.
The staff thinks that the single performance obligation (the right to access the entity’s intellectual property for a period of time) could be considered to have multiple distinct services of providing access each day, week, month, etc. However, this would only be the case because the entity had first concluded that the nature of the license is the right to access over time (note: if the nature of the license is a right to use the intellectual property, the entity’s performance (its singular act) is complete when it makes the intellectual property available for the customer’s use). The staff thinks the customer benefits from the right of access (capable of being distinct) each day on its own, and each day could be separately identifiable because there is no integration service provided between the days of access provided, no day modifies or customizes another, and the days of access are not highly interdependent or highly interrelated. Similar to the other examples, the staff thinks that the nature of each distinct daily service is the same because the customer consumes and receives a consistent benefit each day (that is, the right to access the intellectual property).
Copyright #year# by Financial Accounting Foundation, Norwalk, Connecticut.
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