Paragraph 606-10-25-31 states that the overall objective when measuring progress toward complete satisfaction of a performance obligation satisfied over time is to depict an entity’s performance in satisfying its performance obligation. As noted in paragraph BC159 of Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), the Board decided it would not be feasible to consider all possible methods and prescribe when an entity should use each method. Accordingly, an entity should use judgment when selecting an appropriate method of measuring progress toward complete satisfaction of a performance obligation. However, that does not mean that an entity has a “free choice.”

It may require more judgment to determine the measure of progress in a combined performance obligation when there are multiple nondistinct promises that have different patterns of performance, but like other performance obligations satisfied over time, an entity must apply judgment in selecting the method that complies with the overall objective. If there is not a clear pattern that applies to all of the goods or services (for example, all services are time based over the same time period), the staff does not think that entities should default to a “final deliverable” or “predominant deliverable” methodology. Instead, an entity should consider the nature of the entity’s overall promise for the combined performance obligation and performance required to completely satisfy the entire performance obligation. To make that assessment, the staff thinks it is important to consider the reasons why the entity decided that the goods or services are not distinct and have been bundled into a combined performance obligation.

If an entity thinks that the result of a single measure of progress for a combined performance obligation does not faithfully depict the economics of the arrangement, the staff thinks it could be an indicator that the entity has not identified the appropriate performance obligations (that is, there might be more than one performance obligation). That is not to say the entity definitively has identified the wrong performance obligation(s). The staff understands there will be cases under Topic 606 (similar to current practice) in which the entity has properly identified the unit of account and selecting a single measure of progress for the combined performance obligation will require significant judgment.

The staff has prepared a few scenarios to illustrate how to approach this issue. It is important for stakeholders to note when reading the scenarios and staff views that an entity will need to consider the specific facts and circumstances of a contract with a customer and sometimes apply significant judgment to identify an appropriate performance obligation and measure of progress that depicts an entity’s “performance in transferring control of goods or services promised to a customer (that is, the satisfaction of an entity’s performance obligation)” (paragraph 606-10-25-31).

In the staff’s view, the entity should use a measure of progress that depicts the performance of the hosting services beginning when the hosting service commences. The nature of the entity’s overall promise (and, therefore, combined performance obligation) is to provide the hosting service, and no revenue would be recognized over the implementation period because that promise does not transfer a service to a customer. The entity would select a method that depicts the performance of the hosting services to measure progress toward completion. For example, a time-based method might be considered appropriate. The entity would need to consider whether it meets the criteria to capitalize the costs of implementation in accordance with paragraph 340-40-25-5.

The staff thinks that the nature of the entity’s overall promise is the hosting service and the implementation service does not transfer a service to a customer. If the implementation does not transfer a service, then it would be disregarded from the performance obligation, similar to set up activities described in paragraph 606-10-25-17.

The staff thinks this view is analogous to setup activities in an outsourcing arrangement as discussed in Example 53, Nonrefundable Upfront Fee (paragraphs 606-10-55-358 through 55-360). In that example, setup activities are not considered to be part of the performance obligation because they do not transfer a good or service to a customer. Similarly, paragraph 606-10-55-52 states that if nonrefundable fees relate to a good or service, the entity should evaluate whether to account for the good or service as a separate performance obligation. Paragraph 606-10-55-53 goes on to state that “if those setup activities do not satisfy a performance obligation, the entity should disregard those activities (and related costs) when measuring progress in accordance with paragraph 606-10-55-21.” That is because the costs of setup activities do not depict the transfer of services to the customer. Similarly, in this scenario, the implementation service is not a separate performance obligation and does not satisfy a separate performance obligation. The staff also thinks costs incurred during implementation would likely be capitalized in accordance with paragraph 340-40-25-5.

The staff thinks the conclusion that the implementation is not capable of being distinct supports the conclusion that the nature of the entity’s overall promise is to provide hosting services. In fact, the staff thinks including the implementation service in the measure of progress is inconsistent with the conclusion that the implementation is not capable of being distinct in accordance with paragraph 606-10-25-19(a). That is, concluding the implementation is not capable of being distinct means that the customer cannot benefit from that service (either on its own or together with other readily available resources), which also means control does not transfer. Said differently, because a service is transferred when the customer obtains control of that asset (paragraph 606-10-25-23) and control includes the customer’s ability to obtain substantially all the remaining benefits from the good or service (paragraph 606-10-25-25), performing only the service that the customer cannot benefit from would not transfer control. Because the implementation services are performed before the customer benefiting from the hosting service, it should be excluded from the measure of progress pursuant to paragraph 606-10-25-34, which states that an entity shall exclude from the measure of progress any goods or services for which the entity does not transfer control to a customer.

This does not mean the staff thinks that anytime a good or service is not capable of being distinct it should be excluded entirely from the measure of progress or that all services in a combined performance obligation must commence before recognizing revenue. For example, assume an entity enters into a contract to provide Service A, Service B, and Service C. The services are bundled into a combined performance obligation because Service A commences first and is not capable of being distinct without Service B or C. Additionally, all three services are highly interrelated and not separately identifiable. Assume Service A commences in month 1, Service B commences in month 2 and Service C commences in month 3, all continue through the end of the contract period, and the entity concludes the combined performance obligation is satisfied over time. In this fact pattern, the customer would not be able to obtain any benefit until Service B commences (that is, the customer does not benefit from Service A on its own). The entity would need to consider the nature of the entity’s overall promise to determine the appropriate measure of progress but would not necessarily have to wait until Service C commenced to begin recognizing revenue. That is, the entity might be able to begin recognizing revenue when Service B commences.

In the staff’s view, the entity should use a measure of progress that depicts the performance of completing the customized software solution. All the revenue would be recognized over the period the customization services are performed.

While each promised good or service in the combined performance obligation is capable of being distinct, the license and installation service are inputs the entity uses to produce the combined output. As such, the nature of the combined performance obligation is developing the customized software over time. Therefore, the staff thinks that, because the creation of the customized software solution is the promise that is being performed over time, the measure of progress should be based on a method that reflects the entity’s progress towards the completion of that service and, therefore, complete satisfaction of the combined performance obligation.

In the staff’s view, the entity should use a measure of progress that best depicts the performance of the license. The nature of the overall performance obligation is the franchisee’s right to access the license and, therefore, the measure of progress would depict the transfer of the license. For example, using a time-based output method, the entire transaction price would be recognized ratably over the 10-year period. The entire transaction price of CU1,150,000 would be recognized over the 10-year license agreement.

Because the consulting services and license are interrelated and the consulting services actually enhance the benefit the franchisee will receive over the entire license period, the staff think the nature of the overall performance obligation is the franchisee’s right to access the license. Even if the franchisor’s level of effort is higher over the first year than any other individual year, given the relationship between the license and services, a time-based method over the entire ten-year period would accurately depict the complete satisfaction of the performance obligation.

However, each example is illustrative, and judgment will need to be applied based on the specific facts and circumstances of an arrangement with a customer.