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3.4 Assessing whether a good or service is “distinct”
Publication date: 31 Mar 2024
us Revenue guide
Each distinct good or service is a performance obligation. Performance obligations are the unit of account for purposes of applying the revenue standard and form the basis for how and when revenue is recognized. When there are multiple promises in a contract, management will need to determine whether goods or services are distinct, and therefore separate performance obligations. The assessment of whether a good or service is distinct is a two-pronged test; the good or service must be both: (1) capable of being distinct and (2) separately identifiable.
A good or service that is promised to a customer is distinct if both of the following criteria are met:
a. The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (that is, the good or service is capable of being distinct).
b. The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (that is, the promise to transfer the good or service is distinct within the context of the contract).
3.4.1 Capable of being distinct
A good or service is capable of being distinct if the customer can benefit from that good or service on its own or with other resources that are readily available. A customer can benefit from a good or service if it can be used, consumed, or sold (for an amount greater than scrap value) to generate economic benefits. A good or service is also typically capable of being distinct if a reporting entity regularly sells that good or service on a standalone basis.
A good or service that cannot be used on its own, but can be used with readily available resources, also meets this criterion, as the reporting entity has the ability to benefit from it. Readily available resources are goods or services that are sold separately, either by the reporting entity or by others in the market. Readily available resources also include resources that the customer has already obtained, either from the reporting entity or through other means. As a result, the timing of delivery of goods or services (that is, whether a necessary resource is delivered before or after another good or service) can impact the assessment of whether the customer can benefit from the good or service.
“Capable of being distinct” is only the first criterion of the distinct assessment. Management will also have to assess whether the promised good or service is “separately identifiable” from other goods or services in the contract (refer to RR 3.4.2).
Examples 10 and 11 of the revenue standard (ASC 606-10-55-137 through ASC 606-10-55-150K) illustrate the assessment of whether a good or service is capable of being distinct.
3.4.2 Separately identifiable
After determining that a good or service is capable of being distinct, the next step is assessing whether the good or service is separately identifiable from other promises in the contract.
In assessing whether an entity’s promises to transfer goods or services to the customer are separately identifiable…the objective is to determine whether the nature of the promise, within the context of the contract, is to transfer each of those goods or services individually or, instead, to transfer a combined item or items to which the promised goods or services are inputs. Factors that indicate that two or more promises to transfer goods or services to a customer are not separately identifiable include, but are not limited to, the following:
a. The entity provides a significant service of integrating the goods or services with other goods or services promised in the contract into a bundle of goods or services that represent the combined output or outputs for which the customer has contracted. In other words, the entity is using the goods or services as inputs to produce or deliver the combined output or outputs specified by the customer. A combined output or outputs might include more than one phase, element, or unit.
b. One or more of the goods or services significantly modifies or customizes, or are significantly modified or customized by, one or more of the other goods or services promised in the contract.
c. The goods or services are highly interdependent or highly interrelated. In other words, each of the goods or services is significantly affected by one or more of the other goods or services in the contract. For example, in some cases, two or more goods or services are significantly affected by each other because the entity would not be able to fulfill its promise by transferring each of the goods or services independently.
The factors are intended to help a reporting entity determine whether its performance in transferring multiple goods or services in a contract is fulfilling a single promise to a customer. The factors above are not an exhaustive list and should also not be used as a checklist.
Understanding what a customer expects to receive as a final product is necessary to assess whether a good or service is separately identifiable or whether it should be combined with other goods or services into a single performance obligation. Some contracts contain a promise to deliver multiple goods or services, but the customer is not purchasing the individual items. Rather, the customer is purchasing the final good or service (the combined item or items) that those individual items (the inputs) create when they are combined. Judgment is needed to determine whether there is a single performance obligation or multiple separate performance obligations. Management needs to consider the terms of the contract and all other relevant facts, including the economic substance of the transaction, to make this assessment. Management should also consider how the goods and services are marketed to the customer; however, management cannot solely rely on this evidence. For example, describing an arrangement as a “solution” in marketing materials does not, on its own, support a conclusion that there is a single performance obligation.
Management should consider whether the combined item is greater than, or substantially different from, the sum of the individual goods and services. In other words, management should consider whether there is a transformative relationship between the goods or services in the process of fulfilling the contract. For example, a contract to construct a wall could include promises to provide labor, lumber, and sheetrock. The individual inputs (the labor, lumber, and sheetrock) are being used to create a combined item (the wall) that is substantially different from the sum of the individual inputs. The promise to construct a wall is therefore a single performance obligation in this example.
The assessment of the “highly interdependent or highly interrelated” factor may require significant judgment. The goods and services in a contract should not be combined solely because one of the goods or services would not have been purchased without the others. For example, a contract that includes delivery of equipment and routine installation is not necessarily a single performance obligation even though the customer would not purchase the installation if it had not purchased the equipment. The fact that the one item depends on the other (in this example, the installation cannot be performed without the customer first purchasing the equipment) does not, on its own, support a conclusion that there is a single performance obligation. In other words, a “two-way” dependency between two elements in a contract is necessary to conclude they are highly interdependent or highly interrelated.
Management should also consider whether the reporting entity could fulfill its promise to provide a good or service if it did not provide other goods or services identified in the contract. If the reporting entity’s performance in providing a good or service in the contract would differ significantly if it did not provide the other goods or services, this may indicate that the goods or services are highly interdependent or highly interrelated and therefore, are not separately identifiable. Similarly, if the intended contractual benefit to the customer depends on the reporting entity transferring multiple goods and services, this may indicate those goods and service are highly interdependent or highly interrelated.
Example RR 3-2, Example RR 3-3, Example RR 3-4, and Example RR 3-5 illustrate the application of the “separately identifiable” guidance. This concept is also illustrated in Examples 10 and 11 of the revenue standard (ASC 606-10-55-137 through ASC 606-10-55-150K). Refer to RR 9.3 for discussion of assessing whether a license of intellectual property promised in a contract is distinct.
EXAMPLE RR 3-2
Distinct goods or services — bundle of goods or services are combined
Contractor enters into a contract to build a house for a new homeowner. Contractor is responsible for the overall management of the project and identifies various goods and services that are provided, including architectural design, site preparation, construction of the home, plumbing and electrical services, and finish carpentry. Contractor regularly sells these goods and services individually to customers.
How many performance obligations are in the contract?
Analysis
The bundle of goods and services should be combined into a single performance obligation in this fact pattern. The promised goods and services are capable of being distinct because the homeowner could benefit from the goods or services either on their own or together with other readily available resources. This is because Contractor regularly sells the goods or services separately to other homeowners and the homeowner could generate economic benefit from the individual goods and services by using, consuming, or selling them.
However, the goods and services are not separately identifiable from other promises in the contract. Contractor’s overall promise in the contract is to transfer a combined item (the house) to which the individual goods or services are inputs. This conclusion is supported by the fact that Contractor provides a significant service of integrating the various goods and services into the home that the homeowner has contracted to purchase.
EXAMPLE RR 3-3
Distinct goods or services — bundle of goods or services are not combined
SoftwareCo enters into a contract with a customer to provide a perpetual software license, installation services, and three years of postcontract customer support (unspecified future upgrades and telephone support). The installation services require the reporting entity to configure certain aspects of the software, but do not significantly modify the software. These services do not require specialized knowledge, and other sophisticated software technicians could perform similar services. The upgrades and telephone support do not significantly affect the software’s benefit or value to the customer.
How many performance obligations are in the contract?
Analysis
There are four performance obligations: (1) software license, (2) installation services, (3) unspecified future upgrades, and (4) telephone support.
The customer can benefit from the software (delivered first) because it is functional without the installation services, unspecified future upgrades, or the telephone support. The customer can benefit from the subsequent installation services, unspecified future upgrades, and telephone support together with the software, which it has already obtained.
SoftwareCo concludes that each good and service is separately identifiable because the software license, installation services, unspecified future upgrades, and telephone support are not inputs into a combined item the customer has contracted to receive. SoftwareCo can fulfill its promise to transfer each of the goods or services separately and does not provide any significant integration, modification, or customization services.
EXAMPLE RR 3-4
Distinct goods or services — contractual requirement to use the vendor’s service
SoftwareCo enters into a contract with a customer to provide a perpetual software license, installation services, and three years of postcontract customer support (unspecified future upgrades and telephone support). The installation services require the reporting entity to configure certain aspects of the software, but do not significantly modify the software. These services do not require specialized knowledge, and other sophisticated software technicians could perform similar services. The upgrades and telephone support do not significantly affect the software’s benefit or value to the customer. The customer is contractually required to use SoftwareCo’s installation services.
How many performance obligations are in the contract?
Analysis
The contractual requirement to use SoftwareCo’s installation services does not change the evaluation of whether the goods and services are distinct. SoftwareCo concludes that there are four performance obligations: (1) software license, (2) installation services, (3) unspecified future upgrades, and (4) telephone support.
The customer can benefit from the software (delivered first) because it is functional without the installation services, unspecified future upgrades, or the telephone support. The customer can benefit from the subsequent installation services, unspecified future upgrades, and telephone support together with the software, which it has already obtained.
SoftwareCo concludes that each good and service is separately identifiable because the software license, installation services, unspecified future upgrades, and telephone support are not inputs into a combined item the customer has contracted to receive. SoftwareCo can fulfill its promise to transfer each of the goods or services separately and does not provide any significant integration, modification, or customization services.
EXAMPLE RR 3-5
Distinct goods or services — bundle of goods or services are combined
SoftwareCo enters into a contract with a customer to provide a perpetual software license, installation services, and three years of postcontract customer support (unspecified future upgrades and telephone support). The installation services require SoftwareCo to substantially customize the software by adding significant new functionality enabling the software to function with other computer systems owned by the customer. The upgrades and telephone support do not significantly affect the software’s benefit or value to the customer.
How many performance obligations are in the contract?
Analysis
There are three performance obligations: (1) license to customized software, (2) unspecified future upgrades, and (3) telephone support.
SoftwareCo determines that the promise to the customer is to provide a customized software solution. The software and customization services are inputs into the combined item for which customer has contracted and, as a result, the software license and installation services are not separately identifiable and should be combined into a single performance obligation. This conclusion is further supported by the fact that SoftwareCo is performing a significant service of integrating the licensed software with the customer’s other computer systems. The nature of the installation services also results in the software being significantly modified and customized by the service.
The unspecified future upgrades and telephone support are separate performance obligations because they are not inputs into a combined item the customer has contracted to receive. SoftwareCo can fulfill its promise to transfer each of the goods or services separately and does not provide any significant integration, modification, or customization services.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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