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Performance obligations can result from other common contract terms or promises implied by a reporting entity’s customary business practices. The assessment of whether certain contract terms or implicit promises create performance obligations requires judgment in some situations.

3.6.1 Activities that are not performance obligations

Activities that a reporting entity undertakes to fulfill a contract that do not transfer goods or services to the customer are not performance obligations. For example, administrative tasks to set up a contract or mobilization efforts are not performance obligations if those activities do not transfer a good or service to the customer. Judgment may be required to determine whether an activity transfers a good or service to the customer.
Reporting entities in certain industries undertake pre-production activities, including the design and development of products or the creation of a new technology based on the needs of a customer. An example is a reporting entity that enters into an arrangement with an auto manufacturer to design and develop tooling prior to the production of automotive parts. Management should first evaluate if the arrangement with the manufacturer, whether in connection with a supply contract or in anticipation of one, is in the scope of the revenue standard; for example, management might conclude the pre-production activities are not a revenue-generating activity because they are not part of the reporting entity’s ongoing major or central operations. Arrangements not in the scope of the revenue standard are subject to other applicable guidance; therefore, any related payments or reimbursements would not be presented as revenue from contracts with customers. For arrangements in the scope of the revenue standard, management should evaluate whether the pre-production activities represent a performance obligation (that is, whether control of a good or service is transferred to the customer). Pre-production activities that do not transfer a good or service to the customer are activities to fulfill the performance obligations in the contract. Refer to Revenue TRG Memo No. 46 and the related meeting minutes in Revenue TRG Memo No. 49 for further discussion of this topic. Additionally, refer to RR 11 for further discussion on accounting for costs to fulfill a contract.
Revenue is not recognized when a reporting entity completes an activity that is not a performance obligation, as illustrated by Example RR 3-7 and Example RR 3-8.
EXAMPLE RR 3-7

Identifying performance obligations — activities
FitCo operates health clubs. FitCo enters into contracts with customers for one year of access to any of its health clubs for $300. FitCo also charges a $50 nonrefundable joining fee to compensate, in part, for the initial activities of registering the customer.
How many performance obligations are in the contract?
Analysis
There is one performance obligation in the contract, which is the right provided to the customer to access the health clubs. FitCo’s activity of registering the customer is not a service to the customer and therefore does not represent satisfaction of a performance obligation. Refer to RR 8.4 for considerations related to the treatment of the upfront fee paid by the customer.
EXAMPLE RR 3-8

Identifying performance obligations — activities
CartoonCo is the creator of a new animated television show. It grants a three-year term license to RetailCo for use of the characters’ likenesses on consumer products. RetailCo is required to use the latest image of the characters from the television show. There are no other goods or services provided to RetailCo in the arrangement. When entering into the license agreement, RetailCo reasonably expects CartoonCo to continue to produce the show, develop the characters, and perform marketing to enhance awareness of the characters. RetailCo may start selling consumer products with the characters’ likenesses once the show first airs on television.
How many performance obligations are in the arrangement?
Analysis
The license is the only performance obligation in the arrangement. CartoonCo’s continued production, internal development of the characters, and marketing of the show are not performance obligations as such additional activities do not directly transfer a good or service to RetailCo. Refer to RR 9 for other considerations related to this example, such as the timing of revenue recognition for the license.

3.6.2 Implicit promises in a contract

The customer’s perspective should be considered when assessing whether an implicit promise gives rise to a performance obligation. Customers might make current purchasing decisions based on expectations implied by a reporting entity’s customary business practices or marketing activities. A performance obligation exists if there is a valid expectation, based on the facts and circumstances, that additional goods or services will be delivered for no additional consideration.
Customers develop their expectations based on written contracts, customary business practices of certain reporting entities, expected behaviors within certain industries, and the way products are marketed and sold. Customary business practices vary between reporting entities, industries, and jurisdictions. They also vary between classes of customers, nature of the product or service, and other factors. Management will therefore need to consider the specific facts and circumstances of each arrangement to determine whether implied promises exist.
Implied promises made by the reporting entity to the customer in exchange for the consideration promised in the contract do not need to be enforceable by law in order for them to be evaluated as a performance obligation. This is in contrast to optional customer purchases in exchange for additional consideration, which are not included as performance obligations in the current contract unless the customer option provides a material right (refer to RR 3.5). Implied promises can create a performance obligation under a contractual agreement, even when enforcement is not assured because the customer has an expectation of performance by the reporting entity. The boards noted in the basis for conclusions to the revenue standard that failing to account for these implied promises could result in all of the revenue being recognized even when the reporting entity has unsatisfied promises with the customer. Example 12 in the revenue standard (ASC 606-10-55-151 through ASC 606-10-55-157) illustrates a contract containing an implicit promise to provide services.

3.6.3 Product liability and patent infringement protection

A reporting entity could be required (for example, by law or court order) to pay damages if its products cause damage or harm to others when used as intended. A requirement to pay damages to an injured party is not a separate performance obligation. Such payments should be accounted for in accordance with guidance on loss contingencies. Compensation provided to a customer for failing to comply with the terms of the contract or to resolve customer complaints would generally be accounted for as consideration payable to a customer and recorded as a reduction of revenue (refer to RR 4.3.3.11).
Promises to indemnify a customer against claims of patent, copyright, or trademark infringements are also not separate performance obligations, unless the reporting entity’s business is to provide such protection. These protections are similar to warranties that ensure that the good or service operates as intended. These types of obligations are accounted for in accordance with the guidance on loss contingencies. Refer to RR 8.3 for further considerations related to warranties, including certain types of warranties that are accounted for as performance obligations.

3.6.4 Shipment of goods to a customer

Arrangements that involve shipment of goods to a customer might include promises related to the shipping service that give rise to a performance obligation. Management should assess the explicit shipping terms to determine when control of the goods transfers to the customer and whether the shipping services are a separate performance obligation.
Shipping and handling services may be considered a separate performance obligation if control of the goods transfers to the customer before shipment, but the reporting entity has promised to ship the goods (or arrange for the goods to be shipped). In contrast, if control of a good does not transfer to the customer before shipment, shipping is not a promised service to the customer. This is because shipping is a fulfillment activity as the costs are incurred as part of transferring the goods to the customer.
Management should assess whether the reporting entity is the principal or an agent for the shipping service if it is a separate performance obligation. This will determine whether the reporting entity should record the gross amount of revenue allocated to the shipping service or the net amount, after paying the shipper. Refer to RR 10 for further consideration related to this assessment.
The revenue standard includes an accounting policy election that permits reporting entities to account for shipping and handling activities that occur after the customer has obtained control of a good as a fulfillment cost rather than as an additional promised service. Reporting entities that make this election will recognize revenue when control of the good transfers to the customer. A portion of the transaction price would not be allocated to the shipping service; however, the costs of shipping and handling should be accrued when the related revenue is recognized. Management should apply this election consistently to similar transactions and disclose the use of the election, if material, in accordance with ASC 235, Notes to Financial Statements. The policy election should not be applied by analogy to other services.
Example RR 3-9 and Example RR 3-10 illustrate the potential accounting outcomes for sale of a product and a promise to ship the product.
EXAMPLE RR 3-9

Identifying performance obligations — shipping and handling services
Manufacturer enters into a contract with a customer to sell five flat screen televisions. The customer requests that Manufacturer arrange for delivery of the televisions. The delivery terms state that legal title and risk of loss pass to the customer when the televisions are given to the carrier.
The customer obtains control of the televisions at the time they are shipped and can sell them to another party. Manufacturer is precluded from selling the televisions to another customer (for example, redirecting the shipment) once the televisions are picked up by the carrier at Manufacturer’s shipping dock. Manufacturer does not elect to treat shipping and handling activities as a fulfillment cost.
How many performance obligations are in the arrangement?
Analysis
There are two performance obligations: (1) sale of the televisions and (2) shipping service. The shipping service does not affect when the customer obtains control of the televisions, assuming the shipping service is distinct. Manufacturer will recognize revenue allocated to the sale of the televisions when control transfers to the customer (that is, upon shipment) and recognize revenue allocated to the shipping service when performance occurs.
Since Manufacturer is arranging for the shipment to be performed by another party (that is, a third-party carrier), it must also evaluate whether to record the revenue allocated to the shipping services on a gross basis as principal or on a net basis as agent. Refer to RR 10 for further discussion of the principal versus agent assessment.
EXAMPLE RR 3-10

Identifying performance obligations — shipping and handling accounting election
Manufacturer enters into a contract with a customer to sell five flat screen televisions. The customer requests that Manufacturer arrange for delivery of the televisions. The delivery terms state that legal title and risk of loss pass to the customer when the televisions are given to the carrier.
The customer obtains control of the televisions at the time they are shipped and can sell them to another party. Manufacturer is precluded from selling the televisions to another customer (for example, redirecting the shipment) once the televisions are picked up by the carrier at Manufacturer’s shipping dock. Manufacturer elects to account for shipping and handling activities as a fulfillment cost.
How many performance obligations are in the arrangement?
Analysis
There is one performance obligation in the arrangement because Manufacturer has elected to account for shipping and handling activities as a fulfillment cost. Manufacturer will recognize revenue and accrue the shipping and handling costs when control of the televisions transfers to the customer upon shipment. Manufacturer does not need to assess whether it is the principal or agent for the shipping service since the shipping service is not accounted for as a promise in the contract. Manufacturer should disclose its election with its accounting policy disclosures.
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