Performance Obligations

Definition

Performance obligations are the specific promises made by a company to a customer in a contract to transfer distinct goods or services. They represent the unit of account for revenue recognition, as a company must allocate the transaction price to each distinct performance obligation and recognize revenue as those obligations are satisfied.

5 Must Know Facts For Your Next Test

1. Performance obligations are the foundation for revenue recognition under the new revenue standard (ASC 606), replacing the previous 'risks and rewards' model.
2. Companies must identify the distinct performance obligations in a contract, which may include the sale of goods, rendering of services, or a combination of both.
3. The transaction price must be allocated to each distinct performance obligation based on their relative standalone selling prices.
4. Revenue is recognized as the company satisfies its performance obligations, either over time or at a point in time, depending on the nature of the obligation.
5. Identifying and accounting for performance obligations is critical for companies to accurately report revenue and comply with the new revenue recognition standard.

Review Questions

• Explain how the concept of performance obligations relates to the revenue recognition principle.
  • The revenue recognition principle states that revenue should be recognized when it is earned, rather than when cash is received. Performance obligations are the specific promises made to a customer in a contract, and represent the unit of account for revenue recognition. A company must allocate the transaction price to each distinct performance obligation and recognize revenue as those obligations are satisfied over time or at a point in time. This ensures that revenue is recorded in the appropriate accounting period, aligning with the revenue recognition principle.
• Describe the process of identifying and accounting for distinct performance obligations within a contract.
  • In order to properly recognize revenue, a company must first identify the distinct performance obligations within a customer contract. This involves analyzing the contract to determine if there are multiple promised goods or services that are separately identifiable. The company must then allocate the total transaction price to each distinct performance obligation based on their relative standalone selling prices. Revenue is then recognized as the company satisfies each performance obligation, either over time or at a point in time, depending on the nature of the promise. Accurately identifying and accounting for performance obligations is critical for a company to report revenue in accordance with the new revenue recognition standard (ASC 606).
• Evaluate the importance of performance obligations in the context of current and future sales and purchase transactions.
  • Performance obligations are the foundation for revenue recognition under the new revenue standard, replacing the previous 'risks and rewards' model. They represent the specific promises made to a customer in a contract, and the unit of account for which revenue must be recognized. Properly identifying and accounting for performance obligations is critical for companies to accurately report revenue and comply with the new standard. This has significant implications for both current and future sales and purchase transactions, as companies must analyze contracts, allocate transaction prices, and recognize revenue in a manner that faithfully depicts the transfer of goods or services to customers. The concept of performance obligations will continue to be a key consideration for companies as they manage revenue recognition across all of their sales and purchase transactions going forward.

Related terms

Revenue Recognition Principle:

The revenue recognition principle states that revenue should be recognized when it is earned, rather than when cash is received. This principle is closely tied to performance obligations, as revenue is recognized as a company fulfills its promises to the customer.

Transaction Price:

The transaction price is the amount of consideration a company expects to receive in exchange for transferring promised goods or services to a customer. It must be allocated to each distinct performance obligation in order to properly recognize revenue.

Distinct Goods or Services: Distinct goods or services are components of a contract that are separately identifiable. A company must identify the distinct performance obligations within a contract in order to properly allocate the transaction price and recognize revenue.