Summary: Under Ind AS 115 and IFRS 15, a key aspect of revenue recognition involves identifying performance obligations in a contract, which means assessing what goods or services the entity has committed to deliver. This evaluation is not limited to a literal reading of the contract; it requires determining whether each promised item or service is distinct and capable of being delivered separately. For instance, a construction contract that includes design, procurement, and installation may either represent one integrated promise or multiple obligations, depending on whether the elements have standalone value. If the design is project-specific and interlinked with execution, it would be treated as a single obligation. However, if each component is independently deliverable, they must be accounted for separately. Similarly, a software package sold with implementation and support may involve multiple obligations if the software functions without customisation. But where the software needs vendor-specific integration, it may be treated as a single combined obligation with revenue recognised over time. In telecom, bundling of handsets with service contracts appears to involve separate items, but since handset costs are recovered through future service charges, revenue needs to be allocated across both components based on transaction economics. The standard also addresses implied or non-explicit promises—such as optional training or extended warranties—which may qualify as performance obligations if customers reasonably expect them to be part of the offering. Ultimately, determining performance obligations is a judgment-based process that looks beyond contract wording to the commercial substance of the arrangement. It requires companies to assess how goods and services are interrelated and whether they provide separate value to the customer. This assessment ensures that revenue is recognised in a manner that reflects the transfer of control and value delivery over time or at a point in time, depending on the nature of the obligation.
When analysing revenue recognition under Ind AS 115 and IFRS 15, one fundamental question needs to be considered which is -what exactly the entity promising to deliver? Identifying performance obligations is at the core of determining how and when revenue should be recognized. It is not at all that straightforward because just listing promises in a contract does not necessarily mean each one is a distinct performance obligation.
Take, for example, a construction contract that includes design, procurement of materials, and installation. Are these separate performance obligations, or do they form a single, integrated promise? If breaking them apart would be unrealistic for the customer? say, the design is tailored specifically to the project and has no standalone value, then it is a single performance obligation. But if each element can be sold separately and provides distinct benefits, they must be accounted for individually.
Consider a software vendor selling an enterprise solution bundled with implementation and ongoing support. If the software can be used independently of the support services and the customer derives value from each component separately, these are distinct performance obligations. However, if the software requires significant customization that only the vendor can perform, then implementation and software form a single obligation, with revenue recognized over time.
Now, let us think in different perspective. What if obligations appear distinct on paper but, in reality, are inseparable? Picture a telecom company selling handsets bundled with multi-year service plans. The customer gets a discounted handset upfront, but the telecom recoups costs through service fees. Despite being separate elements, the handset’s pricing is economically tied to the service contract. The standard requires allocating revenue proportionally to reflect the actual transaction economics.
Then there are cases where contracts include vague or implied promises. A manufacturer selling industrial machinery might provide optional training sessions. If the customer expects and relies on these sessions, they could be an implicit performance obligation, even if not explicitly priced in the contract. Similarly, warranties covering more than just basic defect repairs could constitute separate obligations requiring distinct revenue recognition.
Ultimately, identifying performance obligations is not just about reading the contract it is about understanding the substance of the transaction. If components are distinct and deliverable separately, they should be accounted for individually. If they form a cohesive package, revenue should be recognized as a whole. This judgment-driven analysis calls for a deep dive into the facts and circumstances of each contract. Companies must evaluate not only what is promised but how those promises interrelate in the delivery of value.
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