1. What is a performance obligation under IFRS 15, and why does the unit of account decide everything downstream?
A performance obligation is a promise in a contract with a customer to transfer a distinct good or service, or a series of distinct goods or services that are substantially the same and have the same pattern of transfer. It is the unit of account for the whole standard. Step 4 allocates the transaction price to it, Step 5 tests it for timing, and the disclosure requirements describe it. Change the number of performance obligations and you change reported revenue without changing a single commercial term.
Appendix A defines a performance obligation as "A promise in a contract with a customer to transfer to the customer either: (a) a good or service (or a bundle of goods or services) that is distinct; or (b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer."
Two things in that definition repay attention. The first is the word promise. The unit of account is not the good, not the invoice line, not the deliverable in the statement of work. It is the promise to transfer. That distinction looks pedantic until you reach IFRS 15.29, which is drafted around promises rather than around things, and which produces different answers as a result. The second is the bracket in limb (a). A bundle of goods or services can itself be the distinct item. The standard therefore contemplates from the outset that several separable things may be one obligation.
"At contract inception, an entity shall assess the goods or services promised in a contract with a customer and shall identify as a performance obligation each promise to transfer to the customer either: (a) a good or service (or a bundle of goods or services) that is distinct; or (b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer (see paragraph 23)."
The assessment is made at contract inception. That is the date the promises are fixed, the date the stand-alone selling prices are measured under IFRS 15.76, and the date the timing determination is made under IFRS 15.32. It is not revisited every reporting period because performance has drifted. It is revisited when the contract is modified, and then IFRS 15.18 to 15.21 governs what happens next, which is covered in the note on contract modifications.
Note also that IFRS 15.22 says "each promise". This is not a materiality gate written into the standard. There is no de minimis exemption in IFRS 15.22 to 15.30 for small promises. Practitioners routinely apply general materiality to immaterial promises, and that is defensible under IAS 8 and the Conceptual Framework, but it is an application of materiality and should be documented as one rather than presented as a reading of the standard.
Why the unit of account is the whole game
Take a contract worth CU 1,000,000 covering a software licence, an implementation project and three years of support. If the file concludes one performance obligation satisfied over the three-year term, year one revenue on a straight-line basis is CU 333,333. If the file concludes three performance obligations, with the licence transferring on day one, year one revenue can exceed CU 700,000. That is a swing of more than double, driven entirely by Step 2. The transaction price did not move. The cash did not move. The customer relationship did not move.
The same mechanism runs through the balance sheet. More performance obligations generally means more of the contract is satisfied earlier, which converts contract liability into revenue faster and can turn a contract liability position into a contract asset position where billing lags performance. It runs through the disclosures too: IFRS 15.120 requires the aggregate transaction price allocated to unsatisfied performance obligations, so the remaining performance obligation balance is a direct function of the Step 2 conclusion. And it runs through the incremental costs of obtaining a contract, because the amortisation period under IFRS 15.99 is tied to the transfer of the goods or services to which the asset relates.
| Step | What it does | What it inherits from Step 2 |
|---|---|---|
| Step 3, transaction price | IFRS 15.47 measures the consideration expected | Nothing directly, but the constraint in IFRS 15.56 is applied by reference to the amounts allocated |
| Step 4, allocation | IFRS 15.74 splits the price on relative stand-alone selling prices | The number of buckets, and therefore whether any allocation happens at all under IFRS 15.75 |
| Step 5, timing | IFRS 15.31 to 15.38 decide over time or point in time | The thing being tested. Each obligation gets its own answer |
| Presentation | IFRS 15.105 to 15.109 give contract asset and contract liability | The point at which performance is complete for each obligation |
| Disclosure | IFRS 15.119 and 15.120 describe obligations and remaining obligations | The population being described |
Practitioner note
On review, the fastest way to test whether a Step 2 conclusion has been thought about is to ask what the answer would have been if one fact were different. If the preparer cannot name a fact that would flip the conclusion, the conclusion was almost certainly asserted rather than reached. A Step 2 memo that could be applied unchanged to a different contract in the same portfolio is a template, not an analysis.
Local FAQs
Does IFRS 15 ever let you treat a whole contract as one performance obligation without analysis? No. IFRS 15.30 permits the outcome that all promised goods and services are a single performance obligation, but only as the result of the combining process. The analysis still has to be performed and the criterion relied on still has to be named.
Is the unit of account the same as the invoicing unit? Not necessarily and often not. Invoicing is a commercial and cash flow decision. IFRS 15.22 fixes the unit of account by reference to promises and distinctness. Where the two diverge, the difference shows up as a contract asset or contract liability under IFRS 15.105.
Potential risks
The dominant risk in this unit is that the assessment is never actually performed. A contract goes into the revenue system with the deliverables that appear on the order form, and the accounting follows the order form rather than IFRS 15.22. That is defensible only where someone has checked that the order form and the promises coincide, and that check is itself the Step 2 working paper.
2. Which promises go into the assessment, and which activities drop out?
IFRS 15.24 requires the population of promises to include implied promises created by customary business practices, published policies or specific statements, where those create a valid expectation in the customer at the date of contracting. IFRS 15.25 then removes activities the entity must perform to fulfil the contract that do not transfer anything to the customer, with administrative set-up given as the example. Getting this population right is the step most files skip.
"A contract with a customer generally explicitly states the goods or services that an entity promises to transfer to a customer. However, the performance obligations identified in a contract with a customer may not be limited to the goods or services that are explicitly stated in that contract. This is because a contract with a customer may also include promises that are implied by an entity's customary business practices, published policies or specific statements if, at the time of entering into the contract, those promises create a valid expectation of the customer that the entity will transfer a good or service to the customer."
The test in that sentence is a valid expectation held by the customer, judged at the time of entering into the contract. It is not a test of legal enforceability in the strict sense, and it is not a test of the entity's intention. A published free-shipping policy, a customary practice of providing unspecified upgrades to existing customers, a statement in a sales presentation that a dedicated engineer will be available for the first six months: each of these can be a promise that IFRS 15.22 requires to be assessed, even where the signed contract is silent.
The practical difficulty is that the evidence for implied promises does not sit in the contract file. It sits in marketing material, website terms, standard customer communications and the sales team's habits. A Step 2 process that only reads the contract will systematically miss them. On audits of companies with large standardised customer bases, this is one of the more productive places to look.
"Performance obligations do not include activities that an entity must undertake to fulfil a contract unless those activities transfer a good or service to a customer. For example, a services provider may need to perform various administrative tasks to set up a contract. The performance of those tasks does not transfer a service to the customer as the tasks are performed. Therefore, those setup activities are not a performance obligation."
This is a filter, not a judgement. The question is binary: does the activity transfer a good or service to the customer, or does it merely put the entity in a position to perform? Credit checks, opening a customer account, configuring internal systems, mobilising a team, procuring materials that remain the entity's until installed: none of these transfer anything. They are costs of fulfilment, and IFRS 15.95 to 15.98 govern whether they are capitalised.
The trap is that set-up activities are frequently charged for. A non-refundable activation fee, an onboarding fee, a mobilisation payment. IFRS 15.B49 is explicit that a non-refundable upfront fee relating to an activity that does not transfer a promised good or service is an advance payment for future goods or services, recognised as revenue when those future goods or services are provided. IFRS 15.B51 then keeps the set-up cost out of the measure of progress where the activity is not a satisfied performance obligation. Charging for something does not convert it into a promise.
The promise inventory in practice
The output of this unit should be a written list. Not a paragraph of narrative, a list. For each entry it should record where the promise comes from, whether it is explicit or implied, and whether it survives the IFRS 15.25 filter. A typical enterprise software contract produces something like the following before any distinctness assessment has been done.
| Candidate promise | Source | IFRS 15.25 filter |
|---|---|---|
| Term licence to the core platform | Explicit, clause 2 | Transfers a right, retained |
| Implementation and configuration services | Explicit, statement of work | Transfers a service, retained |
| Data migration from the legacy system | Explicit, statement of work | Transfers a service, retained |
| Technical support helpdesk for three years | Explicit, clause 9 | Transfers a stand-ready service, retained |
| Unspecified future updates on a when-and-if-available basis | Explicit, clause 9, and IFRS 15.26(e) names this pattern | Transfers a stand-ready service, retained |
| Two named training courses | Explicit, schedule 3 | Transfers a service, retained |
| Provisioning the customer tenant and issuing credentials | Explicit, clause 4, charged as a set-up fee | Transfers nothing, removed under IFRS 15.25 |
| Assignment of a customer success manager | Implied, standard practice for this tier and stated in the proposal | Assess under IFRS 15.24, likely retained |
| Indemnity for third-party patent claims | Explicit, clause 17 | Not a performance obligation, IFRS 15.B33 sends it to IAS 37 |
Nine candidates in, seven promises out. One of the two removals is made by a paragraph outside IFRS 15.22 to 15.30, which is a reminder that Step 2 is not a self-contained exercise. The list is what the IFRS 15.27 assessment then runs on.
IFRS 15.26 provides a non-exhaustive list of the forms a promised good or service can take, running from the sale of an entity's own inventory through to granting options to purchase additional goods or services where those options provide a material right. Two entries on that list are worth flagging in this unit.
IFRS 15.26(e) covers "providing a service of standing ready to provide goods or services (for example, unspecified updates to software that are provided on a when-and-if-available basis) or of making goods or services available for a customer to use as and when the customer decides". Stand-ready obligations are promises. The absence of any activity in a period does not mean nothing was transferred. This matters for support arrangements, for capacity reservations and for the subscription models discussed in the note on SaaS and subscription revenue.
IFRS 15.26(g) covers rights granted to a customer that the customer can pass on to its own customer, for example where a manufacturer selling to a retailer promises an additional good or service to the end consumer. That promise sits in the manufacturer's contract with the retailer even though the retailer never receives it.
Enforceability. A promise that the entity is not obliged to perform is not a performance obligation, because IFRS 15 Appendix A defines a contract as an agreement that creates enforceable rights and obligations. Where a customer can cancel a future period without penalty and the entity can decline to serve it, the promise for that period does not exist for accounting purposes. This is the point at which contract term and enforceable period diverge, and it is a frequent source of overstated remaining performance obligation disclosures under IFRS 15.120.
Local FAQs
Does a free item given at the entity's discretion create a promise? Only where the discretion has been surrendered in substance. If the entity has done it consistently for that class of customer and the customer knows it, IFRS 15.24 is likely engaged whatever the contract says. If it is genuinely decided case by case after contracting, there is no valid expectation at contract inception.
Are mobilisation costs on a long-term service contract ever a performance obligation? Only where mobilisation transfers something. Building an asset that the customer controls during construction transfers a good. Recruiting and training the entity's own staff does not, and IFRS 15.25 excludes it. The cost may still be capitalised under IFRS 15.95 if the criteria there are met.
Potential risks
Two risks dominate. The first is under-population: implied promises are missed because the process only reads the signed contract. The second is over-population: activities that transfer nothing are promoted to performance obligations because they carry a separate fee, which inflates the number of obligations and produces revenue earlier than the standard allows. The IFRS 15.25 filter and the IFRS 15.B49 treatment of upfront fees are the controls for the second, and a walkthrough of the sales and marketing material is the control for the first.
3. Limb one: what does capable of being distinct actually require under IFRS 15.27(a) and IFRS 15.28?
IFRS 15.27(a) asks whether the customer can benefit from the good or service on its own or together with other readily available resources. IFRS 15.28 defines benefit broadly and defines readily available resources broadly, including resources the entity has already transferred under the same contract. The result is that this limb is met by almost everything. It is a capability test, not a test of what the customer intends to do.
"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 (ie the good or service is capable of being distinct); and (b) the entity's promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (ie the promise to transfer the good or service is distinct within the context of the contract)."
The parenthetical labels are the standard's own shorthand and they are worth using in working papers because they keep the two limbs apart. Limb (a) is capable of being distinct. Limb (b) is distinct within the context of the contract. Both must be met, so failure of either produces a non-distinct promise that IFRS 15.30 then requires to be combined.
"A customer can benefit from a good or service in accordance with paragraph 27(a) if the good or service could be used, consumed, sold for an amount that is greater than scrap value or otherwise held in a way that generates economic benefits."
Read the verbs. Used, consumed, sold above scrap, or held in a way that generates economic benefits. Sold above scrap is a very low bar. Held in a way that generates economic benefits is lower still. A partially completed asset that the customer could sell to a third party for more than its scrap value is capable of being distinct even if the customer would never do so.
IFRS 15.28 continues: "A readily available resource is a good or service that is sold separately (by the entity or another entity) or a resource that the customer has already obtained from the entity (including goods or services that the entity will have already transferred to the customer under the contract) or from other transactions or events."
That definition does most of the work. Three sources of readily available resources are recognised. Something sold separately by the entity. Something sold separately by anyone else. Something the customer already has, expressly including things the entity itself will have transferred earlier under the same contract. The last of these is why installation services usually clear limb (a): by the time installation is performed, the customer has already received the equipment under the contract, and the equipment is therefore a readily available resource.
IFRS 15.28 closes with an evidential point: "For example, the fact that the entity regularly sells a good or service separately would indicate that a customer can benefit from the good or service on its own or with other readily available resources." Regular separate sale is evidence, not a requirement. A good the entity has never sold separately can still be capable of being distinct if a third party sells something equivalent, or if the customer could use it with what it already has.
Capability, not intention
The most common misreading of limb (a) is to ask what the customer will actually do. That is not the question. The standard asks whether the customer can benefit. A customer buying a turbine and an installation service has no intention of reselling the turbine, engaging a third-party installer or holding the turbine as an investment. None of that matters. If the turbine could be used, consumed, sold above scrap or held for economic benefit, whether alone or with resources available in the market, limb (a) is met.
The corollary is that limb (a) rarely fails, and when it does fail the reason is usually structural rather than commercial. Genuine failures cluster in a small number of situations:
- An input that has no function outside the specific combined output and no market. A partly written module of code that only compiles against the entity's proprietary framework, where the customer has no licence to that framework and no third party supplies one.
- A licence that the customer cannot exercise without another promise in the contract that is not available from any other source. A term licence to software that runs only on the entity's proprietary hardware, where that hardware is also being supplied under the contract and is not available elsewhere, fails limb (a) at the point the licence is granted, because at that moment the customer has no readily available resource to use it with.
- A design that has no value except as an input to the manufacture the entity is also contracted to perform, and which the customer has no right to give to another manufacturer.
Notice that in each case the failure is about the absence of any route to benefit, not about inconvenience or cost. A customer who would find it expensive or awkward to buy the complementary resource elsewhere still has a readily available resource. Limb (a) is not a commercial reasonableness test.
Practitioner note
Because limb (a) is almost always met, a working paper that spends two pages on IFRS 15.28 and three lines on IFRS 15.29 has its effort in the wrong place. My view: the useful discipline is to record limb (a) in a sentence with the evidence source, most often "the entity sells this separately, price list attached", and then put the analytical weight on limb (b), where the answer is actually in dispute. Reviewers should be suspicious of the reverse pattern, because a file that leans on limb (a) is often a file where limb (b) was uncomfortable.
Local FAQs
Does limb (a) fail because the good is useless to the customer without training? Usually not. If training is available from the entity or anyone else, it is a readily available resource under IFRS 15.28 and limb (a) is met.
Can a good be capable of being distinct even if the entity has never sold it separately? Yes. IFRS 15.28 treats regular separate sale as evidence that limb (a) is met, not as a condition. Separate sale by another entity, or use with resources the customer already has, is enough.
Does limb (a) look at the customer's own resources? Yes, expressly. IFRS 15.28 includes resources the customer has obtained from other transactions or events, so the customer's existing estate is part of the analysis.
Potential risks
The risk here runs in one direction: concluding that limb (a) fails in order to avoid the harder limb (b) analysis. Because limb (a) failure produces the same outcome as limb (b) failure, namely combination under IFRS 15.30, it is tempting to stop early. It is also visible on review, because a limb (a) failure requires the file to assert that the customer had no route at all to any economic benefit, which is a strong claim that a price list or a competitor's website will often contradict.
4. Limb two: how do you apply the separately identifiable test in IFRS 15.27(b) and the three factors in IFRS 15.29?
IFRS 15.29 sets an objective and then gives three factors that indicate the objective is not met. The objective is to decide whether the nature of the promise is to transfer the items individually or to transfer a combined output to which they are inputs. The three factors are a significant integration service, significant modification or customisation, and high interdependence or interrelation. Where a factor is present, the promises are not separately identifiable and they combine.
"In assessing whether an entity's promises to transfer goods or services to the customer are separately identifiable in accordance with paragraph 27(b), 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:"
Three drafting choices in that sentence control everything that follows. First, the subject is "promises to transfer", not "goods or services". IFRS 15.29 does not ask whether the items can be pulled apart. It asks whether the entity's promise to transfer one of them can be identified separately from its promise to transfer the others. Two physically separable machines can be a single performance obligation, and two inseparable elements of an integrated system can occasionally be two.
Second, the factors are stated as indicators that the promises are not separately identifiable. There is no list of factors indicating that they are. Absence of all three is not proof of separability, it is simply the absence of evidence against it, which combined with the objective normally supports a separate obligation.
Third, the list is expressly not exhaustive: "include, but are not limited to". A factor outside the three can point to a combined output, provided it genuinely serves the stated objective. In practice the three cover the ground, and a file relying on a fourth factor of its own invention should expect to be challenged.
Why the promise wording is not a technicality
Consider a contract to supply and install a lift in a new building, where the entity also supplies the shaft doors, the controller and the cabling. Physically these are separable components with their own part numbers, and several of them are sold separately in the market. If IFRS 15.29 asked whether the goods were separable, the answer would be a straightforward yes and the contract would contain five or six performance obligations. It does not ask that. It asks whether the entity has promised to transfer a controller, and separately to transfer a set of doors, or whether it has promised to transfer a working lift into which those components are inputs. On ordinary facts it is the latter, and the contract is one performance obligation because IFRS 15.29(a) is present.
Now change the facts. The customer already has a lift, installed by a different contractor. It buys a replacement controller from the entity and asks the entity to fit it. Same physical component, same fitting activity. But the entity has not been asked to deliver a working lift. It has been asked to deliver a controller and to fit it into a system that already exists and that the entity did not build. IFRS 15.29(a) is not present, because the combined output for which the customer contracted is not being produced by the entity from its own inputs. Two performance obligations. The component did not change. The promise did.
"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."
The word doing the work is "significant". Every multi-element contract involves some coordination. Sequencing deliveries, agreeing a project plan and holding weekly calls are not an integration service. What IFRS 15.29(a) describes is the entity taking the promised items as raw material and producing something the customer has specified that did not exist before, and for which the customer holds the entity responsible as a whole.
The closing sentence matters more than it looks. "A combined output or outputs might include more than one phase, element or unit." This defeats the argument that a contract cannot have one performance obligation because it has milestones, phases or separately priced work packages. A phased construction of a plant delivered in three stages can be one combined output. Conversely, it does not mean phases must be combined. It removes phasing from the argument entirely.
Worked factor test: IFRS 15.29(a) integration
Facts. An engineering firm contracts to deliver a bottling line to a beverage producer. The contract covers a filler, a capper, a labeller, a conveyor system and the control software that sequences them, plus commissioning to a stated throughput of 24,000 bottles an hour. Each machine is available from the entity and from competitors on a stand-alone basis. Acceptance is against the throughput specification for the line as a whole, and no payment milestone is unconditional on line acceptance.
Limb (a). Each machine could be used, or sold above scrap value. IFRS 15.27(a) is met for every item, evidenced by the fact that the entity sells the machines separately, which IFRS 15.28 identifies as indicative.
Limb (b), factor (a). The customer has contracted for a bottling line performing at a stated rate, not for five machines. The entity is using the machines and the software as inputs to produce that line. Acceptance is at line level. IFRS 15.29(a) is present.
Conclusion. One performance obligation. The reason recorded in the file is the significant integration service in IFRS 15.29(a) evidenced by the line-level throughput specification and line-level acceptance, not the fact that the customer cannot bottle anything until commissioning is complete.
"one or more of the goods or services significantly modifies or customises, or are significantly modified or customised by, one or more of the other goods or services promised in the contract."
The factor runs in both directions, which the drafting makes explicit. Service A can modify good B, or good B can be modified by service A. Either way the promises are not separately identifiable. The threshold is again significance. Configuring parameters within a product's standard configuration screens is not modification. Writing code that changes how the product behaves, altering its data model, or building interfaces that become part of the delivered product, generally is.
The distinction between configuration and customisation is where most software files are won or lost, and it is a factual question that the accounting team cannot answer alone. It requires someone who knows what the implementation team actually did. A file that asserts "the implementation does not customise the software" without evidence from the delivery organisation is an assertion, not a conclusion.
Worked factor test: IFRS 15.29(b) customisation
Facts. A vendor licenses a standard claims-handling platform to an insurer and contracts to implement it. The implementation involves rewriting the platform's rules engine to reflect the insurer's underwriting logic, building a bespoke document-generation module inside the platform, and altering the platform's data model to carry policy attributes the standard product does not support. The vendor will maintain the modified build for the insurer under the support agreement. The modified build is not offered to other customers.
Limb (a). The licence is capable of being distinct. The insurer could use the standard platform, and the vendor sells it separately. IFRS 15.27(a) met.
Limb (b), factor (b). The implementation service significantly modifies the licensed software, and the software is significantly modified by the implementation service. The functionality the insurer contracted for does not exist in the standard product. IFRS 15.29(b) is present.
Conclusion. The licence and the implementation combine into one performance obligation under IFRS 15.30. The support service is assessed separately and is normally a second obligation, because support does not modify anything and is available at renewal on its own. The interaction between licensing and customisation is developed further in the note on licensing of intellectual property.
"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 fulfil its promise by transferring each of the goods or services independently."
This is the factor most often misapplied, because ordinary commercial dependency reads like interdependence. The standard's own gloss is strict: each item is significantly affected by the others, to the point that the entity could not fulfil its promise by transferring them independently. The dependency has to run both ways and it has to be significant.
A one-way dependency is not enough. Software that needs a licence to run is dependent on the licence, but the licence is not affected by the support service. A machine that needs installation is dependent on the installer, but the installation service is not significantly affected by the machine where the installer is fitting a standard product. In both cases IFRS 15.29(c) is not present, whatever the commercial reality of the customer needing both.
Worked factor test: IFRS 15.29(c) interdependence
Facts. A specialist manufacturer contracts to design and build a bespoke test rig for an aerospace customer, and separately to write the acquisition and analysis software that drives it. Neither exists yet. The rig's sensor architecture is being designed around the software's sampling model, and the software's calibration routines are being written against the rig's specific mechanical tolerances, which are not yet fixed. Neither can be completed without decisions taken on the other, and neither will function with any third-party alternative.
Limb (a). Marginal. The rig could probably be sold above scrap value, so IFRS 15.27(a) is likely met on the rig. The software has no application outside this rig and no resale market, so limb (a) arguably fails on the software alone. The file should reach a view and record it rather than skating over it.
Limb (b), factor (c). Each is significantly affected by the other. The design of one is an input into the design of the other, in both directions. The entity could not fulfil its promise by transferring them independently. IFRS 15.29(c) is present.
Conclusion. One performance obligation. Note that IFRS 15.29(a) may also be present on these facts, because the customer has contracted for a working test capability. Where two factors point the same way, the file should say so. A conclusion supported by two factors is more robust on reassessment than one resting on a single marginal factor.
| Factor | Present when | Not present merely because |
|---|---|---|
| 15.29(a) significant integration service | The entity uses the promised items as inputs to produce a combined output the customer specified, and takes responsibility for that output | The entity sequences deliveries, runs a project plan, or delivers in phases. IFRS 15.29(a) expressly allows a combined output to have several phases |
| 15.29(b) significant modification or customisation | One promise changes what another promise delivers, in either direction, beyond the product's standard configurability | The product is set up, parameterised or configured within its designed options, or data is loaded into it unchanged |
| 15.29(c) high interdependence or interrelation | Each item is significantly affected by the others, so the entity could not fulfil its promise by transferring them independently | The customer commercially needs both, or one cannot be used without the other. That is a one-way functional dependency |
The error this article was rewritten to correct. An earlier version of this page justified a single performance obligation for custom software on the basis that "the customer must wait for completion", and stated that delivery plus installation is always one obligation. Both statements are wrong. Waiting appears nowhere in IFRS 15.27, IFRS 15.28 or IFRS 15.29. It is a Step 5 observation about the pattern of transfer, tested under IFRS 15.35 and IFRS 15.38, and it has no bearing on the unit of account. Bespoke software bundles frequently are one performance obligation, but the reason is IFRS 15.29(a) or IFRS 15.29(b). Delivery plus installation is sometimes one obligation and sometimes two, and Unit 5 below sets the two fact patterns side by side.
Real filer: SAP SE on software licences against support
SAP's revenue accounting policy distinguishes on-premise software licences from the support services sold alongside them, treating them as separate performance obligations. Licence revenue is recognised when control of the licence transfers to the customer, while support is recognised over the support period as a stand-ready service. The policy describes the allocation of the transaction price across the identified performance obligations on a relative stand-alone selling price basis, with the support element benchmarked to observable renewal pricing. The relevant point for Step 2 is that a standard licence supplied without significant modification does not combine with the support that follows it, because no IFRS 15.29 factor is present.
SAP SE, Annual Report 2023, notes to the consolidated financial statements, revenue recognition accounting policy.Real filer: Vodafone Group Plc on handset and airtime
Vodafone's revenue accounting policy treats the handset and the airtime service in a bundled consumer contract as separate performance obligations. The handset is recognised at the point control transfers to the customer, and the airtime service is recognised over the contract term. The transaction price is allocated between the two on the basis of their relative stand-alone selling prices, with the effect that the amount recognised on handset delivery differs from the amount invoiced at that date, giving rise to a contract asset that unwinds across the term. This is the clearest widely disclosed example of Step 2 driving both the split and the timing: the handset and the airtime clear IFRS 15.27(a) easily, no IFRS 15.29 factor combines them, and the contract therefore produces two revenue streams from a single monthly bill.
Vodafone Group Plc, Annual Report 2023, notes to the consolidated financial statements, revenue accounting policy and contract asset disclosures.Real filer: BT Group plc on multi-element customer contracts
BT's revenue accounting policy explains that its contracts frequently contain multiple promised goods and services, that the group assesses whether those promises are distinct, and that the transaction price is allocated to the identified performance obligations by reference to relative stand-alone selling prices. The policy separately identifies equipment supplied to customers and the connectivity or managed services provided over the contract term, and describes the contract asset that arises where revenue recognised on equipment exceeds amounts billed. It also flags the judgement involved in identifying the performance obligations in complex enterprise contracts, which is the disclosure IFRS 15.123 is asking for.
BT Group plc, Annual Report 2023, notes to the consolidated financial statements, revenue from contracts with customers.Local FAQs
Do you have to test all three IFRS 15.29 factors, or stop at the first one you find? Once a factor is clearly present the promises are not separately identifiable and combination follows. But testing the others costs little and strengthens the file, because a conclusion resting on one marginal factor is fragile if that factor is challenged or if the contract is later modified.
Can a contract have an IFRS 15.29 factor between some promises but not others? Yes, and that is the normal case. IFRS 15.29 operates between pairs and groups of promises, not across the contract as a whole. Figure 2 above is exactly that pattern.
Is a single acceptance certificate for the whole contract decisive? It is evidence for IFRS 15.29(a), often strong evidence, because it shows the customer contracted for a combined output. It is not decisive on its own, because acceptance mechanics are also driven by commercial and payment considerations.
Potential risks
The dominant risk is treating the three factors as a scorecard and concluding that two out of three negative means separate obligations. IFRS 15.29 does not work that way. One factor clearly present is enough to combine. A second risk is the drift from IFRS 15.29(c) into ordinary commercial dependency, which produces spurious combination and defers revenue that should have been recognised. A third is the mirror error described in the flag above, where timing is imported into a test that does not contain it.
5. What does IFRS 15.30 require when a promise is not distinct, and what does that mean for the file?
IFRS 15.30 requires a non-distinct promise to be combined with other promised goods or services until a distinct bundle is identified. The combination is iterative, not a single step, and the endpoint can be the whole contract. The practical requirement is that the file records which promises were combined, with which, and on the strength of which criterion.
"If a promised good or service is not distinct, an entity shall combine that good or service with other promised goods or services until it identifies a bundle of goods or services that is distinct. In some cases, that would result in the entity accounting for all the goods or services promised in a contract as a single performance obligation."
Two features of the drafting are frequently missed. The first is that it is a loop. You combine, then you retest the bundle against IFRS 15.27. If the bundle is still not distinct, you combine again. Only when a distinct bundle emerges does the loop stop. That is the dashed feedback arrow in Figure 1.
The second is that IFRS 15.30 does not say which promises to combine with. It says "other promised goods or services". Where a contract contains several non-distinct promises and several distinct ones, the combination is not automatic and the entity has to reason about which promises belong to which combined output. In a contract with two independent projects and a support wrapper, the correct answer may be three performance obligations, not one, even though several individual promises failed IFRS 15.27 on their own.
Equipment supply plus installation, run twice
This is the fact pattern where the error corrected above does the most damage, because both answers are common and neither is a default. The two runs below use the same equipment, the same installer and the same price. Only the nature of the promise differs.
| Run B1: two performance obligations | Run B2: one performance obligation | |
|---|---|---|
| What is supplied | A standard palletising machine from the entity's catalogue, plus installation | The same standard palletising machine, plus installation |
| What the installation involves | Positioning, bolting to the floor, connecting to a standard power supply, and running the manufacturer's calibration routine | Re-engineering the machine's infeed to accept the customer's existing conveyor, writing control code to sequence it with the customer's existing filler and wrapper, and commissioning the whole line to a contracted throughput |
| Could a third party install it | Yes. Several regional engineering firms perform this installation and the entity's manual is public | No. The re-engineering requires the entity's design authority and the control code is written against its firmware |
| What the customer accepts | The machine on delivery, then the installation on sign-off. Payment for the machine is not conditional on installation | The line, against a throughput specification. No payment milestone is unconditional on line acceptance |
| IFRS 15.27(a) | Met. The machine is sold separately, which IFRS 15.28 identifies as indicative, and installation is available from third parties | Met. The machine is still sold separately. Limb (a) is not what changes |
| IFRS 15.29(a) | Not present. The entity is not producing a combined output. It is delivering a machine and fitting it | Present. The machine and the control work are inputs to a working line that the customer specified |
| IFRS 15.29(b) | Not present. The machine is unmodified. Calibration is within its designed setup | Present. The infeed is re-engineered, so the installation service significantly modifies the machine |
| IFRS 15.29(c) | Not present. The dependency runs one way only. The machine is not significantly affected by the installer | Present. Neither element can be completed without decisions taken on the other |
| Conclusion | Two performance obligations. Machine and installation are separately identifiable | One performance obligation under IFRS 15.30 |
| The deciding fact | The scope of the installation work. In B2 the entity was engaged to deliver a functioning production line and to modify the machine to fit it, which engages IFRS 15.29(a) and IFRS 15.29(b). In B1 it was engaged to deliver a machine and bolt it down. The customer's inability to use the machine before installation is identical in both runs and decides nothing | |
The numbers, run B1
Contract price CU 900,000. The entity's observable stand-alone selling price for the machine is CU 800,000 and for a comparable routine installation is CU 200,000. The sum of stand-alone selling prices is CU 1,000,000, so the contract carries a CU 100,000 discount, which IFRS 15.81 requires to be allocated proportionately across all performance obligations unless the IFRS 15.82 conditions for a targeted allocation are met. They are not met here, because the entity does not regularly sell this particular bundle at this discount.
Allocation under IFRS 15.74 and IFRS 15.76 on relative stand-alone selling prices:
| Performance obligation | Stand-alone selling price | Proportion | Allocated |
|---|---|---|---|
| Palletising machine | CU 800,000 | 80% | CU 720,000 |
| Installation service | CU 200,000 | 20% | CU 180,000 |
| Total | CU 1,000,000 | 100% | CU 900,000 |
The machine transfers at a point in time on delivery, because none of the IFRS 15.35 criteria is met. The installation is satisfied over time under IFRS 15.35(a), because the customer simultaneously receives and consumes the benefit of an installer working on an asset the customer already controls. Assume delivery occurs on 20 December and installation completes on 14 January, with the full CU 900,000 invoiced on delivery and payable in 30 days.
| Date | Entry | Dr | Cr |
|---|---|---|---|
| 20 Dec | Trade receivable | CU 900,000 | |
| Revenue, equipment | CU 720,000 | ||
| Contract liability | CU 180,000 | ||
| 20 Dec | Cost of sales | CU 545,000 | |
| Inventory | CU 545,000 | ||
| 14 Jan | Contract liability | CU 180,000 | |
| Revenue, installation | CU 180,000 |
Revenue in the December period is CU 720,000. The CU 180,000 sits as a contract liability at the year end and is disclosed within remaining performance obligations under IFRS 15.120 unless the practical expedient in IFRS 15.121 applies. The cost of sales figure of CU 545,000 is the carrying amount of the machine and is used here only to make the entry complete.
The numbers, run B2
Same CU 900,000. One performance obligation, so IFRS 15.75 switches off the allocation requirements in IFRS 15.76 to 15.86 entirely. There is nothing to allocate. The whole CU 900,000 attaches to the single obligation, and Step 5 is then run once on that obligation. On these facts the entity concludes that IFRS 15.35(b) is not met because the customer does not control the work in progress, and that IFRS 15.35(c) is not met because the contract permits termination for convenience with payment of costs only and no margin, so the obligation is satisfied at a point in time on line acceptance under IFRS 15.38.
| Date | Entry | Dr | Cr |
|---|---|---|---|
| 20 Dec | Trade receivable | CU 900,000 | |
| Contract liability | CU 900,000 | ||
| 31 Dec | No revenue entry. Machine and installation costs to date sit in inventory or work in progress | ||
| 14 Feb | Contract liability | CU 900,000 | |
| Revenue, integrated line | CU 900,000 | ||
| 14 Feb | Cost of sales | CU 690,000 | |
| Inventory and work in progress | CU 690,000 |
December revenue is nil against CU 720,000 in run B1. The commercial substance differs, the price does not, and the entire difference is produced by the IFRS 15.29 assessment. That is why this factor test has to be evidenced rather than asserted.
Practitioner note
My view: the single most useful question to put to the delivery team on an equipment and installation file is "if the customer had bought this machine from you and hired someone else to install it, would it work?" If the answer is yes, IFRS 15.29(a) and 15.29(b) are almost certainly absent and you are looking at two obligations. If the answer is no because the entity has to redesign part of the machine or write code that ties it to other equipment, you are looking at one, and now you have the evidence to say which factor drove it.
Local FAQs
If two promises combine, does the combined obligation have a stand-alone selling price? Not directly, and it does not need one unless there are other obligations to allocate against. Where allocation is required, IFRS 15.78 requires the stand-alone selling price of the combined item to be estimated, and IFRS 15.79 lists the acceptable methods including the residual approach subject to its conditions.
Can combination cross contracts? Only where the contracts themselves are combined under IFRS 15.17, which is a Step 1 question with its own criteria. IFRS 15.30 operates within a contract as identified in Step 1.
Potential risks
The combination step is where files go quiet. A memo often states that promises A and B are not distinct and then jumps to a single performance obligation for the whole contract without explaining why C and D were swept in as well. That is a real risk on multi-project contracts, where the correct answer frequently has more than one obligation despite several individual promises failing IFRS 15.27.
Worked example A: licence, implementation and support, run in full
This is the bundle that generates more Step 2 disagreement than any other, and it is worth running from the top rather than jumping to a conclusion. The facts below are constructed for illustration and are not any company's numbers.
Facts. On 1 January 20X6 a vendor contracts with a customer for a three-year term licence to a standard enterprise resource planning module, an implementation project, and three years of technical support and unspecified updates. The single contract price is CU 1,000,000, invoiced in full on signature and payable within 30 days. The vendor sells the licence separately at CU 700,000 for a three-year term, sells implementation work of this scope separately at CU 250,000, and renews support at CU 100,000 a year, giving CU 300,000 for three years. The implementation consists of installing the module, loading the customer's opening data, configuring the standard workflow options that the product exposes to administrators, and training two groups of users. No code is written. The product is not altered. Other consultancies implement this product and the vendor's implementation manual is published.
Promise inventory, IFRS 15.24 and IFRS 15.25
Three surviving promises: the licence, the implementation service, and the support and updates package. Account provisioning and licence-key issuance are removed under IFRS 15.25 because they transfer nothing. Support and updates are treated as one promise because both are stand-ready services under IFRS 15.26(e) delivered continuously over the same period, and neither is separately identifiable from the other in the sense IFRS 15.29 describes.
Limb one, IFRS 15.27(a) tested against IFRS 15.28
The licence is capable of being distinct. The vendor sells it separately, which IFRS 15.28 identifies as indicative, and the customer could use it with implementation resources available in the market. The implementation service is capable of being distinct, because by the time it is performed the customer holds the licence, and IFRS 15.28 expressly treats goods or services the entity will already have transferred under the contract as readily available resources. Support is capable of being distinct because it is sold separately at renewal. All three clear limb one.
Limb two, each IFRS 15.29 factor tested on each pairing
| Pairing | 15.29(a) integration | 15.29(b) modification | 15.29(c) interdependence | Separately identifiable |
|---|---|---|---|---|
| Licence and implementation | No. The vendor is not producing a combined output from inputs. It is delivering a product and setting it up within its own designed options | No. Configuration within the product's administrator settings is not modification. No code is written and the product is unchanged | No. The dependency is one way. The implementation needs the licence; the licence is not significantly affected by the implementation | Yes |
| Licence and support | No | No. Updates are delivered on a when-and-if-available basis and do not customise the licence for this customer | No. Support is a stand-ready service the customer can renew or decline | Yes |
| Implementation and support | No | No | No. They run in different periods and neither affects the other | Yes |
Conclusion. Three performance obligations. Note what did not appear in that reasoning: the customer's inability to run the system until implementation finishes, the fact that the three items were sold together at a discount, and the fact that the customer would never buy the licence without the implementation. None of those is in IFRS 15.27, IFRS 15.28 or IFRS 15.29.
Change one fact and the answer changes. If the implementation had involved rewriting the module's approval logic and building a bespoke interface into the customer's treasury system, IFRS 15.29(b) would be present and the licence and implementation would combine under IFRS 15.30, leaving two performance obligations. The support would still stand alone. The word that would appear in the working paper is customisation, not waiting.
Allocation under IFRS 15.74 and IFRS 15.76 to 15.80
IFRS 15.74 requires the transaction price to be allocated to each performance obligation on a relative stand-alone selling price basis. IFRS 15.76 requires those prices to be determined at contract inception, and IFRS 15.77 makes the observable separate selling price the best evidence. All three prices are observable here, so no estimation under IFRS 15.78 or 15.79 is required.
| Performance obligation | Stand-alone selling price | Proportion | Allocated | Timing |
|---|---|---|---|---|
| Term licence | CU 700,000 | 56% | CU 560,000 | Point in time on delivery of the licence key, a right to use the software as it exists |
| Implementation service | CU 250,000 | 20% | CU 200,000 | Over time under IFRS 15.35(a), measured by an input method |
| Support and updates | CU 300,000 | 24% | CU 240,000 | Over time, straight line across 36 months as a stand-ready service |
| Total | CU 1,250,000 | 100% | CU 1,000,000 |
The sum of stand-alone selling prices is CU 1,250,000 against a price of CU 1,000,000, so the contract carries a CU 250,000 discount, a 20% reduction. IFRS 15.81 requires that discount to be allocated proportionately across all three obligations unless the IFRS 15.82 conditions are met, which they are not, because the vendor does not regularly sell this specific bundle at this specific discount. Proportionate allocation is exactly what the relative stand-alone selling price calculation above produces: each obligation bears 20% less than its stand-alone price. Check the arithmetic: 560,000 plus 200,000 plus 240,000 equals 1,000,000, and 700,000 times 0.8 equals 560,000, 250,000 times 0.8 equals 200,000, and 300,000 times 0.8 equals 240,000.
Journals for the year ended 31 December 20X6
Assume the licence key is delivered on 2 January 20X6, the implementation is 60% complete at 31 December 20X6 on a cost-to-cost input measure under IFRS 15.41 and B18, and support has run for 12 of its 36 months.
| Ref | Entry | Dr | Cr |
|---|---|---|---|
| 1 | Trade receivable, on invoicing at contract inception | CU 1,000,000 | |
| Contract liability | CU 1,000,000 | ||
| 2 | Contract liability, on transfer of the licence | CU 560,000 | |
| Revenue, software licence | CU 560,000 | ||
| 3 | Contract liability, implementation at 60% of CU 200,000 | CU 120,000 | |
| Revenue, implementation services | CU 120,000 | ||
| 4 | Contract liability, support for 12 of 36 months on CU 240,000 | CU 80,000 | |
| Revenue, support and updates | CU 80,000 |
Year 1 revenue is CU 560,000 plus CU 120,000 plus CU 80,000, which is CU 760,000. The contract liability at 31 December 20X6 is CU 1,000,000 less CU 760,000, which is CU 240,000. That balance reconciles to the unsatisfied performance: CU 80,000 of implementation remaining, being 40% of CU 200,000, plus CU 160,000 of support remaining, being 24 of 36 months on CU 240,000. CU 80,000 plus CU 160,000 equals CU 240,000. The remaining performance obligation disclosure under IFRS 15.120 is CU 240,000, expected to be recognised CU 160,000 in 20X7 and CU 80,000 in 20X8, being implementation of CU 80,000 plus support of CU 80,000 in 20X7 and support of CU 80,000 in 20X8.
The answer the corrected error would have produced
If the file had concluded a single performance obligation on the basis that the customer cannot use the system until implementation is complete, the whole CU 1,000,000 would attach to one obligation recognised across the three-year term. On a straight-line basis year 1 revenue would be CU 333,333. Against the correct answer of CU 760,000 that is an understatement of CU 426,667, more than 40% of the contract value misplaced by a single unsupported sentence in a Step 2 memo. The error is not conservative and it is not a presentational nicety. It moves revenue between years and it changes the contract liability, the remaining performance obligation disclosure and the amortisation period of any capitalised contract cost asset under IFRS 15.99.
Real filer: Microsoft Corporation on licences supplied with software assurance
Microsoft's revenue recognition policy explains that its volume licensing arrangements typically contain multiple performance obligations, and that the transaction price is allocated to them on a relative stand-alone selling price basis. The policy distinguishes the licence element, recognised when the customer obtains the right to use the software, from the software assurance and support elements, which give the customer rights to updates and services over the term and are recognised rateably across that term. The disclosure also explains that judgement is applied in determining stand-alone selling prices where they are not directly observable. That is the same structure as worked example A: a licence transferring at a point in time and a stand-ready service transferring over the term, held apart because no IFRS 15.29 factor combines them.
Microsoft Corporation, Form 10-K for the year ended 30 June 2023, note on revenue recognition and accounting policies.6. How does the series guidance in IFRS 15.22(b) and IFRS 15.23 work, and why is it not an election?
Where a contract promises a series of distinct goods or services that are substantially the same and have the same pattern of transfer, IFRS 15.22(b) treats the whole series as one performance obligation. IFRS 15.23 sets two conditions, both of which must be met: each item in the series would be satisfied over time under IFRS 15.35, and the same measure of progress under IFRS 15.39 and 15.40 would apply to each. Where those conditions hold, series treatment is required. There is no choice.
"A series of distinct goods or services has the same pattern of transfer to the customer if both of the following criteria are met: (a) each distinct good or service in the series that the entity promises to transfer to the customer would meet the criteria in paragraph 35 to be a performance obligation satisfied over time; and (b) in accordance with paragraphs 39-40, the same method would be used to measure the entity's progress towards complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer."
Notice the sequencing. IFRS 15.22(b) itself contains two requirements: the goods or services must be distinct, and they must be substantially the same. IFRS 15.23 then defines only the third requirement, the same pattern of transfer. So there are three hurdles in total and IFRS 15.23 addresses one of them, which is a common source of confusion in working papers that treat IFRS 15.23 as the whole test.
Condition (a) is worded hypothetically: each item "would meet" the IFRS 15.35 criteria. You are asked to imagine each daily or monthly service as a stand-alone performance obligation and ask whether it would be satisfied over time. For routine recurring services the answer is normally yes under IFRS 15.35(a), because the customer simultaneously receives and consumes the benefit. For a series of discrete goods delivered at points in time, the answer is no, and the series guidance is unavailable however identical the goods are.
Condition (b) asks whether one measure of progress would serve for every item in the series. Where the units of service are genuinely uniform, a single output measure such as transactions processed, or a time-elapsed measure, will serve. Where the effort or output profile differs materially between periods, condition (b) fails and the series guidance is unavailable.
Substantially the same, and the day as the unit
The requirement that the goods or services be substantially the same is assessed on the nature of the promise rather than on the volume of activity. In a facilities management contract the promise on a quiet day and the promise on a busy day is the same promise: to stand ready and to perform the contracted services. The activities differ, the promise does not. In a contract to deliver a series of separately negotiated professional engagements, each with its own scope, the promise differs each time and the series guidance is unavailable.
The practical consequence is that the unit of account inside a series is normally very small, often a day or a month. That is not a problem, because the series concept exists precisely so that an entity does not have to account for 1,825 daily performance obligations across a five-year cleaning contract. But it does have consequences that reach beyond convenience, which is the next part of this unit.
Worked example C: a five-year transaction-processing contract
Facts. A payments business contracts with a retailer to process card transactions for five years. The fee is CU 0.10 per transaction. In addition, the contract provides an annual volume bonus of CU 200,000 payable if transactions processed in that contract year exceed 25 million. Expected volumes are 20 million in year 1, 24 million in year 2, 30 million in year 3, 32 million in year 4 and 34 million in year 5, giving 140 million over the term. The bonus is expected to be earned in years 3, 4 and 5.
Step 2, is each day distinct? Yes. The retailer benefits from each day's processing on its own, so IFRS 15.27(a) is met. The entity provides no integration service across days, does not modify one day's service by reference to another, and the days are not interdependent, so no IFRS 15.29 factor is present and IFRS 15.27(b) is met.
Are they substantially the same? Yes, under IFRS 15.22(b). The promise each day is the same promise to process transactions presented on that day. Volume varies. The nature of the promise does not.
IFRS 15.23(a). Each day's processing, tested as if it were a stand-alone performance obligation, would be satisfied over time under IFRS 15.35(a), because the retailer simultaneously receives and consumes the benefit of the processing as it is performed. Condition met.
IFRS 15.23(b). The same measure of progress, transactions processed, would be used for every day in the series. Condition met.
Conclusion. One performance obligation for the whole five years under IFRS 15.22(b). This is mandatory. The entity cannot elect to account for five annual obligations instead.
"Paragraphs 76-86 do not apply if a contract has only one performance obligation. However, paragraphs 84-86 may apply if an entity promises to transfer a series of distinct goods or services identified as a single performance obligation in accordance with paragraph 22(b) and the promised consideration includes variable amounts."
This is the paragraph that makes the series concept matter rather than merely tidy. Ordinarily, one performance obligation means no allocation. But a series is one performance obligation built out of distinct units, and IFRS 15.75 preserves the variable consideration allocation machinery in IFRS 15.84 to 15.86 for exactly that case. The distinct daily or annual units survive inside the single obligation for allocation purposes.
"An entity shall allocate a variable amount (and subsequent changes to that amount) entirely to a performance obligation or to a distinct good or service that forms part of a single performance obligation in accordance with paragraph 22(b) if both of the following criteria are met: (a) the terms of a variable payment relate specifically to the entity's efforts to satisfy the performance obligation or transfer the distinct good or service (or to a specific outcome from satisfying the performance obligation or transferring the distinct good or service); and (b) allocating the variable amount of consideration entirely to the performance obligation or the distinct good or service is consistent with the allocation objective in paragraph 73 when considering all of the performance obligations and payment terms in the contract."
Applied to the facts above, the year 3 bonus of CU 200,000 depends on volume processed in year 3. IFRS 15.85(a) is met because the payment terms relate specifically to a specific outcome from transferring the distinct services of that year. IFRS 15.85(b) is met because pinning the bonus to the year that earned it depicts the consideration to which the entity expects to be entitled for that year's services, which is the IFRS 15.73 objective. So the CU 200,000 is allocated entirely to year 3.
Where the variable consideration lands, and where it would have landed
Year 3 revenue under the series treatment is 30 million transactions at CU 0.10, which is CU 3,000,000, plus the full CU 200,000 bonus allocated under IFRS 15.85, giving CU 3,200,000.
Now suppose the entity had instead concluded that the contract was a single performance obligation of a different kind, a five-year integrated processing service that is not a series, for example because it wrongly decided that the days were not distinct. The variable consideration would then form part of the transaction price for one undifferentiated obligation, measured by a single measure of progress across the whole term. IFRS 15.85 would be unavailable, because there would be no distinct good or service inside the obligation to allocate to, and IFRS 15.75 would have switched off IFRS 15.76 to 15.86 in full. The CU 200,000 would be spread across all 140 million transactions expected over the term and recognised by cumulative catch-up. The comparison below isolates the year 3 bonus only; the separate year 4 and year 5 bonuses run through the same mechanics on their own years and are held constant on both sides so the year 3 effect can be traced in isolation.
| Series, IFRS 15.22(b) with IFRS 15.85 | Single undifferentiated obligation | |
|---|---|---|
| Basis | Bonus allocated entirely to the year 3 distinct services | Bonus enters the transaction price and is spread over 140 million expected transactions |
| Rate applied to the bonus | n/a, allocated in full to year 3 | CU 200,000 divided by 140,000,000, which is CU 0.0014286 per transaction |
| Cumulative transactions to end of year 3 | 74,000,000 | 74,000,000 |
| Bonus recognised by end of year 3 | CU 200,000 | 74/140 of CU 200,000, which is CU 105,714 |
| Bonus deferred into years 4 and 5 | Nil | CU 94,286 |
| Year 3 revenue | CU 3,000,000 plus CU 200,000, giving CU 3,200,000 | CU 3,000,000 plus CU 105,714, giving CU 3,105,714 |
| Difference in year 3 | CU 94,286, roughly 3% of the year's revenue, produced entirely by the Step 2 conclusion | |
The arithmetic checks: CU 105,714 recognised by the end of year 3 plus CU 94,286 deferred equals the CU 200,000 bonus. The per-transaction rate of CU 0.0014286 multiplied by 74,000,000 transactions gives CU 105,714 to the nearest CU. The point is not the size of the difference in this illustration, which is modest. It is that the two answers come from the same contract, and the file has to be able to say which one applies and why. The interaction with estimating and constraining the bonus itself is covered in the note on variable consideration, and the mechanics of splitting a price across obligations are set out in the note on transaction price allocation.
The disclosure consequence
The series conclusion also reaches IFRS 15.120, which requires disclosure of the aggregate transaction price allocated to performance obligations that are unsatisfied or partially unsatisfied at the reporting date, and an explanation of when that amount will be recognised. A five-year series is one partially unsatisfied performance obligation running to year 5. Five annual obligations would be one partially satisfied obligation and four unsatisfied ones. The aggregate number can be similar, but the time-banding under IFRS 15.120(b)(i) and the narrative under IFRS 15.120(b)(ii) are not, and the practical expedient in IFRS 15.121(a) for contracts with an original expected duration of one year or less is unavailable to a five-year series however short its internal units are.
Real filer: Rolls-Royce Holdings plc on long-term service agreements
Rolls-Royce accounts for its long-term service agreements on civil aerospace engines under IFRS 15, and its revenue policy explains that these arrangements provide maintenance and related services over the life of the engine, with consideration that is substantially variable because it is driven by engine flying hours. The policy describes recognition of revenue as the services are provided, measured by reference to the activity delivered, and it identifies the estimation of future flying hours and maintenance events as a key source of estimation uncertainty. The Step 2 relevance is that a long-term availability-style service arrangement is the archetype of a promise assessed as a continuous service rather than a sequence of separately identified overhaul events, and the disclosure explains the judgement in a way IFRS 15.123 contemplates.
Rolls-Royce Holdings plc, Annual Report 2023, notes to the consolidated financial statements, revenue accounting policy and critical accounting judgements.Local FAQs
Can a series contain goods rather than services? In principle yes, but condition (a) in IFRS 15.23 requires each item to be satisfied over time under IFRS 15.35, and discrete goods delivered at points in time will not meet that. So in practice the series guidance applies to services and to stand-ready arrangements.
Does the series guidance apply where the price per unit changes over the term? A changing price does not by itself break IFRS 15.22(b) or IFRS 15.23, because those tests are about the nature of the promise and the pattern of transfer, not the price. The price change is dealt with in Step 3 and, where it is variable, in the IFRS 15.85 allocation.
What if only part of the contract is a series? That is common. A contract can contain a distinct implementation obligation and a separate five-year series obligation. IFRS 15.22 applies promise by promise, and both outcomes can coexist in one contract.
Potential risks
The main risk is treating the series as an accounting convenience adopted for systems reasons rather than as a conclusion reached under IFRS 15.23. Where the conditions are not in fact met, for example because the measure of progress genuinely differs between periods, applying series treatment produces the wrong allocation of variable consideration. The opposite risk is ignoring the series concept entirely on a long service contract, which forfeits the IFRS 15.85 allocation and pushes performance-linked payments into the wrong periods.
7. When is a customer option a performance obligation, and what makes a right material?
IFRS 15.B40 makes an option a performance obligation only where it gives the customer a material right that it would not have received without entering into the contract. The benchmark is a discount incremental to the range of discounts typically given for those goods or services to that class of customer in that market. An option priced at stand-alone selling price is a marketing offer under IFRS 15.B41, accounted for when exercised.
IFRS 15.B39 sets the scope: "Customer options to acquire additional goods or services for free or at a discount come in many forms, including sales incentives, customer award credits (or points), contract renewal options or other discounts on future goods or services."
IFRS 15.B40 sets the test: "If, in a contract, an entity grants a customer the option to acquire additional goods or services, that option gives rise to a performance obligation in the contract only if the option provides a material right to the customer that it would not receive without entering into that contract (for example, a discount that is incremental to the range of discounts typically given for those goods or services to that class of customer in that geographical area or market). If the option provides a material right to the customer, the customer in effect pays the entity in advance for future goods or services and the entity recognises revenue when those future goods or services are transferred or when the option expires."
The comparison in the parenthesis is precise and it is worth reading slowly. The discount is compared to the range of discounts typically given, for those goods or services, to that class of customer, in that market. A 15% renewal discount is not a material right if the entity routinely gives 10% to 20% off to customers of that size in that territory. The same 15% is a material right if the entity's normal range for that class is 0% to 5%.
The closing sentence explains the economics. Where the right is material, the customer has prepaid for future goods or services. That is why the allocated amount sits as a contract liability and is released either when the optional goods are transferred or when the option lapses. It is not a provision and it is not a marketing cost.
"If a customer has the option to acquire an additional good or service at a price that would reflect the stand-alone selling price for that good or service, that option does not provide the customer with a material right even if the option can be exercised only by entering into a previous contract. In those cases, the entity has made a marketing offer that it shall account for in accordance with this Standard only when the customer exercises the option to purchase the additional goods or services."
The clause "even if the option can be exercised only by entering into a previous contract" closes off an argument that is otherwise attractive. Exclusivity does not make a right material. If only existing customers can buy the add-on, but they buy it at its normal price, there is no right worth anything and no performance obligation. What matters is price against stand-alone selling price, not access.
Loyalty programmes and discounted renewals
Loyalty points are the textbook material right and the easiest to see. A customer who spends CU 100 and receives points redeemable against future purchases has paid for two things: the goods bought today and the entitlement to a future discount. IFRS 15.B40 makes the second a performance obligation, and the transaction price is split between them.
Worked illustration. A retailer sells goods for CU 100,000 in a period and grants 10,000 loyalty points, each redeemable for CU 1 off a future purchase. Based on history, the retailer expects 9,500 points to be redeemed. The stand-alone selling price of the points is estimated under IFRS 15.B42 by reference to the discount the customer would obtain on exercise, adjusted for the likelihood of exercise, giving 9,500 times CU 1, which is CU 9,500. The goods have an observable stand-alone selling price of CU 100,000.
| Performance obligation | Stand-alone selling price | Proportion | Allocated |
|---|---|---|---|
| Goods transferred today | CU 100,000 | 91.324% | CU 91,324 |
| Material right, the points | CU 9,500 | 8.676% | CU 8,676 |
| Total | CU 109,500 | 100% | CU 100,000 |
| Entry | Dr | Cr |
|---|---|---|
| Cash | CU 100,000 | |
| Revenue, goods | CU 91,324 | |
| Contract liability, loyalty points | CU 8,676 |
CU 91,324 plus CU 8,676 equals CU 100,000. The CU 8,676 is released to revenue as points are redeemed, in proportion to points redeemed against total points expected to be redeemed, or on expiry. Where actual redemption experience diverges from the estimate, the proportion is updated and the effect is recognised in the period of change. The full treatment of options, warranties and returns is developed in the note on warranties, returns and customer options.
Discounted renewals and the IFRS 15.B42 practical alternative
A renewal option priced below the normal renewal price is the second common material right. A one-year subscription at CU 1,000 with a contractual right to renew for a second year at CU 700, where the entity's normal renewal price for that class is CU 1,000, gives the customer a right worth CU 300 adjusted for the probability of renewal. That is a performance obligation and part of the CU 1,000 initial price must be allocated to it.
"Paragraph 74 requires an entity to allocate the transaction price to performance obligations on a relative stand-alone selling price basis. If the stand-alone selling price for a customer's option to acquire additional goods or services is not directly observable, an entity shall estimate it. That estimate shall reflect the discount that the customer would obtain when exercising the option, adjusted for both of the following: (a) any discount that the customer could receive without exercising the option; and (b) the likelihood that the option will be exercised."
Both adjustments matter. Adjustment (a) strips out any discount available anyway, which is the same benchmark IFRS 15.B40 uses. Adjustment (b) probability-weights the right. An option nobody exercises is worth very little, and the estimate should say so.
"If a customer has a material right to acquire future goods or services and those goods or services are similar to the original goods or services in the contract and are provided in accordance with the terms of the original contract, then an entity may, as a practical alternative to estimating the stand-alone selling price of the option, allocate the transaction price to the optional goods or services by reference to the goods or services expected to be provided and the corresponding expected consideration. Typically, those types of options are for contract renewals."
This is the practical alternative usually referred to as the look-through approach. Rather than valuing the option, the entity treats the expected optional periods as if they were part of the contract and spreads the total expected consideration across the total expected goods or services. It is available only where the optional goods or services are similar to the original ones and are provided on the original contract terms, which is why the standard says these are typically renewal options.
Worked through on the subscription above, with an expected renewal probability of 100% for illustration: total expected consideration is CU 1,000 plus CU 700, which is CU 1,700, across two years of a similar service, giving CU 850 a year rather than CU 1,000 in year 1 and CU 700 in year 2. The mechanism produces the same economic outcome as valuing the option, without requiring the option itself to be priced. Where renewal is less than certain, the expected goods or services and expected consideration are both adjusted, and the two approaches converge.
Practitioner note
My view: the material right assessment is the most under-evidenced judgement in Step 2, because the benchmark it needs, the range of discounts typically given to that class of customer in that market, is pricing data that finance teams rarely hold. The right control is to obtain the discount distribution from the commercial function once a year and keep it on file. Without it, every material right conclusion in the entity rests on someone's recollection of what the sales team normally does, which is not evidence and does not survive a challenge.
Local FAQs
Is a free trial a material right? Where the trial is offered to anyone, no right has been granted by entering into a contract, so IFRS 15.B40 is not engaged. Where the trial is granted only under an existing contract and is worth more than the discounts typically available, it can be.
Does a volume discount that applies retrospectively create a material right? Usually not. A retrospective rebate on purchases already made is variable consideration under IFRS 15.50 rather than an option over future goods. A prospective discount on future purchases triggered by past volume is closer to an option and should be tested under IFRS 15.B40.
What happens to the contract liability if the option is never exercised? IFRS 15.B40 releases it to revenue when the option expires. Where the entity expects a portion of rights never to be exercised, the breakage guidance in IFRS 15.B46 allows that expected breakage to be recognised in proportion to the pattern of rights exercised, rather than waiting for expiry.
Potential risks
The commonest failure is treating every renewal discount as a material right without benchmarking, which creates spurious performance obligations and defers revenue that should have been recognised. The mirror failure is treating none of them as material rights because the individual amounts look small, which understates the deferral across a large customer base. Both are avoided by holding the discount range on file.
8. What is not a separate performance obligation under IFRS 15?
Assurance-type warranties are not performance obligations under IFRS 15.B30 and go to IAS 37. Activities that transfer nothing, including administrative set-up and shipping activity performed after control has passed, are excluded by IFRS 15.25. Promises the entity is not obliged to perform are outside the contract as defined in Appendix A. Each of these exclusions has a specific paragraph behind it and none is a matter of preference.
Assurance-type warranties
IFRS 15.B29 deals with the easy case: "If a customer has the option to purchase a warranty separately (for example, because the warranty is priced or negotiated separately), the warranty is a distinct service because the entity promises to provide the service to the customer in addition to the product that has the functionality described in the contract. In those circumstances, an entity shall account for the promised warranty as a performance obligation in accordance with paragraphs 22-30 and allocate a portion of the transaction price to that performance obligation in accordance with paragraphs 73-86."
Separate purchasability is decisive. Where the customer can buy it, it is a distinct service and a performance obligation. No further analysis is needed.
IFRS 15.B30 deals with the harder case: "If a customer does not have the option to purchase a warranty separately, an entity shall account for the warranty in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets unless the promised warranty, or a part of the promised warranty, provides the customer with a service in addition to the assurance that the product complies with agreed-upon specifications."
The correct terminology is assurance-type and service-type. An assurance-type warranty promises only that the product meets the specification the parties agreed. It is not a promise to transfer anything further, so it is not a performance obligation and IAS 37 applies to the expected cost of honouring it. A service-type warranty promises something beyond that assurance, and IFRS 15.B32 makes the additional service a performance obligation.
IFRS 15.B31 lists factors for the assessment, including whether the warranty is required by law, the length of the coverage period, and the nature of the tasks the entity promises to perform. On the first, IFRS 15.B31(a) states that where the entity is required by law to provide a warranty, "the existence of that law indicates that the promised warranty is not a performance obligation because such requirements typically exist to protect customers from the risk of purchasing defective products". On the second, IFRS 15.B31(b) states that "the longer the coverage period, the more likely it is that the promised warranty is a performance obligation".
IFRS 15.B32 closes with a practical concession: where an entity promises both an assurance-type and a service-type warranty but cannot reasonably account for them separately, both are accounted for together as a single performance obligation. That is a conservative default and it should not be reached for as a first resort.
Shipping and handling activity
Shipping is a genuine Step 2 question with a genuine answer, and it turns on when control transfers. Where the contract terms mean control passes to the customer at the entity's dock, the entity's subsequent activity in arranging carriage does not transfer any further good or service. It is a fulfilment activity of the kind IFRS 15.25 excludes, and the cost is a cost of fulfilment. Where control passes on delivery to the customer's premises, the carriage happens before control transfers and is likewise not a separate promise, because there is only one transfer taking place.
The situation that does produce a second performance obligation is where the entity has promised a distinct delivery service after control has passed, for example a promise to ship goods the customer has already taken control of at a bill-and-hold location. IFRS 15.B79 to 15.B82 govern bill-and-hold arrangements, and IFRS 15.B82 contemplates custodial services as a promise separate from the goods themselves. The point for Step 2 is that shipping is assessed on the same criteria as everything else and does not have its own rule.
No IFRS accounting policy election for shipping. Practitioners familiar with US GAAP will know the election in ASC 606 that permits shipping and handling activities performed after control transfers to be accounted for as a fulfilment activity rather than as a promised service. IFRS 15 contains no equivalent election. Under IFRS the assessment runs through IFRS 15.22 to 15.30 on the facts. The broader comparison is set out in the note on IFRS 15 against ASC 606.
Administrative set-up and mobilisation
Covered in Unit 2 above, but worth restating here because it is the most frequently misclassified item in the list. IFRS 15.25 excludes activities the entity must undertake to fulfil a contract that do not transfer a good or service, and names set-up tasks as the example. The presence of a separate fee is irrelevant. IFRS 15.B49 treats a non-refundable upfront fee for such an activity as an advance payment for the future goods or services, and IFRS 15.B51 stops the set-up costs from inflating the measure of progress on the obligations that do exist.
Unenforceable promises
Appendix A defines a contract as an agreement creating enforceable rights and obligations, and IFRS 15.9(a) requires the parties to have approved the contract and to be committed to perform. A promise the entity can withdraw at will, in relation to a period the customer can exit without penalty, does not create an obligation to transfer anything. Where a multi-year arrangement is terminable monthly by either party without compensation, the enforceable contract is a monthly one, whatever the stated term. This has a direct effect on the remaining performance obligation disclosure under IFRS 15.120, which frequently overstates commitments by using the stated term rather than the enforceable one.
| Item | Why it is excluded | Where it goes instead |
|---|---|---|
| Assurance-type warranty not separately purchasable | IFRS 15.B30. It promises only that the product meets specification | IAS 37 provision |
| Legal liability for harm caused by products | IFRS 15.B33. Not a promise to transfer a good or service | IAS 37 |
| Patent and copyright indemnities | IFRS 15.B33 | IAS 37 |
| Account set-up, provisioning, credit checks | IFRS 15.25. Transfers nothing | Fulfilment cost under IFRS 15.95, fee treated as an advance under IFRS 15.B49 |
| Shipping activity where control has already transferred and no further service is promised | IFRS 15.25 on the facts. No IFRS election exists | Fulfilment cost |
| Option priced at stand-alone selling price | IFRS 15.B41. No material right | Accounted for on exercise |
| Promise relating to a period either party can exit without penalty | Appendix A definition of a contract, with IFRS 15.9 | Outside the contract until the period becomes enforceable |
| Mobilisation and team training by the entity | IFRS 15.25. Transfers nothing to the customer | Fulfilment cost, capitalised if IFRS 15.95 is met |
Local FAQs
Does a longer warranty automatically become service-type? No, but IFRS 15.B31(b) treats length as an indicator, on the reasoning that a warranty running well beyond the period in which manufacturing defects would emerge is likely providing something more than assurance.
If the entity cannot split an assurance and a service warranty, what happens? IFRS 15.B32 requires both to be accounted for together as a single performance obligation. In practice that defers more revenue than separating them would, so it is not a soft option.
Potential risks
The two risks here pull in opposite directions. Recognising set-up fees as revenue when charged overstates early revenue and is a straightforward IFRS 15.25 and IFRS 15.B49 breach. Treating a service-type warranty as an IAS 37 provision understates the deferral and misstates the presentation, because a provision and a contract liability are different things measured on different bases.
9. How does principal against agent depend on the Step 2 conclusion?
IFRS 15.B34 requires the principal or agent determination to be made for each specified good or service, and defines a specified good or service as a distinct good or service or a distinct bundle of goods or services. That definition points back to IFRS 15.27 to 15.30. Until Step 2 has produced a distinct item, there is nothing to test for control, so the principal assessment cannot substitute for the identification of promises. It follows from it.
"When another party is involved in providing goods or services to a customer, the entity shall determine whether the nature of its promise is a performance obligation to provide the specified goods or services itself (ie the entity is a principal) or to arrange for those goods or services to be provided by the other party (ie the entity is an agent). An entity determines whether it is a principal or an agent for each specified good or service promised to the customer. A specified good or service is a distinct good or service (or a distinct bundle of goods or services) to be provided to the customer (see paragraphs 27-30). If a contract with a customer includes more than one specified good or service, an entity could be a principal for some specified goods or services and an agent for others."
The reference to paragraphs 27 to 30 inside IFRS 15.B34 is the whole point of this unit. The specified good or service is not defined independently. It is defined as the output of the distinct assessment. So the sequence is fixed: identify the promises under IFRS 15.24 and 15.25, apply IFRS 15.27 to 15.30 to establish the distinct items, and only then ask whether the entity controls each of those items before transfer.
The closing sentence is the practical payoff. Because the assessment is made item by item, one contract can produce gross revenue on some obligations and net revenue on others. That is not an anomaly to be smoothed away. It is the model working as drafted.
"To determine the nature of its promise (as described in paragraph B34), the entity shall: (a) identify the specified goods or services to be provided to the customer (which, for example, could be a right to a good or service to be provided by another party (see paragraph 26)); and (b) assess whether it controls (as described in paragraph 33) each specified good or service before that good or service is transferred to the customer."
Step (a) is Step 2. Step (b) is the control assessment. IFRS 15.B34A was added by the 2016 clarifications precisely because entities were jumping to the control indicators without first fixing what it was they were assessing control over. Getting the specified good or service wrong makes the control conclusion meaningless, because control of a bundle and control of its components can point in different directions.
Why the sequence matters in practice
A travel platform sells a package of flight, hotel and airport transfer. If the specified goods and services are three separate distinct items, the platform tests control of each: it may be an agent for the flight, an agent for the hotel and a principal for its own transfer service. If instead the platform is providing a significant integration service under IFRS 15.29(a), assembling a bespoke itinerary that it prices, guarantees and takes responsibility for as a whole, the specified good or service is the package. Control is then tested over the package, and the answer can be principal even though the platform is not the airline. The Step 2 conclusion changed what was being tested, and it changed gross against net.
This is why a principal or agent memo that begins with the IFRS 15.B37 indicators, primary responsibility, inventory risk and pricing discretion, without first establishing the specified good or service, is incomplete regardless of how carefully the indicators are argued. The full analysis, including the control indicators and the presentation consequences, is set out in the note on principal against agent considerations, and this article does not duplicate it.
Practitioner note
My view: on review, the tell is the first heading in the memo. If the first heading is "Control indicators", the file has started in the middle. If the first heading names the specified good or service and explains how it was derived from IFRS 15.27 to 15.30, the analysis has a foundation. The difference is rarely cosmetic, because on intermediated arrangements the gross against net answer often turns entirely on whether the unit assessed is the underlying good or the bundled service around it.
Local FAQs
Can an entity be a principal for a bundle but an agent for its components? Those are alternative conclusions from different Step 2 answers, not simultaneous conclusions. The specified good or service is either the bundle or the components, and IFRS 15.27 to 15.30 decides which.
Does the principal conclusion change the number of performance obligations? No. It changes the measurement of revenue for an obligation, gross or net, not the count. The count was fixed in Step 2.
Potential risks
The risk is inversion: deciding the desired gross or net outcome and then cutting the promises to support it. Because IFRS 15.B34 defines the specified good or service by reference to the distinct test, an entity that manipulates the Step 2 conclusion to reach a gross presentation has committed two errors, not one, and both are visible in the same working paper.
10. What does a Step 2 working paper need to contain to survive review and reassessment?
It needs the promise inventory with sources, the IFRS 15.25 exclusions, the limb (a) conclusion with its evidence, the limb (b) conclusion naming which IFRS 15.29 factor was found or not found and on what facts, the IFRS 15.30 combinations if any, and the fact that would change the answer. A conclusion that does not name the criterion or factor relied on cannot be reassessed, because there is nothing to reassess against.
The seven things the file has to be able to answer
- What did the entity promise? A list, with the source of each promise identified as contractual clause, statement of work, published policy or customary practice. IFRS 15.24 makes the last two mandatory inputs, so a list drawn only from the contract is incomplete on its face.
- What was excluded and why? The IFRS 15.25 filter applied item by item, with the reason recorded as "transfers no good or service to the customer" rather than as "immaterial" or "administrative".
- Is each promise capable of being distinct? One or two sentences per promise with the IFRS 15.28 evidence attached, most often a price list showing separate sale, or the identification of a third-party source.
- Is each promise separately identifiable? The IFRS 15.29 analysis, factor by factor, with the facts that support the answer. This is the part that has to be specific to the contract. "No significant integration service is provided" is an assertion. "The customer accepts each machine independently and payment for the first machine is not conditional on the second, so the entity is not delivering a combined output" is a conclusion.
- What combined, and with what? If IFRS 15.30 was applied, which promises were combined into which bundle, and why those and not others.
- What is the resulting count, and what would change it? A single named fact. If the file cannot identify one, the analysis has not been performed.
- Where does this sit in the disclosures? The judgement identified here is one that IFRS 15.123 may require to be disclosed, and the working paper should say whether it crosses that threshold.
"An entity shall disclose the judgements, and changes in the judgements, made in applying this Standard that significantly affect the determination of the amount and timing of revenue from contracts with customers. In particular, an entity shall explain the judgements, and changes in the judgements, used in determining both of the following: (a) the timing of satisfaction of performance obligations (see paragraphs 124-125); and (b) the transaction price and the amounts allocated to performance obligations (see paragraph 126)."
Read together with IFRS 15.119(a) and (c), which require information about when the entity typically satisfies its performance obligations and the nature of the goods or services promised, the disclosure requirement covers the Step 2 judgement directly. A material judgement about whether a bundle is one obligation or three affects both the amount and the timing of revenue, so where it is significant it has to be explained rather than merely stated.
The word "explain" is doing work. A policy note that states the entity identifies performance obligations in accordance with IFRS 15 has disclosed nothing. A note that says the group concluded that its implementation services do not significantly modify the licensed software and are therefore separate performance obligations, and that a different conclusion would move revenue from the year of delivery into the service period, has explained a judgement.
Why an unreferenced conclusion cannot be reassessed
The assessment is made at contract inception under IFRS 15.22 and is not revisited for ordinary changes in circumstance. But it is revisited when the contract is modified, because IFRS 15.20 and 15.21 require the remaining goods or services to be assessed for distinctness at the modification date, and the answer to that question drives whether the modification is accounted for as a separate contract, as a termination and replacement, or on a cumulative catch-up basis.
That reassessment is only possible if the original conclusion is legible. Suppose a file recorded that a licence and an implementation were one performance obligation "because the customer receives no benefit until go-live". Two years later the customer adds a second module and renegotiates. The reviewer now has to ask whether the remaining goods and services are distinct. The original memo gives no help, because the reason it recorded is not one of the criteria and has no counterpart in IFRS 15.20. If instead the file had recorded that IFRS 15.29(b) was present because the implementation rewrote the product's approval logic, the reassessment is straightforward: has the new module also been customised, or is it being delivered as a standard product alongside a build that is now complete? The original reference gives the reviewer a question to ask.
The same applies to the annual reassessment of estimates that feed off Step 2, such as expected redemption rates on material rights, and to the audit of the following year, where a different team has to understand a conclusion reached by people who have moved on. The reference is not decoration. It is what makes the file reusable.
| Unusable | Defensible |
|---|---|
| "The licence and implementation are a single performance obligation as the customer cannot use the software until implementation is complete." | "The licence and implementation are a single performance obligation. IFRS 15.27(a) is met for both. IFRS 15.27(b) is not met because IFRS 15.29(b) is present: the implementation rewrites the product's approval workflow and alters its data model, so the software delivered is significantly modified by the service. Evidence: change control log CR-114 to CR-162, and the delivery lead's confirmation dated 14 March. IFRS 15.30 therefore combines them. The conclusion would reverse if the scope were reduced to standard configuration only." |
| "Installation is not distinct because it is essential to the equipment working." | "Installation is a separate performance obligation. IFRS 15.27(a) is met because the equipment is sold separately at the list price attached and three named third-party firms perform this installation. No IFRS 15.29 factor is present: no combined output is specified, the equipment is unmodified, and the dependency is one way. Essentiality to the customer is not a criterion in IFRS 15.27." |
| "Each year of the service contract is a separate performance obligation." | "The five-year service is a single performance obligation under IFRS 15.22(b). Each month is distinct under IFRS 15.27. The monthly services are substantially the same because the promise is unchanged. IFRS 15.23(a) is met because each month would be satisfied over time under IFRS 15.35(a). IFRS 15.23(b) is met because hours delivered would measure progress for every month. Series treatment is therefore required, and the annual bonus is allocated under IFRS 15.85 to the year that earns it." |
Local FAQs
How often should the Step 2 conclusion be revisited? Not periodically. It is made at contract inception under IFRS 15.22 and reassessed on modification under IFRS 15.20 and 15.21. Where the entity uses standard contracts, the conclusion is reached once for the contract type and refreshed when the standard terms change.
Does a standard contract need a working paper for every customer? No, but it needs a working paper for the standard terms, plus a control that identifies non-standard contracts and routes them for individual assessment. The second half is the part that is usually missing.
Potential risks
The residual risk is documentation drift. A conclusion reached properly in the year of adoption is copied forward each year without anyone testing whether the underlying facts still hold. Delivery models change. Products that used to require code now expose configuration screens. Installation that used to be bespoke becomes a plug-in module. Each of those flips an IFRS 15.29 factor, and none of them announces itself to the finance team.
What have regulators said about disclosing the Step 2 judgement?
The FRC reviewed IFRS 15 disclosures in the first year of application and found that companies frequently identified that a judgement had been made without explaining how it was made. That is precisely the failure mode described in Unit 10, and IFRS 15.123 is the requirement it breaches.
In its thematic reviews of first-year IFRS 15 disclosures, the Financial Reporting Council examined how companies had implemented the standard's disclosure requirements, and one recurring observation on the disclosure of significant judgements was that companies frequently named a judgement, including judgements on whether revenue was recognised over time or at a point in time, without explaining how the conclusion was reached.
The observation is about timing rather than about Step 2 directly, but the defect it identifies is the same one and it transfers straight across. IFRS 15.123 requires an entity to disclose and explain the judgements that significantly affect the amount and timing of revenue. Naming the judgement is not explaining it. A company that says it exercises judgement in identifying performance obligations, without saying what the judgement was, which criterion it turned on, or what the alternative conclusion would have produced, has told the reader that a decision was made and nothing about how.
Applied to Step 2, an explanation that would satisfy IFRS 15.123 identifies the promises in the arrangement, states the conclusion on distinctness, and names the basis. For a bundled software contract that means saying whether the implementation services significantly modify the licensed software, and what follows from the answer. For a long-term service arrangement it means saying whether the series conditions in IFRS 15.23 are met and how variable consideration is consequently allocated. Neither takes more than a few sentences, and both give a reader something to work with.
Scope note. The FRC observation above is described rather than quoted verbatim, since the exact wording of the source thematic review was not available to verify against.
Five ways Step 2 goes wrong
- Justifying a single performance obligation by the fact that the customer waits. This is the error that prompted this article to be rewritten. A conclusion that custom software, or a supply and install contract, is one performance obligation "because the customer must wait for completion" cites nothing, because waiting appears nowhere in IFRS 15.27, IFRS 15.28 or IFRS 15.29. It is a Step 5 observation about the pattern of transfer, tested under IFRS 15.35 and IFRS 15.38. The correct reasoning names a factor. Bespoke development bundles usually are one obligation, but because IFRS 15.29(a) is present where the entity integrates design, build, configuration and migration into a combined output the customer specified, or because IFRS 15.29(b) is present where the build significantly modifies the licensed product. Equally, delivery plus installation is not always one obligation. Unit 5 sets out two versions of the same contract, one producing two obligations and one producing one, with the deciding fact identified.
- Scoring the IFRS 15.29 factors instead of applying them. The three factors are indicators that promises are not separately identifiable. One clearly present is enough to combine. Files that record "two of three factors are absent, therefore the promises are distinct" have inverted the paragraph, which contains no scoring mechanism and states an objective the factors merely serve.
- Reading IFRS 15.29 as a test of whether the goods can be separated. The paragraph asks whether the promise to transfer each good or service is separately identifiable, not whether the goods themselves are separable. Physically separable components routinely form one obligation because the entity has promised a combined output. The distinction is in the drafting and it changes answers.
- Treating the series guidance as an election. IFRS 15.22(b) is a requirement, not a policy choice. Where the promises are distinct, substantially the same, and both IFRS 15.23 conditions are met, the series is one performance obligation. Applying it where the conditions fail, or ignoring it where they hold, both misallocate variable consideration, because IFRS 15.75 keeps IFRS 15.84 to 15.86 available only for a genuine series.
- Promoting fees into promises. A separately invoiced activation, onboarding or mobilisation fee is not evidence of a performance obligation. IFRS 15.25 excludes activities that transfer nothing, and IFRS 15.B49 treats the related fee as an advance payment for the goods or services that are actually promised. The mirror error is demoting a promise because it is not separately priced, which is equally wrong: price and promise are independent questions, and a free item given as part of a bundle is still a promise.
Frequently asked questions on IFRS 15 performance obligations
What is a performance obligation under IFRS 15?
A performance obligation is defined in Appendix A of IFRS 15 as a promise in a contract with a customer to transfer to the customer either a good or service (or a bundle of goods or services) that is distinct, or a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer. IFRS 15.22 requires the assessment to be made at contract inception. The performance obligation is the unit of account, so it fixes what the transaction price is allocated to under IFRS 15.74 and what timing is tested under IFRS 15.31 and 15.38.
How do you identify performance obligations in IFRS 15 in practice?
Start with IFRS 15.24 and list every promise, explicit and implied, including promises created by customary business practices or published policies that give the customer a valid expectation. Strip out the activities that transfer nothing, which IFRS 15.25 excludes. Then run each remaining promise through the two criteria in IFRS 15.27. Where a promise fails either criterion, IFRS 15.30 requires it to be combined with other promises until a distinct bundle emerges.
What are the two criteria for a distinct good or service in IFRS 15.27?
IFRS 15.27(a) asks whether the customer can benefit from the good or service on its own or together with other resources that are readily available to the customer, which IFRS 15.28 expands. IFRS 15.27(b) asks whether the entity's promise to transfer the good or service is separately identifiable from other promises in the contract, which IFRS 15.29 expands through three factors. Both criteria must be met. In practice almost everything passes 27(a) and the answer is decided by 27(b).
Is a customer having to wait for completion evidence of a single performance obligation?
No. Timing is not one of the criteria in IFRS 15.27 and it does not appear anywhere in IFRS 15.28 or IFRS 15.29. A conclusion that a bundle is one performance obligation because the customer cannot use anything until the end confuses the unit of account in Step 2 with the pattern of transfer in Step 5. The correct reasoning names an IFRS 15.29 factor, normally the significant integration service in 15.29(a) or the significant customisation in 15.29(b).
Is custom software always a single performance obligation under IFRS 15?
Bespoke development bundles often are a single performance obligation, but the reason matters. The reason is usually IFRS 15.29(a), because the developer provides a significant service of integrating design, build, configuration and data migration into one combined output, or IFRS 15.29(b), because the licence is significantly modified by the development work. It is never because the customer waits for delivery. Where a standard licence is delivered first and the development work sits alongside it without changing it, two performance obligations can exist.
Are delivery and installation always one performance obligation?
No. Installation that is routine, that does not modify the equipment and that other suppliers could perform is normally a separate performance obligation, because IFRS 15.27(a) is met through readily available resources under IFRS 15.28 and none of the IFRS 15.29 factors is present. Installation that integrates the equipment into a larger system the customer has contracted for, or that significantly customises it, points to a single performance obligation under IFRS 15.29(a) or 15.29(b).
What is the series guidance in IFRS 15.22(b) and is it optional?
IFRS 15.22(b) treats a series of distinct goods or services that are substantially the same and that have the same pattern of transfer as one performance obligation. IFRS 15.23 sets both conditions: each distinct good or service in the series would meet the IFRS 15.35 criteria to be satisfied over time, and the same method of measuring progress under IFRS 15.39 and 15.40 would be used for each. It is not an accounting policy choice. Where the conditions are met, series treatment is required.
When is a customer option a performance obligation?
IFRS 15.B40 makes an option a performance obligation only where it provides a material right that the customer would not receive without entering into that contract, such as a discount incremental to the range of discounts typically given to that class of customer in that market. IFRS 15.B41 confirms that an option priced at stand-alone selling price is a marketing offer and is accounted for only when exercised. IFRS 15.B42 requires the stand-alone selling price of the option to reflect the discount and the likelihood of exercise.
Are assurance-type warranties separate performance obligations?
No. Where the customer cannot buy the warranty separately and it only assures that the product complies with agreed specifications, IFRS 15.B30 requires it to be accounted for under IAS 37 rather than as a performance obligation. A warranty the customer can buy separately is a distinct service under IFRS 15.B29 and is a performance obligation. A warranty that provides a service beyond that assurance is a performance obligation under IFRS 15.B32, and the factors in IFRS 15.B31 help identify it.
How does Step 2 affect principal versus agent under IFRS 15.B34?
IFRS 15.B34 requires the principal or agent assessment to be made for each specified good or service, and it defines a specified good or service as a distinct good or service or a distinct bundle of goods or services. That definition points straight back to IFRS 15.27 to 15.30. Until the promises have been identified and the distinct assessment has been done, there is nothing to test for control under IFRS 15.B34A, so Step 2 comes first and cannot be skipped.
Key takeaways
- Step 2 fixes the unit of account, and every later step is arithmetic performed on that answer. IFRS 15.22 makes the assessment at contract inception, and the count of performance obligations determines the allocation under IFRS 15.74, the timing under IFRS 15.31, the contract balances under IFRS 15.105 and the disclosures under IFRS 15.119 and 15.120.
- Both criteria in IFRS 15.27 must be met. Limb (a) is met by almost everything once IFRS 15.28 is read properly, because a readily available resource includes anything sold separately by anyone and anything the customer already holds, including items the entity will already have transferred under the same contract.
- Limb (b) decides the real cases. IFRS 15.29 asks whether the promise to transfer each item is separately identifiable, not whether the items are separable, and its three factors indicate only that promises are not separately identifiable. One factor clearly present is enough to combine under IFRS 15.30.
- Timing is not part of the distinct test. Whether the customer must wait is answered by IFRS 15.35 and IFRS 15.38 in Step 5. Bespoke software bundles are usually one performance obligation because of IFRS 15.29(a) or 15.29(b), and delivery plus installation can be one obligation or two depending on whether the entity is producing a combined output or modifying the equipment.
- The series guidance in IFRS 15.22(b) is mandatory where both IFRS 15.23 conditions hold, and it matters beyond convenience because IFRS 15.75 preserves IFRS 15.84 to 15.86, letting a performance-linked payment be allocated under IFRS 15.85 to the distinct period that earned it.
- A conclusion that does not name the criterion or factor relied on cannot be reassessed when the contract is modified under IFRS 15.20 and 15.21, and it cannot support the explanation IFRS 15.123 requires. The reference is what makes the working paper reusable.
About the Author
Usman is an ACCA-qualified member and an audit and financial reporting professional with a decade of Big 4 experience across Deloitte UK, PwC and BDO, currently an Assistant Manager in Deloitte UK's AI-enabled audit practice. He leads statutory and group audit engagements for multinational clients, with a portfolio in the £20m to £30m fee range and teams of 15 to 25 people across multiple jurisdictions. His technical work concentrates on the judgemental end of the accounting and audit standards. Sector exposure spans banking and financial services, automotive, technology, media and telecom, pharmaceuticals and healthcare, and private equity. Alongside audit delivery he advises CFOs and audit committees on adoption and disclosure decisions, and supports audit partners in forming audit opinions. He has coached more than 150 audit professionals to date, and delivers technical training on accounting and audit standards as well as on new AI tools. He also serves as an AI accelerator at Deloitte, testing new audit technology on live engagements, and built the AI platform behind this site. He writes here on the technical judgements that do not have a straightforward answer in the standards, adding an expert view formed in Big 4 practice.
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