Definition
A performance obligation is a promise in a contract to transfer to the customer either a distinct good or service or a series of distinct goods or services that are substantially the same with the same pattern of transfer. A good or service is distinct if the customer can benefit from it on its own or with readily available resources, and the promise is separately identifiable from other promises in the contract. Customers' options for additional goods and services can also be separate obligations if they provide a material right.
Why it matters in an audit or review
Identifying obligations drives the timing of revenue and the allocation of transaction price. Bundled software, installation, and support arrangements are common areas of error. Auditors read contracts, challenge management's distinct analysis, and confirm that revenue is recognized when or as control passes for each obligation. Disclosure of remaining performance obligations may apply, subject to practical expedients.
Example
(Illustrative) A company sells equipment for $90,000 with installation that others can perform and a one-year maintenance plan. If the customer can benefit from each item on its own and the installation does not significantly customize or integrate with the equipment, there are three performance obligations: equipment (point in time), installation, and maintenance (over time).
Common mistakes
- Treating a bundle as one obligation to recognize everything on delivery.
- Missing a material right in renewal pricing.
Sources
- FASB ASC 606-10-25-14 through 25-22 (identifying performance obligations; distinct goods or services)
- FASB ASC 606-10-55-42 through 55-43 (customer options that provide a material right)
- FASB ASC 606-10-50-13 (remaining performance obligations)
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error