What is a performance obligation?
A performance obligation is a promise in a contract to transfer a distinct good or service, or a series of substantially the same distinct goods or services, to the customer. Under ASC 606 it is the unit of account: each obligation receives its share of the price and is recognised when, or as, it is satisfied.
How to tell if a promise is distinct
A promise is an obligation of its own only when both tests hold. If either fails, it is combined with other promises until the bundle is distinct.
- (a)
Capable of being distinct
The customer can benefit from it on its own, or together with resources it already has or can readily obtain. - (b)
Distinct in the context of the contract
It is separately identifiable: not an input to a combined output, not a significant change to another promise, and not highly dependent on the others.
A worked example
In the illustrative example, Clevis Comfrey Inc's $480,000 contract, CTR-2214, carries 4 obligations, and each is satisfied on its own pattern. Four months in, their deferred balances have moved apart.
| Operation | Line | Figure |
|---|---|---|
| Platform, satisfied over time at $13,000 a month | $260,000 | |
| + | Implementation, satisfied at a point in time in March | $0 |
| + | Premium support, satisfied over time at $2,400 a month | $48,000 |
| + | Training credits, satisfied as each session is held | $16,800 |
| = | Still deferred at 30 June | $324,800 |
Treated as one obligation, the $84,000 implementation would have been spread over 24 months instead of recognised in March, when it was delivered.
Common mistakes
Splitting by invoice line
An order form's lines are a pricing layout, not a list of obligations. Two lines that only work together are one obligation, and one line can hold 2.Missing the implied promises
A promise made by customary practice or in a statement of work counts too, such as training or a support commitment, even when no line on the order form prices it.Splitting a monthly service into many obligations
A subscription delivered the same way each month is a series: one obligation satisfied over time, not a new obligation every month.
How Verlix handles it
The Contract agent reads each promise in the signed agreement as an obligation of its own, for a person to review. The Revenue agent then gives every obligation its own schedule, so a point-in-time service and a ratable platform fee never share one.
ASC 606 revenue recognitionRelated terms
ASC 606
The US standard for recognising revenue from customer contracts, in 5 steps.Standalone selling price
What each promise would sell for alone, the basis for allocating a contract's price.Deferred revenue
Billed or collected but not yet earned, a liability until the work is done.