Question

• Entity M, a parts supplier, enters into contract with an OEM (i.e., M’s customer) for fixed consideration of $30 million to (1) construct equipment for the customer that M will use to make parts for the customer and (2) supply 30 million parts to the customer.

• Legal title of the equipment transfers to the customer upon completion of the construction of the equipment (i.e., prior to M beginning production of the parts).

• M is one of many companies that have the ability to both construct the equipment and subsequently produce the parts.

How many performance obligations does the contract have? Explain.

Answer 1

A performance obligation is defined as a promise to provide a “distinct” good or service to a customer. If there exists multiple promises in a contract, companies need to determine whether those goods or services are distinct, and therefore separate performance obligations.

Revenue is recognised when or as each separate performance obligations is satisfied. Performance obligations are satisfied when control of the good or service is transferred to the customer.

In the extant case, the contarct has two Performance obligations since there exists two distinct obligations i.e

1) to construct equipment for the customer that M will use to make parts for the customer and

(2) to supply 30 million parts to the customer.

Revenue from sale of equipment will be recognised when the Legal title of the equipment transfers to the customer upon completion of the construction of the equipment

Revenue from supply 30 million parts to the customer will be recognised as and when when control of the goods gets transferred to the customer.

The total contract price is allocated to different performance obligations based on the relative standalone selling price of each distinct performance obligation.