Step 2 of Revenue Recognition: Identify Performance Obligations

According to the Financial Accounting Standards Board’s (FASB’s) Revenue from Contracts with Customers (referred to hereafter as “the standard”), there are five steps to the revenue recognition process. In this article, we discuss the second step of recognizing revenue: identifying performance obligations.

Performance Obligations Basics

A performance obligation is a contracted party’s promise to transfer a good or service to a customer. This promise may be either implied or explicitly stated in the contract. Identifying these obligations is crucial because doing so could affect when and how much of the allocated revenue of each identified performance obligation will be recognized.

One factor that impacts when recognition occurs is the time frame in which the contracted party fulfills the performance obligation. The standard notes that allocated revenue for a performance obligation may be recognized over a period of time – as opposed to at a point in time – if the obligation satisfies certain criteria. One criterion is that the contracted party’s “performance creates or enhances an asset (for example, work in progress) that the customer controls as the asset is enhanced or created.” For instance, when a construction company has a contract to construct a building on the customer’s land, the customer generally controls any work in progress resulting from the construction company’s performance, indicating that the project is being transferred to the customer over time.

Recognizing Intellectual Property Revenue

A specific type of performance obligation worth mentioning is a license on intellectual property. When to recognize revenue from a license depends on a number of factors, one of which is the type of intellectual property – functional or symbolic – the license covers.

1. Functional intellectual property.
A license of functional intellectual property allows a customer to use the property without requiring continuous maintenance or support from the licensor. One example of such property is accounting software that helps a business manage its finances. Because the licensor does not have to provide ongoing service during the license period, revenue from this property type may be recognized at a point in time.

2. Symbolic intellectual property.
With symbolic intellectual property – such as brands, logos, and sports team names – the licensor must continuously maintain value of its property during the license period. For instance, a restaurant may have a license to use a basketball team’s logo for a specific promotion. If the team does little to uphold its own value, then its logo could be detrimental to the restaurant’s promotion. Given the licensor’s ongoing responsibilities, revenue from this type is recognized over a period of time.

CRI Can Guide You on the Winding Path

It may seem as though the revenue recognition maze has plenty of “blind alleys,” but CRI is here to help you steer clear of dead ends. Contact us if you need assistance identifying performance obligations in your contracts.