Question

Describe the critical factor in evaluating whether a performance obligation is satisfied.

Short answer

Change in control is the deciding factor in determining when a performance obligation is satisfied. The customer controls the product or service when it can direct the use of and obtain all the remaining benefits from the asset or service substantially.

Step-by-step solution

Introduction to Revenue Criteria

1. The customer receives and consumes the benefits as the seller performs.
2. The customer controls the asset as it is created or enhanced

Example- builder constructs a building on a customer’s property).

1. The company does not have an alternative use for the asset created or enhanced

Example -an aircraft manufacturer builds speciality jets to a customer’s specifications) and either

(a) the customer receives benefits as the company performs, and therefore, the task

would not need to be re-performed,

(b) the company has a right to payment, and this right is enforceable.

Methods to measure performance obligation

Companies use various methods to determine the extent of progress toward completion. The most common are the cost-to-cost and units-of-delivery methods. The objective of all these methods is to measure the extent of progress in terms of costs, units, or value-added.

A company recognizes revenue from a performance obligation over time by measuring the progress toward completion. The method selected for measuring progress should depict the transfer of control from the company to the customer.

For many service arrangements, revenue is recognized on a straight-line basis because the performance obligation is being satisfied over the contract period.