Special issues for step 1: identifying the contract

Contract: an agreement that creates legally enforceable rights and obligations.

• 1. For the purposes of applying revenue recognition rules, a contract can be written, verbal, or implicit. [01]

  2. A seller must believe collectibility is probable for a contract to exist for purposes of revenue recognition. 

  3. A contract does NOT exist if:

     • Neither the seller nor the customer has performed any obligations under the contract and

     • both the seller and the customer can terminate the contract without penalty.

Special issues for step 2: identifying the performance obligations

• 1. Prepayments: these are not performance obligations (e.g., a registration fee for a gym membership).

     • Viewed as an advance payment for future products and services and included in the overall transaction price, which is then allocated to various performance obligations.

  2. Quality assurance warranties: obligation by the seller to make repairs or fix previously sold products; not sold separately. Therefore, NOT a performance obligation. 

  3. Extended warranties: an additional service that covers new problems arising after a customer takes control of a product; priced and sold separately. Therefore, is a performance obligation. 

  4. Options: seller give the customer the right to receive additional goods and services at no cost or at a discount (e.g., software upgrade). If the customer would not receive this right without making the original purchase, the option is a performance obligation. [02]