Identifying performance obligations in a contract

A performance obligation is a promise in a contract to transfer a distinct good or service, or a series of substantially the same services. Under FRS 102 paragraph 23.21 a promise is distinct only if the customer can benefit from it on its own or with readily available resources and it is separately identifiable from the other promises in the contract. If either test fails, the item is bundled with other promises until a distinct package is found.

Why does identifying performance obligations decide the revenue answer?

Step 2 of the five step model sets the unit of account. Each performance obligation gets its own share of the price and its own recognition pattern, so splitting a contract into two obligations can move revenue between years, while treating a bundle as one obligation can defer revenue until the whole package is delivered. The revised Section 23 applies to periods beginning on or after 1 January 2026 (paragraph 1.37(b)).

The assessment is made at contract inception (paragraph 23.17). Paragraph 23.19 adds that promises are not limited to the written contract: customary business practices, published policies or specific statements can create implied promises if they give the customer a valid expectation. Free annual check ups that a business always provides, even when the contract is silent, may therefore be a performance obligation.

What does not count as a promise?

Paragraph 23.20 excludes activities the business must carry out to fulfil a contract that do not themselves transfer a good or service to the customer. Set up work, onboarding and internal administration are typical examples. A set up fee charged for them is not revenue on day one; paragraph 23.30 treats a non refundable upfront fee for such activities as an advance payment for the future goods or services. Our page on subscriptions and licences covers joining and set up fees in more depth.

Is the good or service capable of being distinct?

The first test in paragraph 23.21(a) asks whether the customer could benefit from the item on its own or together with other readily available resources. Paragraph 23.22 makes this straightforward for items the business regularly sells separately: they automatically pass. Readily available resources include anything sold separately by the business or anyone else, and anything the customer has already obtained, including items delivered earlier under the same contract (paragraph 23.23). A replacement part that only works with a machine the customer already owns can still be capable of being distinct.

Is the promise separately identifiable?

The second test, paragraph 23.21(b), asks whether the business is really promising to transfer the item individually or is using it as an input to a combined output. Paragraph 23.24 gives three indicators that items are not separately identifiable:

• Significant integration. The business integrates the items into the combined output the customer contracted for. A construction contract where the contractor co ordinates the various tasks needed to build an asset is the standard’s example.
• Significant modification or customisation. One item significantly modifies or customises another, such as existing software plus a service that significantly customises it.
• High interdependence. Each item is significantly affected by the others, so the business could not fulfil its promise by transferring each one independently.

The list is not exhaustive, and the question is about the nature of the promise in the context of the contract, not whether the items are delivered at the same time.

How are warranties and customer options treated?

A warranty that only assures the product meets agreed specifications is accounted for under Section 21 as a provision, not as a performance obligation (paragraph 23.27). If the warranty also provides an additional service, that service is a separate obligation (paragraph 23.28). The factors are whether the warranty can be bought separately, whether it is required by law, how long it lasts, and what tasks the business promises. A warranty that customers can choose to buy separately always provides an additional service.

Options for additional goods or services at a discount are a separate obligation only if they give a material right the customer would not otherwise receive (paragraph 23.31). Loyalty points, sales incentives and renewal discounts are the usual examples (paragraph 23.32); an option priced at the normal standalone selling price is not. See customer loyalty schemes.

When is a series treated as a single obligation?

Paragraph 23.17(b) treats a series of distinct goods or services that are substantially the same and have the same pattern of transfer as one obligation. Paragraph 23.18 requires that each item in the series would be satisfied over time and that the same progress measure would be used for each. Monthly payroll processing or a daily cleaning contract usually fits. This keeps the accounting simple: one obligation recognised over the contract period rather than hundreds of separate monthly promises.

How does this apply to an IT services contract?

Illustration only. An IT firm agrees to supply 20 standard laptops, install standard office software and provide 12 months of helpdesk support for one price.

• The laptops are sold separately by many suppliers and are not modified, so they are distinct.
• Installation of standard software is a service other providers could perform and does not significantly change the laptops, so it is distinct.
• Helpdesk support is sold separately and is a series of similar daily services, so it is one obligation satisfied over 12 months.

The result is three obligations. Change the facts so the firm builds a bespoke stock control system that requires it to significantly customise the software and integrate it with the client’s hardware, and the hardware, software and customisation are probably one combined obligation under paragraph 23.24. Revenue then follows progress on the combined system rather than delivery of the laptops.

Does it change gross or net revenue?

Where another party is involved, the business decides for each obligation whether it is a principal or an agent (paragraph 23.36). A principal controls the specified good or service before it is transferred (paragraph 23.37) and records gross revenue; an agent records only its fee or commission (paragraph 23.40). See principal or agent.

What mistakes come up most often?

• Treating every line on the invoice as a separate obligation without applying paragraph 23.24.
• Treating set up or onboarding as a service delivered to the customer.
• Ignoring implied promises such as free servicing or upgrades that customers have come to expect.
• Treating every warranty as a separate service, or none of them.
• Reassessing obligations each year; the assessment is made at inception and changes only through a contract modification.

Solar Protect provides tax investigation insurance for businesses and fee protection schemes for accountancy practices. Read how our cover works or get a quote.

Related Accountapedia entries

• Allocating price across bundled goods and services
• Warranties: separate service or provision
• IFRS 15 revenue from contracts with customers
• Turnover recognition under FRS 105
• Revenue recognised over time for contracts

Sources

• Financial Reporting Council: FRS 102 September 2024 tmKYWO6

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.