How to separate performance obligations in bundled contracts
- Graziano Stefanelli
- Sep 16
- 3 min read
Bundled contracts often include multiple deliverables—such as goods, services, warranties, or software—sold as a single package. Under IFRS 15 and ASC 606, companies must identify whether these deliverables are distinct performance obligations, which determines how revenue is allocated and recognized. Failing to separate them properly can result in misstated revenues and misaligned timing of earnings. The core principle is to unbundle the contract when components are capable of being distinct and separately beneficial to the customer.
A contract must be analyzed to identify all promised goods or services.
The first step under IFRS 15 and ASC 606 is to assess the contract with a customer and identify all the promised goods and services. These may include:
Tangible products
Installation or setup services
Software licenses
Technical support or updates
Training services
Extended warranties
Not every promise results in a separate performance obligation. Promises must be explicit or implied by customary business practices or marketing materials.
Performance obligations are separate if they are distinct in context and benefit.
To determine whether a good or service is a distinct performance obligation, both of the following criteria must be met:
Capable of being distinct: The customer can benefit from the good or service either on its own or together with other readily available resources.
Distinct within the context of the contract: The promise to transfer the good or service is separately identifiable from other promises in the contract.
If both conditions are met, the component must be accounted for separately.
If not distinct, the goods and services are combined into a single obligation.
If a promised good or service is not distinct, it must be combined with other goods or services until a distinct bundle is identified. This means the entire package is treated as one obligation, and revenue is recognized as the combined performance is satisfied.
Example:
A company sells specialized machinery and provides customization that integrates the equipment into the client’s systems.
Machinery: not usable on its own
Customization: essential for integration
Result: combined into one performance obligation
Revenue is recognized over time if the criteria for progress-based recognition are met.
Transaction price is allocated based on standalone selling prices.
Once the performance obligations are identified, the total transaction price must be allocated among them based on relative standalone selling prices (SSPs).
If observable prices are not available, estimates may be made using:
Adjusted market assessment
Expected cost plus margin
Residual approach (limited use)
Example:
A bundled contract includes:
Each element’s revenue is recognized based on its own delivery pattern—hardware at point in time, software upon license transfer, and support over time.
Revenue is recognized separately for each obligation as control is transferred.
Once allocated, revenue is recognized when (or as) each performance obligation is satisfied:
Point-in-time recognition: For goods or licenses delivered immediately
Over-time recognition: For services or continuous support
Each obligation must have its own pattern of revenue recognition, which improves transparency and consistency.
Disclosures are required for disaggregated performance obligations.
IFRS and US GAAP require entities to disclose:
The nature and timing of performance obligations
Significant judgments in identifying them
Methods used to determine standalone prices
Disaggregation of revenue (e.g., by geography, product line, contract type)
This enhances the clarity of revenue streams and how bundled contracts are structured and executed.
Proper separation of performance obligations in bundled contracts ensures accurate revenue timing, better operational insights, and compliance with IFRS 15 and ASC 606. Whether selling a product with upgrades, services, or additional licenses, the ability to distinguish and allocate obligations is key to aligning accounting with the economics of the deal.
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