This is an example in a small series for illustrating the concepts in What is a good or service that is distinct?
The scenarios in the following example demonstrates how two transactions which are substantively very similar but have different legal contract structures are accounted for in the same way (illustrating how the accounting is not affected by the legal form of the arrangements and instead focuses on the promises made by a vendor to its customer), and how subtle changes in the facts and circumstances can affect the assessment of whether two promises in a contract are separately identifiable (i.e. distinct within the context of the contract).
Entity PD, a property development company, contracts with Entity PI a property investment company to:
- Sell a piece of land currently owned by PD; and Identify Property development obligations – Additional claus
- Construct a property on the land. Identify Property development obligations – Additional claus
In this scenario, the fact pattern is the same as for scenario B, except that the contract contains an additional clause which states that if PD fails to perform as contractually required in respect of the building construction, PI will have the right to transfer title of the land back to PD for a full refund and also have recourse for damages.
PD concludes that in this case, the contract is for the supply of a single product – a building on the specified piece of land, and therefore there is a single performance obligation. The risks PD is assuming by transferring land are not separable from the risks assumed in constructing the building. This would also be the case even if the arrangement had been structured as two separate legal contracts as in scenario A.