4.5.2.4 Allocating consideration to separate performance obligation (Step 4)

Under the proposed rules, under Step 4 an entity shall allocate a discount entirely to one (or some) separate performance obligation(s) in the contract if both of the following criteria are met:

The above seems to imply that if, for example, a supermarket would offer a crate of beer that includes a ‘free beer glass’, and where that supermarket would not sell that beer glass on a stand-alone basis, the ‘discount’ cannot be allocated to the beer glass. However, if the beer glass is not considered a ‘performance obligation’ but rather a ‘marketing incentive’, this is different, because in that case the accountancy rules hold that the free supplies are treated as marketing costs, which implies that no revenue should be allocated to these transactions or elements, making them separate supplies that are made free of charge (I will elaborate on this later in this Section). It is not always clear how to determine whether a supply should be considered a ‘performance obligation’ or a ‘marketing incentive’.

In an appendix containing application guidance to the proposed rules, the Section ‘Customer options for additional goods or services’ includes guidance on the acquisition of additional goods or services for free.1 The fact that in this section, specific reference is made to the paragraphs in the proposed rules that regard the allocation of the transaction price to separate performance obligations2 means that the supply of these free goods can be considered separate performance obligations, if the supply meets the relevant requirements (see above).

The fact that the supply of free goods and services can indeed qualify as separate performance obligations is also supported by the considerations of the Boards of IASB (and FASB) in developing the proposed rules.3In the section about marketing incentives, incidental obligations, and perfunctory obligations, the Boards included the following (deletions and underlining by me, JB):4

“Some respondents to the (…) proposed Update suggested that an entity should account for some promised goods or services as marketing expenses or as incidental obligations even though those promises meet the definition of a performance obligation. Examples of such promised goods or services include “free” handsets provided by telecommunication entities (…). Those respondents thought that revenue should be recognized only for the main goods or services for which the customer has contracted and not for the marketing incentives and other incidental obligations.

When a customer contracts with an entity for a bundle of goods or services, it can be difficult and subjective for the entity to identify the ‘main’ goods or services for which the customer has contracted. In addition, the outcome of that assessment could vary significantly depending on whether an entity performs the assessment from the perspective of its business model or from the perspective of the customer. Consequently, the Boards decided that all goods or services promised to a customer as a result of a contract are performance obligations because they are part of the negotiated exchange between the entity and its customer. Although the entity might consider those goods or services to be marketing incentives or incidental goods or services, they are goods or services for which the customer pays and to which the entity should allocate consideration for purposes of revenue recognition. In contrast to performance obligations in a contract, marketing incentives are provided independently of the contract that the incentives are designed to secure. (...)”5

It is clear from the above that for accounting purposes, a difference exists in the (proposed) rules regarding the supply of free goods and services as part of an ‘overall’ agreement, in which case these free supplies should be considered separate performance obligations and part of the consideration should be allocated to these free elements, and the free goods and services that are supplied independently of the contract that these incentives are designed to secure. In the latter case, the free supplies are qualified as ‘marketing incentives’ that are treated as marketing costs, which implies that no revenue should be allocated to these transactions or elements.

The relevant section in the Background Information to the proposed rules confirms that the decisive factor for determining whether a free supply qualifies as a performance obligation or a marketing or promotional offer is whether that supply is based on a contractual promise to transfer a good or service to the customer.6

It seems that under the above accounting rules, part of the consideration for a multiple-element transaction is always allocated to elements that are advertised as ‘free supplies’ in a multiple-element transaction as long as these elements are explicitly included in the agreement governing the multiple-element transaction and as long as the supplies do not qualify as marketing incentives as defined in the relevant (proposed) rules, i.e. never part of the contract but supplied to secure a(nother) contract.

These rules seem very similar to the EU VAT rules on this subject. Looking at the CJEU Kuwait Petroleum case,7 the vouchers (and redemption goods) given away by the fuel company seem to qualify as ‘marketing incentives’ because, in my view as confirmed by the CJEU, the supply of the vouchers is not ‘paid for as part of the (existing) contract regarding the supply of fuel’ and therefore the revenue for the sale of the fuel should not be allocated to these goods.

As another example, the supply of a ‘free’ telephone with a telephone subscription does, in my view, not qualify as a ‘marketing incentive’. The supply is part of the existing contract/part of the agreement and therefore, part of the consideration paid/received for this multiple-element transaction should be allocated to the supply of that telephone. However, in my view, free supplies can also be qualified as ‘marketing incentives’ if they are part of the same supply that is contractually agreed as the ‘main supply’. This is currently reflected in the FASB accounting rules that I will describe in Section 4.5.2.5.

Because the proposed rules are not completely clear about the difference between ‘performance obligations’ and ‘marketing incentives’ and because part of the consideration paid for a multiple-element supply consisting of multiple performance obligations should be allocated to all performance obligations, even if advertised as ‘free’, in my view, these proposed rules are not suited for determining the VAT treatment of multiple-element supplies since they do not properly reflect ‘economic and commercial reality’ as an EU VAT concept.