Final answer:
Multiple performance obligations in a revenue arrangement must be accounted for separately if they are distinct and separately identifiable. This ensures that revenue is recognized accurately and reflects the transfer of goods or services per the financial reporting standards.
Step-by-step explanation:
When dealing with revenue recognition, multiple performance obligations in a revenue arrangement must be accounted for separately if the goods or services are distinct, meaning the customer can benefit from the good or service on its own or together with other resources that are readily available to the customer, and the entity's promise to transfer the goods or service to the customer is separately identifiable from other promises in the contract. This is based on the standards set forth by the Financial Accounting Standards Board (FASB) and the International Financial Reporting Standards (IFRS).
In practice, this means that when a contract with a customer includes multiple promises, each promise needs to be evaluated to determine if it represents a separate performance obligation. For example, if a software company sells a software license along with a one-year customer support contract, these would typically be accounted for as two separate performance obligations because they each deliver distinct value to the customer.
The criteria for separately identifying performance obligations are important to ensure that revenue is recognized in a way that accurately reflects the transfer of goods or services to the customer. Companies must apply judgement and consider the specific facts and circumstances of each contract to properly identify performance obligations and recognize revenue accordingly.