providing or receiving a significant benefit of financing. [IFRS 15.BC232].
Even if conditions in a contract would otherwise indicate that a significant financing
component exists, the standard includes several situations that the Board has determined
do not provide the customer or the entity with a significant benefit of financing. These
situations, as described in paragraph 62 of IFRS 15, include the following:
• The customer has paid for the goods or services in advance and the timing of the
transfer of those goods or services is at the discretion of the customer. In these
situations (e.g. prepaid phone cards, customer loyalty programmes), the Board
noted in the Basis for Conclusions that the payment terms are not related to a
financing arrangement between the parties and the costs of requiring an entity to
account for a significant financing component would outweigh the benefits
because an entity would need to continually estimate when the goods or services
will transfer to the customer. [IFRS 15.BC233].
• A substantial amount of the consideration promised by the customer is variable
and is based on factors outside the control of the customer or entity. In these
situations, the Board noted in the Basis for Conclusions that the primary purpose
of the timing or terms of payment may be to allow for the resolution of
uncertainties that relate to the consideration, rather than to provide the customer
or the entity with the significant benefit of financing. In addition, the terms or
timing of payment in these situations may be to provide the parties with assurance
of the value of the goods or services (e.g. an arrangement for which consideration
is in the form of a sales-based royalty). [IFRS 15.BC233].
• The difference between the promised consideration and the cash selling price of the
good or service arises for reasons other than the provision of financing to either the
customer or the entity (e.g. a payment is made in advance or in arrears in accordance
with the typical payment terms of the industry or jurisdiction). In certain situations,
the Board determined the purpose of the payment terms may be to provide the
customer with assurance that the entity will complete its obligations under the
contract, rather than to provide financing to the customer or the entity. Examples
include a customer withholding a portion of the consideration until the contract is
complete (illustrated in Example 28.44 at 6.5.1 below) or a milestone is reached, or an
entity requiring a customer to pay a portion of the consideration upfront in order to
secure a future supply of goods or services. See 6.5.2.A below for further discussion.
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As explained in the Basis for Conclusions, the Board decided not to provide an overall
exemption from accounting for the effects of a significant financing component arising
from advance payments. This is because ignoring the effects of advance payments may
skew the amount and timing of revenue recognised if the advance payment is significant
and the purpose of the payment is to provide the entity with financing. [IFRS 15.BC238].
For example, an entity may require a customer to make advance payments in order to
avoid obtaining the financing from a third party. If the entity obtained third-party
financing, it would likely charge the customer additional amounts in order to cover the
finance costs incurred. The Board decided that an entity’s revenue should be consistent
regardless of whether it receives the significant financing benefit from a customer or
from a third party because, in either scenario, the entity’s performance is the same.
In order to conclude that an advance payment does not represent a significant financing
component, we believe that an entity needs to support why the advance payment does
not provide a significant financing benefit and describe its substantive business
purpose.77 As a result, it is important that entities analyse all of the relevant facts and
circumstances. Example 28.46 at 6.5.1 below illustrates an entity’s determination that a
customer’s advance payment represents a significant financing component.
Example 28.47 at 6.5.1 below illustrates an entity’s determination that a customer’s
advance payment does not represent a significant financing component.
The assessment of significance is made at the individual contract level. As noted in the
Basis for Conclusions, the Board decided that it would be an undue burden to require
an entity to account for a financing component if the effects of the financing component
are not significant to the individual contract, but the combined effects of the financing
components for a portfolio of similar contracts would be material to the entity as a
whole. [IFRS 15.BC234].
When an entity concludes that a financing component is significant to a contract, in
accordance with paragraph 64 of IFRS 15, it determines the transaction price by
applying an interest rate to the amount of promised consideration. The entity uses the
same interest rate that it would use if it were to enter into a separate financing
transaction with the customer at contract inception. The interest rate needs to reflect
the credit characteristics of the borrower in the contract, which could be the entity or
the customer, depending on who receives the financing. Using the risk-free rate or a
rate explicitly stated in the contract that does not correspond with a separate financing
rate would not be acceptable. [IFRS 15.BC239]. While not explicitly stated in the standard,
we believe an entity would consider the expected term of the financing when
determining the interest rate in light of current market conditions at contract inception.
In addition, paragraph 64 of IFRS 15 is clear that an entity does not update the interest
rate for changes in circumstances or market interest rates after contract inception.
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The standard requires that the interest rate be a rate similar to that the entity would
have used in a separate financing transaction with the customer. Because most entities
are not in the business of entering into free-standing financing arrangements with their
customers, they may find it difficult to identify an appropriate rate. However, most
entities perform some level of credit analysis before financing purchases for a customer,
so they likely have some information about the customer’s credit risk. For entities that
have different pricing for products depending on the time of payment (e.g. cash
discounts), the standard indicates that the appropriate interest rate, in some cases, could
be determined by identifying the rate that discounts the nominal amount of the
promised consideration to the cash sales price of the good or service.
Entities likely have to exercise significant judgement to determine whether a significant
financing component exists when there is more than one year between the transfer of
goods or services and the receipt of contract consideration. Entities should consider
sufficiently documenting their analyses to support their conclusions.
6.5.1
Examples of significant financing components
The standard includes the following examples to illustrate these concepts.
Example 28.43 illustrates a contract t
hat contains a significant financing component
because the cash selling price differs from the promised amount of consideration and
there are no other factors present that would indicate that this difference arises for
reasons other than financing. In this example, the contract also contains an implicit
interest rate that is determined to be commensurate with the rate that would be
reflected in a separate financing transaction between the entity and its customer at
contract inception, as follows. [IFRS 15.IE135-IE140].
Example 28.43: Significant financing component and right of return
An entity sells a product to a customer for CU121 that is payable 24 months after delivery. The customer
obtains control of the product at contract inception. The contract permits the customer to return the product
within 90 days. The product is new and the entity has no relevant historical evidence of product returns or
other available market evidence.
The cash selling price of the product is CU100, which represents the amount that the customer would pay
upon delivery for the same product sold under otherwise identical terms and conditions as at contract
inception. The entity’s cost of the product is CU80.
The entity does not recognise revenue when control of the product transfers to the customer. This is because
the existence of the right of return and the lack of relevant historical evidence means that the entity cannot
conclude that it is highly probable that a significant reversal in the amount of cumulative revenue recognised
will not occur in accordance with paragraphs 56-58 of IFRS 15. Consequently, revenue is recognised after
three months when the right of return lapses.
The contract includes a significant financing component, in accordance with paragraphs 60-62 of IFRS 15.
This is evident from the difference between the amount of promised consideration of CU121 and the cash
selling price of CU100 at the date that the goods are transferred to the customer.
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The contract includes an implicit interest rate of 10 per cent (i.e. the interest rate that over 24 months
discounts the promised consideration of CU121 to the cash selling price of CU100). The entity evaluates the
rate and concludes that it is commensurate with the rate that would be reflected in a separate financing
transaction between the entity and its customer at contract inception. The following journal entries illustrate
how the entity accounts for this contract in accordance with paragraphs B20-B27 of IFRS 15.
• When the product is transferred to the customer, in accordance with paragraph B21 of IFRS 15:
Asset for right to recover product to be returned
CU80(a)
Inventory CU80
(a) This
example does not consider expected costs to recover the asset.
• During the three-month right of return period, no interest is recognised in accordance with paragraph 65
of IFRS 15 because no contract asset or receivable has been recognised.
• When the right of return lapses (the product is not returned):
Receivable CU100(a)
Revenue CU100
Cost of sales
CU80
Asset for product to be returned
CU80
(a) The receivable recognised would be measured in accordance with IFRS 9. This example assumes
there is no material difference between the fair value of the receivable at contract inception and the
fair value of the receivable when it is recognised at the time the right of return lapses. In addition, this
example does not consider the impairment accounting for the receivable.
Until the entity receives the cash payment from the customer, interest revenue would be recognised in
accordance with IFRS 9. In determining the effective interest rate in accordance with IFRS 9, the entity would
consider the remaining contractual term.
Example 28.43 also illustrates the requirement in paragraph 65 of IFRS 15, which
provides that interest income or interest expense is recognised only to the extent that a
contract asset (or receivable) or a contract liability is recognised in accounting for a
contract with a customer. See further discussion in 6.5.3 below.
In Example 28.44, the difference between the promised consideration and the cash
selling price of the good or service arises for reasons other than the provision of
financing. In this example, the customer withholds a portion of each payment until the
contract is complete in order to protect itself from the entity failing to complete its
obligations under the contract, as follows. [IFRS 15.IE141-IE142].
Example 28.44: Withheld payments on a long-term contract
An entity enters into a contract for the construction of a building that includes scheduled milestone payments for
the performance by the entity throughout the contract term of three years. The performance obligation will be
satisfied over time and the milestone payments are scheduled to coincide with the entity’s expected performance.
The contract provides that a specified percentage of each milestone payment is to be withheld (i.e. retained) by
the customer throughout the arrangement and paid to the entity only when the building is complete.
The entity concludes that the contract does not include a significant financing component. The milestone
payments coincide with the entity’s performance and the contract requires amounts to be retained for reasons
other than the provision of finance in accordance with paragraph 62(c) of IFRS 15. The withholding of a
specified percentage of each milestone payment is intended to protect the customer from the contractor failing
to adequately complete its obligations under the contract.
Example 28.45 illustrates two situations. [IFRS 15.IE143-IE147]. In Case A, a contractual
discount rate reflects the rate in a separate financing transaction. In Case B, it does not.
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Example 28.45: Determining the discount rate
An entity enters into a contract with a customer to sell equipment. Control of the equipment transfers to the
customer when the contract is signed. The price stated in the contract is CU1 million plus a five per cent
contractual rate of interest, payable in 60 monthly instalments of CU18,871.
Case A – Contractual discount rate reflects the rate in a separate financing transaction
In evaluating the discount rate in the contract that contains a significant financing component, the entity
observes that the five per cent contractual rate of interest reflects the rate that would be used in a separate
financing transaction between the entity and its customer at contract inception (i.e. the contractual rate of
interest of five per cent reflects the credit characteristics of the customer).
The market terms of the financing mean that the cash selling price of the equipment is CU1 million. This
amount is recognised as revenue and as a loan receivable when control of the equipment transfers to the
customer. The entity accounts for the receivable in accordance with IFRS 9.
Case B – Contractual discount rate does not reflect the rate in a separate financing transaction
In evaluating the discount rate in the contract that contains a significant financing component, the entity
observes that the five per cent contractual rate of interest is significantly lower than the 12 per cent interest
rate that would be used in a separate financing transaction between the entity
and its customer at contract
inception (i.e. the contractual rate of interest of five per cent does not reflect the credit characteristics of the
customer). This suggests that the cash selling price is less than CU1 million.
In accordance with paragraph 64 of IFRS 15, the entity determines the transaction price by adjusting the
promised amount of consideration to reflect the contractual payments using the 12 per cent interest rate
that reflects the credit characteristics of the customer. Consequently, the entity determines that the
transaction price is CU848,357 (60 monthly payments of CU18,871 discounted at 12 per cent). The entity
recognises revenue and a loan receivable for that amount. The entity accounts for the loan receivable in
accordance with IFRS 9.
Example 28.46 illustrates a contract with an advance payment from the customer that
the entity concludes represents a significant benefit of financing. It also illustrates a
situation in which the implicit interest rate does not reflect the interest rate that would
be used in a separate financing transaction between the entity and its customer at
contract inception, as follows. [IFRS 15.IE148-IE151].
Example 28.46: Advance payment and assessment of discount rate
An entity enters into a contract with a customer to sell an asset. Control of the asset will transfer to the
customer in two years (i.e. the performance obligation will be satisfied at a point in time). The contract
includes two alternative payment options: payment of CU5,000 in two years when the customer obtains
control of the asset or payment of CU4,000 when the contract is signed. The customer elects to pay CU4,000
when the contract is signed.
The entity concludes that the contract contains a significant financing component because of the length of
time between when the customer pays for the asset and when the entity transfers the asset to the customer, as
well as the prevailing interest rates in the market.
The interest rate implicit in the transaction is 11.8 per cent, which is the interest rate necessary to make the
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 421
