International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

by International GAAP 2019 (pdf)

  two alternative payment options economically equivalent. However, the entity determines that, in accordance

  with paragraph 64 of IFRS 15, the rate to be used in adjusting the promised consideration is six per cent,

  which is the entity’s incremental borrowing rate.

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  The following journal entries illustrate how the entity would account for the significant financing component:

  • recognise a contract liability for the CU4,000 payment received at contract inception:

  Cash CU4,000

  Contract liability

  CU4,000

  • during the two years from contract inception until the transfer of the asset, the entity adjusts the promised

  amount of consideration (in accordance with paragraph 65 of IFRS 15) and accretes the contract liability

  by recognising interest on CU4,000 at six per cent for two years:

  Interest expense

  CU494(a)

  Contract liability

  CU494

  (a) CU494 = CU4,000 contract liability × (6 per cent interest per year for two years).

  • recognise revenue for the transfer of the asset:

  Contract liability

  CU4,494

  Revenue CU4,494

  In Example 28.47, involving a contract with an advance payment from the customer, the

  entity determines that a significant financing component does not exist because the

  difference between the amount of promised consideration and the cash selling price of

  the good or service arises for reasons other than the provision of financing, as follows.

  [IFRS 15.IE152-IE154].

  Example 28.47: Advance payment

  An entity, a technology product manufacturer, enters into a contract with a customer to provide global

  telephone technology support and repair coverage for three years along with its technology product. The

  customer purchases this support service at the time of buying the product. Consideration for the service is an

  additional CU300. Customers electing to buy this service must pay for it upfront (i.e. a monthly payment

  option is not available).

  To determine whether there is a significant financing component in the contract, the entity considers the

  nature of the service being offered and the purpose of the payment terms. The entity charges a single upfront

  amount, not with the primary purpose of obtaining financing from the customer but, instead, to maximise

  profitability, taking into consideration the risks associated with providing the service. Specifically, if

  customers could pay monthly, they would be less likely to renew and the population of customers that

  continue to use the support service in the later years may become smaller and less diverse over time

  (i.e. customers that choose to renew historically are those that make greater use of the service, thereby

  increasing the entity’s costs). In addition, customers tend to use services more if they pay monthly rather than

  making an upfront payment. Finally, the entity would incur higher administration costs such as the costs

  related to administering renewals and collection of monthly payments.

  In assessing the requirements in paragraph 62(c) of IFRS 15, the entity determines that the payment terms

  were structured primarily for reasons other than the provision of finance to the entity. The entity charges

  a single upfront amount for the services because other payment terms (such as a monthly payment plan)

  would affect the nature of the risks assumed by the entity to provide the service and may make it

  uneconomical to provide the service. As a result of its analysis, the entity concludes that there is not a

  significant financing component.

  Revenue

  2127

  6.5.2

  Implementation questions on identifying and accounting for

  significant financing components

  See 5.6.1.I above for discussion on whether an entity is required to evaluate if a customer

  option that provides a material right includes a significant financing component.

  6.5.2.A

  Payment terms reflect reasons other than the provision of finance

  According to IFRS 15, a significant financing component does not exist if the difference

  between the promised consideration and the cash selling price of the good or service

  arises for reasons other than the provision of finance. [IFRS 15.62(c)]. At the March 2015

  TRG meeting, the TRG members discussed whether this factor should be broadly or

  narrowly applied.

  The TRG members generally agreed that there is likely significant judgement involved

  in determining whether either party is providing financing or the payment terms are for

  another reason. The TRG members also generally agreed that the Board did not seem

  to intend to create a presumption that a significant financing component exists if the

  cash selling price differs from the promised consideration.

  The TRG agenda paper noted that, although paragraph 61 of IFRS 15 states that the

  measurement objective for a significant financing component is to recognise revenue for

  the goods or services at an amount that reflects the cash selling price, this measurement

  objective is only followed when an entity has already determined that a significant

  financing component exists. The fact that there is a difference in the promised

  consideration and the cash selling price is not a principle for determining whether a

  significant financing component actually exists. It is only one factor to consider.78

  Many of the TRG members noted that it requires significant judgement in some

  circumstances to determine whether a transaction includes a significant financing

  component.79

  6.5.2.B

  Existence of a financing component when the promised consideration is

  equal to the cash selling price

  Under IFRS 15, an entity must consider the difference, if any, between the amount of

  promised consideration and the cash selling price of a promised good or service when

  determining whether a significant financing component exists in a contract.

  [IFRS 15.61(a)]. At the March 2015 TRG meeting, the TRG members were asked to

  consider whether a financing component exists if the promised consideration is equal

  to the cash selling price.

  The TRG members generally agreed that even if the list price, cash selling price

  and promised consideration of a good or service are all equal, an entity should not

  automatically assume that a significant financing component does not exist. This would

  be a factor to consider, but it would not be determinative.80

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  As discussed at 6.5.2.A above, while paragraph 61 of IFRS 15 states that the

  measurement objective for a significant financing component is to recognise revenue

  for the goods or services at an amount that reflects the cash selling price, this

  measurement objective is only followed when an entity has already determined that a

  significant financing component exists. The fact that there is no difference between the

  promised consideration and the cash selling price is not determinative in the evaluation

  of whether a significant financing component actually exists. It is a factor to consider,

  but it is not the only factor and is not determinative. As discussed above, an entity needs

  to consider all facts and circumstances in this evaluation.

  The TRG agenda paper noted that the list price may not always equal the cash selling
r />   price (i.e. the price that a customer would have paid for the promised goods or services

  if the customer had paid cash for those goods or services when (or as) they transfer to

  the customer, as defined in paragraph 61 of IFRS 15). For example, if a customer offers

  to pay cash upfront when the entity is offering ‘free’ financing to customers, the

  customer that offers the upfront payment may be able to pay less than the list price.

  Determining a ‘cash selling price’ may require judgement and the fact that an entity

  provides ‘interest-free financing’ does not necessarily mean that the cash selling price

  is the same as the price another customer would pay over time. Entities would have to

  consider the cash selling price in comparison to the promised consideration in making

  the evaluation based on the overall facts and circumstances of the arrangement.

  This notion is consistent with paragraph 77 of IFRS 15 on allocating the transaction price

  to performance obligations based on stand-alone selling prices (see 7.1 below), which

  indicates that a contractually stated price or a list price for a good or service may be (but

  is not presumed to be) the stand-alone selling price of that good or service. The TRG

  agenda paper noted that it may be possible for a financing component to exist, but that

  it may not be significant. As discussed at 6.5 above, entities need to apply judgement in

  determining whether the financing component is significant.81

  6.5.2.C

  Accounting for financing components that are not significant

  At the March 2015 TRG meeting, the TRG members generally agreed that the standard

  does not preclude an entity from deciding to account for a financing component that is

  not significant. For example, an entity may have a portfolio of contracts in which there

  is a mix of significant and insignificant financing components. An entity could choose to

  account for all of the financing components as if they were significant in order to avoid

  having to apply different accounting methods to each.

  An entity electing to apply the requirements for significant financing components to an

  insignificant financing component would need to be consistent in its application to all

  similar contracts with similar circumstances.82

  6.5.2.D

  Determining whether the significant financing component practical

  expedient applies to contracts with a single payment stream for multiple

  performance obligations

  The standard includes a practical expedient that allows an entity not to assess a contract

  for a significant financing component if the period between the customer’s payment and

  the entity’s transfer of the goods or services is one year or less. [IFRS 15.63]. The TRG

  Revenue

  2129

  members were asked, at the March 2015 TRG meeting, how entities should consider

  whether the practical expedient applies to contracts with a single payment stream for

  multiple performance obligations.

  The TRG members generally agreed that entities either apply an approach of allocating

  any consideration received:

  (1) to the earliest good or service delivered; or

  (2) proportionately between the goods or services depending on the facts and

  circumstances.

  The TRG agenda paper on this topic provided an example of a telecommunications

  entity that enters into a two-year contract to provide a device at contract inception

  and related data services over 24 months in exchange for 24 equal monthly

  instalments.83 Under approach (1) above, an entity would be allowed to apply the

  practical expedient because the period between transfer of the good or service and

  customer payment would be less than one year for both the device and the related

  services. This is because, in the example provided, the device would be ‘paid off’

  after five months. Under approach (2) above, an entity would not be able to apply the

  practical expedient because the device would be deemed to be paid off over the full

  24 months (i.e. greater than one year).

  Approach (2) above may be appropriate in circumstances similar to the example in

  the TRG agenda paper, when the cash payment is not directly tied to a particular

  good or service in a contract. However, approach (1) may be appropriate when the

  cash payment is directly tied to the earliest good or service delivered in a contract.

  However, the TRG members noted it may be difficult to tie a cash payment directly

  to a good or service because cash is fungible. Accordingly, judgement is required

  based on the facts and circumstances.84

  6.5.2.E

  Calculating the adjustment to revenue for significant financing components

  At the March 2015 TRG meeting, the TRG members discussed how an entity would calculate

  the adjustment to revenue for contracts that include a significant financing component.

  The TRG members generally agreed that the standard does not contain requirements

  for how to calculate the adjustment to the transaction price due to a significant financing

  component. A financing component is recognised as interest expense (when the

  customer pays in advance) or interest income (when the customer pays in arrears).

  Entities need to consider requirements outside IFRS 15 to determine the appropriate

  accounting treatment (i.e. IFRS 9).85

  6.5.2.F

  Allocating a significant financing component when there are multiple

  performance obligations in a contract

  At the March 2015 TRG meeting, the TRG members discussed how an entity would

  allocate a significant financing component when there are multiple performance

  obligations in a contract.

  The standard is clear that, when determining the transaction price in Step 3 of the model, the

  effect of financing is excluded from the transaction price prior to the allocation of the

  transaction price to performance obligations (which occurs in Step 4). However, stakeholders

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  had questioned whether an adjustment for a significant financing component could ever be

  attributed to only one or some of the performance obligations in the contract, rather than to

  all of the performance obligations in the contract. This is because the standard only includes

  examples in which there is a single performance obligation.

  The TRG members generally agreed that it may be reasonable for an entity to attribute a

  significant financing component to one or more, but not all, of the performance obligations

  in the contract. In doing so, the entity may analogise to the exceptions for allocating

  variable consideration and/or discounts to one or more (but not all) performance

  obligations, if specified criteria are met (see 7.3 and 7.4 below, respectively).86 However,

  attribution of a financing component to one (or some) of the performance obligations

  requires the use of judgement, especially because cash is fungible.

  6.5.2.G

  Significant financing components: considering whether interest expense

  can be borrowing costs eligible for capitalisation

  IAS 23 – Borrowing Costs – requires borrowing costs to be capitalised if they are directly

  attributable to the acquisition, construction or production of a qualifying asset (whether

  or not the funds have been borrowed specifically for that purpose, see Chapter 21 for
<
br />   further discussion on IAS 23). [IAS 23.8]. IAS 23 and IFRS 15 do not specifically address

  whether interest expense arising from a customer contract with a significant financing

  component can be considered as borrowing costs eligible for capitalisation.

  According to IAS 23, borrowing costs are ‘interest and other costs that an entity incurs

  in connection with the borrowing of funds.’ [IAS 23.5 – IAS 23.6]. Interest expense arising

  from customer contracts with a significant financing component might qualify as

  borrowing costs eligible for capitalisation if they are directly attributable to the

  acquisition, construction or production of a qualifying asset.

  For most revenue transactions, it is likely that entities would be considering inventory

  when determining whether there is a qualifying asset. According to IAS 23, inventory

  can be a qualifying asset, but ‘... inventories that are manufactured, or otherwise

  produced, over a short period of time, are not qualifying assets. Assets that are ready for

  their intended use or sale when acquired are also not qualifying assets.’ [IAS 23.7].

  Significant judgement may be needed to determine whether inventories take a

  substantial period of time to manufacture or produce before being ready for their

  intended use or sale. However, it may be helpful for an entity to consider how it satisfies

  its performance obligations as part of this determination. In particular, entities should

  note that, if a performance obligation is satisfied over time, by definition, the customer

  obtains control of the good or service (and the entity derecognises any related

  inventory) as the entity performs. As discussed in 8.2.4.D, its performance should not

  result in the creation of a material asset in the entity’s accounts (e.g. work in progress).

  It is also important to note that capitalisation of borrowing costs is not required by

  IAS 23 for inventories that are manufactured, or otherwise produced, in large quantities

  on a repetitive basis even if they meet the definition of a qualifying asset. [IAS 23.4(b)].

  The IFRS Interpretations Committee received a request on the capitalisation of