Under IFRS 15, an entity is required to assess whether a contract contains a significant financing component, if it receives consideration more than one year before or after it transfers goods or services to the customer (i.e., the consideration is prepaid or is paid after the goods or services are provided).

If the timing of payments agreed by the parties to the contract, provides either the customer or the vendor with a significant financing benefit, then IFRS 15 requires that the transaction price is adjusted to reflect this ‘financing component’.

Example 1

ABC Ltd enters into a contract with a customer to sell an existing printing machine such that control of the printing machine vests with the customer in two years’ time.

The contract has two payment options. The customer can pay $300.000 when the contract is signed or $380.000 in two years’ time when the customer gains control of the printing machine.

The interest rate implicit in the contract is 12,5% in order to adjust for the risk involved in the delay in payment. However, ABC’s incremental borrowing rate is 6%.

The customer paid $300.000 when the contract was signed.

Solution 1

The accounting for a sale arising from a contract which has a significant financing component should be comparable to the accounting for a loan with the same features.

In substance, ABC is borrowing $300.000 from the customer and will settle this amount through the construction of the printing machine.

An entity should use the discount rate which would be reflected in a separate financing transaction between the entity and its customer at contract inception.

Therefore, in this case the rate which should be used in adjusting the promised consideration is 6%, which is the entity’s incremental borrowing rate, and not 12,5%.

The journals are as follows:

Year 0

DR CASH $300.000

            CR CONTRACT LIABILITY $300.000 – loan by customer

 Year 1

DR P/L $18.000 (300k * 6%) – representing interest on the loan

                                                                          CR CONTRACT LIABILITY $18.000

 Year 2

DR P/L $19.080 (318k * 6%) – representing interest on the loan

                                                                         CR CONTRACT LIABILITY $19.080

 DR CONTRACT LIABILITY $337.080 (300.000+18.000+19.080)       

                                                    CR REVENUE $337.080 – on completion of the construction