The Board included a list of factors in Topic 606 to indicate when a significant financing component might not exist. Implementation questions have arisen about the factor in paragraph 606-10-32-17(c) regarding how “broadly” this factor should be applied.

The question arises, in part, due to the interaction of the guidance in paragraphs 606-10-32-15 and 606-10-32-16. Paragraph 606-10-32-15 explains the principle is to adjust the promised amount of consideration for the time value of money if the customer or entity receive a significant benefit of financing the transfer of goods or services to the customer. The objective when adjusting the promised amount of consideration for a significant financing component in paragraph 606-10-32-16 is to recognize revenue for the goods and services at an amount that reflects what the cash selling price would be without the significant financing component that the entity already concluded exists based on applying Topic 606. It is important to note that the objective of measuring a significant financing component should not be interpreted as the principle for evaluating whether a significant financing component exists. Rather, it is the objective an entity should apply when adjusting the transaction price because it has concluded there is a significant financing component under Topic 606.

When reading the totality of the guidance on significant financing components, including the basis for conclusions of Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), it seems clear that the Board did not intend to include a presumption that if the cash selling price varies from promised consideration (or there is a long-time frame between transfer of the goods and payment), then a significant financing component exists. That is, the standard does not include such a presumption and requires the use of judgment in the assessment. Paragraph BC231 of Update 2014-09 discusses some of the Board’s considerations.

Paragraph BC230 provides some further guidance on this topic. This paragraph highlights that an entity should consider whether the payment terms of the contract provide the benefit of financing to the customer or entity (and which is significant at the contract level). It is noting that there may be other reasons than providing financing and reasons why the consideration is not remitted at the time the performance obligations are satisfied. An entity will need to apply judgment to determine whether the payment terms are providing finance or are for another reason. Paragraph 606-10-32-17(c) contains some language about the difference being proportional to the reason for the difference.

The staff further notes that paragraph 606-10-32-16 deemphasized “the expected length of time between when the entity transfers the promised goods or services to the customer and when the customer pays for those goods or services” as compared to exposure drafts of Topic 606 as a direct response to feedback from stakeholders on those previous exposure drafts.

Furthermore, the Board included the factors in paragraph 606-10-32-17 to clarify the circumstances in which a contract does not provide the entity or the customer with a significant benefit of financing. The basis for conclusions of Update 2014-09 includes discussion of the factor included in paragraph 606-10-32-17(c).

The staff notes that the basis for conclusions specifically (paragraph BC238) discusses why the Board did not provide an exemption for advance payments. Furthermore, the standard includes two examples on advance payments. In Example 29, Advance Payment and Assessment of the Discount Rate (paragraph 606-10-55-240), the entity concludes there is a significant financing component due to the different payment options available to the customer and length of time between the advance payment from the customer and the transfer of control. In Example 30, Advance Payment (paragraph 606-10-55-244), the entity concludes that there is not a significant financing component because the timing difference relates to a reason other than financing.

Topic 606 is clear that advance payments are not excluded from the scope of the guidance on significant financing component. However, the Board readily acknowledged that there may be valid non-financing reasons for an advance payment. In those cases, an entity should establish why that feature of the arrangement is not providing a significant financing benefit but is instead there for a different and substantive business purpose. As previously noted, in addition to having a reason other than financing, paragraph 606-10-32-17(c) requires the difference between the promised consideration and cash selling price of the good or service to be proportional to the reason for the difference.

In the staff’s view, determining whether a contract with a customer includes a significant financing component is a matter of judgment, both in determining whether a financing component exists and, if so, in determining the significance of the benefit that the financing component provides to the customer or the entity. The guidance referred above seems to make clear that the Board thinks some contracts provide a significant benefit of financing, but that differences (a) between the timing of payment and the transfer to the goods or services and (b) between the stated price and the cash selling price of a good or service are not necessarily indicative of a significant financing component. It is important that entities analyze all of the facts and circumstances in the arrangement in applying the guidance on significant financing components to determine if one exists. It is clear that judgment will be required in this area of Topic 606.

The Board included a number of items for an entity to consider when making judgments about whether a significant financing component exists in a contract. Those considerations include the criteria in paragraph 606-10-32-16, the factors in paragraph 606-10-32-17, and several illustrative examples (Examples 26, 27, 28 (Case A), 28 (Case B), 29, and 30 starting at paragraph 606-10-55-227).

In addition, to reduce the cost and complexity of applying the guidance on significant financing components, the Board decided to include a practical expedient in the guidance. Paragraph 606-10-32-18 states that an entity need not adjust the promised amount of consideration for the effects of a significant financing component if the entity expects that the period between when the entity transfers a promised good or service and when the customer pays for that promised good or service will be one year or less. The staff thinks this practical expedient should substantially reduce the population of contracts for which an entity would be required to evaluate whether a significant financing component exists (that is, because most contracts would be eligible for the practical expedient, an entity would not be required to make judgmental evaluations about whether there is an implied financing element).

The Board could have removed judgment in this area by not requiring any consideration of whether a significant financing component exists. That decision would have been a significant difference compared with existing GAAP for (a) revenue and (b) many other areas. The Board also could have removed judgment by always requiring a financing component to be accounted for whenever there is a difference between the timing of payments in comparison to performance. However, such a decision would have been inconsistent with the feedback the Board received from stakeholders about circumstances in which the difference is unrelated to financing and likely would result in more cost and complexity than permitting an entity to apply judgment in determining when a contract includes the significant benefit of financing to one of the parties.

TRG members agreed that there is no presumption in the standard that a significant financing component exists or does not exist when there is a difference in timing between when goods and services are transferred and when the promised consideration is paid. An entity will need to apply judgment to determine whether the payment terms are providing financing or are for another reason. TRG members discussed the factor in paragraph 606-10-32-17(c) relating to whether the difference in promised consideration and cash selling price is for a reason other than financing, noting that it might be more likely that an advance payment would meet that factor compared to payments in arrears. However, TRG members also agreed that there is no presumption as to whether advance payments do or do not contain significant financing components and that advance payments should be assessed under Topic 606. However, several members stressed that when entities consider whether the difference in promised consideration and cash selling price is for a reason other than financing, they also must consider whether the difference between those amounts is proportional to the reason for the difference. Many TRG members noted that it will require significant judgment in some circumstances to determine whether a transaction does, or does not, include a significant financing component, and they thought that when the Boards developed Topic 606, they understood judgment may often be required in this area.