1. Some stakeholders have informed the staff that there questions on the guidance in Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers, and IFRS 15 Revenue from Contracts with Customers (collectively referred to as the ‘new revenue standard'), regarding significant financing components. The implementation questions relate to the following topics:

2. At the January 26, 2015 TRG meeting, a preliminary discussion was held on some of these topics (TRG Agenda Ref No. 20). That discussion was based on the submission received by the staff. TRG members indicated that the issues should be brought back for further discussion at a TRG meeting. Accordingly, this memo provides analysis beyond the stakeholder submission that was previously provided to TRG members.

3. The core principle of the new revenue standard is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services (emphasis added). In Step 3 of the model in the new revenue standard, an entity determines the transaction price. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring the promised goods or services in the contract to a customer (excluding amounts collected on behalf of third parties). In determining the transaction price, an entity considers the effects of various items (for example, variable consideration and the existence of a significant financing component). The new revenue standard includes guidance (as well as discussion in the Basis for Conclusions) about when a significant financing component exists and how to account for significant financing components. The questions in this paper relate to that guidance.

4. The new revenue standard includes the following guidance about when a significant financing component exists in a contract within the scope of this guidance ² (note: Examples 26-30 in the standard illustrate the application of the guidance in these paragraphs, but are not included in this paper):

5. Existing U.S. GAAP and IFRS include guidance about accounting for the time value of money in a revenue transaction. However, the guidance in the new revenue standard includes more guidance on the topic than existing standards, and in particular because it applies to advance payments as well as payments in arrears, the guidance represents a change from existing U.S. GAAP and general practice under IFRS.

6. IAS 18 Revenue states that if the arrangement"effectively constitutes a financing transaction”, the fair value of the consideration must be determined by discounting all future receipts using an imputed rate of interest. Similarly in U.S. GAAP, if products are sold on extended payment terms, and collection is reasonably assured, Subtopic 835-30, Imputation of Interest (which includes the guidance formerly in Accounting Principles Board Opinion No. 21, Interest on Receivables and Payables), requires that the receivable and the revenue be recognized at the present value of the payments, and a portion of the payments be attributed to interest income.

7. The following two paragraphs in the new revenue standard (as well as Examples 28 and 29) provide guidance on how to account for a significant financing component:

8. The Boards included a list of factors in the new revenue standard to indicate when a significant financing component might not exist. Implementation questions have arisen about the factor in paragraph 606-10-32-17(c) [62(c)], which is included in the background section above.

9. The question posed in the submission received by the staff relates to how "broadly" this factor should be applied. The stakeholder submission includes the following two views:

10. The question arises, in part, due to the interaction of the guidance in paragraphs 606-10-32-15 [60] and 606-10-32-16 [61]. Paragraph 606-10-32-15 [60] 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 [61] 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 the new revenue standard. It is important to note that the objective of measuring a significant financing component should not be interpreted as the principle for evaluating whether or not 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 the new revenue standard.

11. View A implies that there is a presumption (although that presumption might be overcome) 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. If read in isolation, some stakeholders might come to this conclusion after reading paragraph 606-10-32-15 [60] due to the use of the term"time value of money"in that paragraph when describing the principle. However, when reading the totality of the guidance on significant financing components, including the Basis for Conclusions, it seems clear that View A is not what was intended by the Boards. That is, the standard does not include a presumption and requires the use of judgment in the assessment.
Paragraph BC231 discusses some of the Boards' considerations.

12. 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) [62(c)] contain some language about the difference being proportional to the reason for the difference.

13. The staff further note that paragraph 606-10-32-16 [61] 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 the new revenue standard as a direct response to feedback from stakeholders on those previous exposure drafts. Stakeholders commented that, as drafted, the proposed guidance appeared to create the presumption embodied by View A.

14. Further, the Boards included the factors in 606-10-32-17 [62] 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 includes the following discussion of the factor included in paragraph 606-10-32-17(c)[62(c)]:

15. View B implies that it was the Boards' intention for paragraph 606-10-32-17(c) [62(c)] to be applied broadly and that it should capture all or most advance payments. In other words, View B implies that an advance payment generally would not contain a significant financing component.

16. The staff note that the Basis for Conclusions specifically discusses why the Boards did not provide an exemption for advance payments.

17. Further, the standard includes two examples on advance payments. In Example 29, 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, the entity concludes that there is not a significant financing component because the timing difference relates to a reason other than financing.

18. The new revenue standard is clear that advance payments are not excluded from the scope of the guidance on significant financing component. However, the Boards 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) [62(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.

19. 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 staff think the interpretations expressed in View A and View B are opposite ends of the spectrum of how one might interpret the guidance, such that the Boards' intent may be best characterized as something in between. The guidance outlined above seems to make clear that the Boards think 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 of 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 the new revenue standard.

20. The Boards 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 [61], the factors in paragraph 606-10-32-17 [62], and several illustrative examples (Examples 26, 27, 28 (Case A), 28 (Case B), 29, and 30).

21. In addition, to reduce the cost and complexity of applying the guidance on significant financing components, the Boards decided to include a practical expedient in the guidance. Paragraph 606-10-32-18 [63] 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 think this practical expedient should substantially reduce the population of contracts for which an entity would be required to evaluate whether or not 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).

22. The Boards could have removed judgment in this area by not requiring any consideration of whether a significant financing component exists. Such a decision would have been a significant difference compared with existing U.S. GAAP and IFRS for (a) revenue and (b) many other areas. The Boards 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 Boards 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.

23. The standard includes the following objective for adjusting the promised amount of consideration for a significant financing component:

[Emphasis added]

24. Some stakeholders have questioned whether this guidance implies that there is never a significant financing component when there is not a difference between the amount of promised consideration and the cash selling price. In certain industries, it may be common for the promised consideration and cash selling price to be equal. Consider the following examples.

25. In the examples above, the list price of the goods is equal to the promised consideration in the contract. However, it is important to note that the list price might not always equal the cash selling price and a contract might have an implied interest rate that is different from a stated interest rate. For example, if a customer offers to pay cash upfront when the entity is offering"free"financing, the customer might be able to pay less than the list price. That is, the true cash selling price might be (in fact, may be likely to be) less than the list price. This notion is consistent in concept with the guidance in paragraph 606-10-32-32 [77], which states that a contractually stated price or a list price for a good or service may be (but shall not be presumed to be) the standalone selling price of that good or service.

26. In the examples above, if the list price, the cash selling price, and the promised consideration are all equal, the respective entities should not automatically assume that there is no significant financing component. The difference, if any, between the amount of promised consideration and the cash selling price is

a

consideration (that is, it is one of two factors in paragraph 606-10-32-16 [61], not the only consideration), not a presumption, in determining whether a significant financing component exists. The guidance in paragraph 606-10-32-16 [61] further specifies that an entity should consider all relevant facts and circumstances. Accordingly, this one fact, that the cash selling price is equal to the selling price in the contract, would not be the totality of the assessment. However, if the list price, the cash selling price, and the promised consideration are all, in fact, equal (including after careful consideration of whether the list price is the cash selling price), that might indicate that the contract does not include a significant financing component.

27. It also may be possible that in these type of scenarios (that is, zero implied interest) that a financing component exists but that it may not be significant. Entities will need to apply judgment in determining whether or not the financing component is significant or not.

28. The standard requires accounting for"significant"financing components. Some stakeholders have questioned whether it would be acceptable to account for financing components that are not significant.

29. The staff understand that the genesis of this question has to do with the fact that the assessment of the significance of the financing component is based on an evaluation of the contract. That is, an entity might deem the financing to not be significant at the contract level, but might prefer to account for it if it is material at the entity level (although the standard does not require an entity level assessment of materiality in this area). Additionally, an entity may have a portfolio of contracts that include financing components for which some are significant and others are insignificant. In this scenario, it would likely be less burdensome to implement the standard if the entity accounts for the financing component across all contracts in its portfolio instead of having to apply two methods of accounting (that is, apply financing component accounting to some and not to others). The Boards' rationale for placing the significance assessment at the contract level is described in the Basis for Conclusions as follows

30. As described in this Basis paragraph, the rationale for assessing significance at the contract level was to reduce the burden for entities. That is, it was for practical reasons rather than conceptual reasons. The staff is not aware of any guidance in the standard that would preclude an entity from deciding to account for a financing component that is not significant.

31. The new revenue standard permits an entity to use the following practical expedient in applying the guidance on significant financing component:

32. The staff has received implementation questions about scenarios in which the cash payment may not be directly tied to a particular good or service in a contract.

Consider the following example:

33. In determining the period between when the entity transfers a promised good or service and when the customer pays for that good or service, the question arises as to whether the entity should consider the full monthly consideration received as a payment of the first good or service delivered (that is, follow a first-in-first-out approach) or whether the entity should proportionately allocate the monthly consideration promised in the contract between the equipment and the services.

34. Assume that the entity transfers the device first and recognizes revenue for CU500. Each month the entity transfers the services and recognizes revenue for CU79. The two alternatives for determining whether the practical expedient applies are illustrated as follows

35. Because the service is to be used over a two year period and the payments are also over a two year period, View A would not appropriately reflect the economics of the arrangement. Further, the substance of the transaction is that the customer is financing the purchase of a device and is not financing the service. The staff think View B more appropriately represents the intent of the standard and the economics of the transaction. Accordingly, in the staff's view, View B is the appropriate method to apply when determining whether the practical expedient in paragraph 606-10-32-18 [63] applies in this example. The example provided and the mechanics used by the staff to arrive at the amounts in View B are fairly simple. An entity would need to apply judgement in determining if the practical expedient applies, especially in fact patterns that are substantially more complex than the example above.

36. While the new revenue standard requires accounting for a significant financing component apart from revenue, the standard does not include explicit guidance on how to calculate the interest income/expense. However, the standard includes guidance on estimating the discount rate and some examples (examples 26 and 29 are included later in this paper). Example 29 includes the calculation of interest expense in an advanced payment scenario. Some stakeholders have raised a question as to how to perform the calculations.

37. The guidance on determining the discount rate in the standard is as follows:

38. The standard also includes guidance on the presentation of the financing component in the income statement as follows:

39. Further the new revenue standard includes some illustrations of how to apply the guidance:

40. Because the standard does not provide guidance on subsequent accounting, entities should refer to respective U.S. GAAP (Subtopic 835-30) and IFRS (IFRS 9 Financial Instruments) to determine the appropriate accounting.

41. Subtopic 835-30 provides guidance on subsequent measurement in situations in which imputation of interest is required. The guidance requires the use of the interest method. That is, with respect to a note for which the imputation of interest is required, the difference between the present value and the face amount shall be treated as discount or premium and amortized as interest expense or income over the life of the note in such a way as to result in a constant rate of interest when applied to the amount outstanding at the beginning of any given period. The guidance allows for other methods of amortization to be used if the results obtained are not materially different from those that would result from the interest method. Although the guidance in Subtopic 835-30 provides guidance when there are extended payment terms to the customer, a similar calculation methodology would be applied to advance payments from a customer. Chapter 5 of IFRS 9 sets out the measurement requirements for financial instruments and, in particular, includes guidance on calculating interest revenue using the effective interest method.

42. The examples in the new revenue standard about the significant financing component guidance include scenarios in which there is a single performance obligation. Stakeholders have raised questions about how to apply the guidance when there are multiple performance obligations. Specifically, the key question stakeholders have raised is whether an adjustment for a significant financing component should 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.

43. Identifying and accounting for significant financing components is part of determining the transaction price (that is, it is part of Step 3 of the revenue model). The transaction price is defined in paragraph 606-10-32-2 [47] as the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services. That is, when determining the transaction price, the effect of financing would be excluded because the financing component (interest expense or interest income) is in exchange for financing, rather than for the exchange of promised goods or services and is a separate component of the contract apart from the revenue generation for goods and service.

44. After determining the total transaction price for the contract, the entity would allocate the transaction price to performance obligations in Step 4. For example, if the consideration in a contract is CU100 and an entity determines that the interest component (significant benefit received by the customer) is CU10, then the transaction price is CU90. The standard requires allocation of the transaction price to the performance obligations in the contract on a relative standalone selling price basis in most cases. However, the standard also requires allocation of a bundled discount and allocation of variable consideration on a basis other than relative standalone selling price when specified criteria in the paragraphs referenced above are met.

45. The staff thinks it would be reasonable to attribute a significant financing component to one or more, but not all, of the performance obligations, by analogy to the allocation of variable consideration or allocation of a discount guidance. That is, it might be possible to determine that a significant financing component relates specifically to one (or some) of the performance obligations in the contract. Attribution of a financing component to one (or some) of the performance obligations will require the use of judgment. Attributing the effect of the significant financing component entirely to one (or some) performance obligations might produce an allocation result that is more consistent with the overall allocation objective in paragraph 606-10-32-28 [73]:

The IASB is the independent standard-setting body of the IFRS Foundation, a not-for-profit corporation promoting the adoption of IFRSs. For more information visit www.ifrs.org

The Financial Accounting Standards Board (FASB) is an independent standard-setting body of the Financial Accounting Foundation, a not-for-profit corporation. The FASB is responsible for establishing Generally Accepted Accounting Principles (GAAP), standards of financial accounting that govern the preparation of financial reports by public and private companies and not-for-profit organizations in the United States and other jurisdictions. For more information visitwww.fasb.org