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The revenue standard provides the following guidance on accounting for arrangements with a significant financing component.

ASC 606-10-32-15

In determining the transaction price, an entity shall adjust the promised amount of consideration for the effects of the time value of money if the timing of payments agreed to by the parties to the contract (either explicitly or implicitly) provides the customer or the entity with a significant benefit of financing the transfer of goods or services to the customer. In those circumstances, the contract contains a significant financing component. A significant financing component may exist regardless of whether the promise of financing is explicitly stated in the contract or implied by the payment terms agreed to by the parties to the contract.

Excerpt from ASC 606-10-32-16

The objective when adjusting the promised amount of consideration for a significant financing component is for an entity to recognize revenue at an amount that reflects 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 (that is, the cash selling price).

Some contracts contain a financing component (either explicitly or implicitly) because payment by a customer occurs either significantly before or significantly after performance. This timing difference can benefit either the customer, if the reporting entity is financing the customer's purchase, or the reporting entity, if the customer finances the reporting entity's activities by making payments in advance of performance. A significant financing component may exist in an arrangement when a customer makes an advance payment because the reporting entity requires financing to fulfill its obligations under the contract that it would otherwise need to obtain from a third party. 
The amount of revenue recognized differs from the amount of cash received from the customer when a reporting entity determines a significant financing component exists. Revenue recognized will be less than cash received for payments that are received in arrears of performance, as a portion of the consideration received will be recorded as interest income. Revenue recognized will exceed the cash received for payments that are received in advance of performance, as interest expense will be recorded and increase the amount of revenue recognized.
Interest income or interest expense resulting from a significant financing component should be presented separately from revenue from contracts with customers. A reporting entity might present interest income as revenue in circumstances in which interest income represents a reporting entity's ordinary activities.
Interest income or interest expense is recognized only if a contract asset (or receivable) or a contract liability has been recognized. For example, consider a sale made to a customer with terms that require payment at the end of three years, but that includes a right of return. If management does not record a contract asset (or receivable) relating to that sale due to the right of return, no interest income is recorded until the right of return period lapses. This is the case even if a significant financing component exists. Interest income is calculated once the return period lapses in accordance with the applicable financial instruments guidance and considering the remaining contract term.
Question RR 4-4 addresses whether a significant financing component relates to all performance obligations.
Question RR 4-4
Can a significant financing component relate to one or more, but not all, of the performance obligations in a contract?
PwC response
Possibly. We believe it may be reasonable in certain circumstances to attribute a significant financing component to one or more, but not all, of the performance obligations in a contract. This assessment will likely require judgment. Management should consider whether it is appropriate to apply the guidance on allocating a discount (refer to RR 5.4) or allocating variable consideration (refer to RR 5.5) by analogy. Refer to Revenue TRG Memo No. 30 and the related meeting minutes in Revenue TRG Memo No. 34 for further discussion of this topic.

4.4.1 Identifying a significant financing component

Identifying a significant financing component in a contract can require judgment. It could be particularly challenging in a long-term arrangement where product or service delivery and cash payments occur throughout the term of the contract.
Management does not need to consider the effects of the financing component if the effect would not materially change the amount of revenue that would be recognized under the contract. The determination of whether a financing component is significant should be made at the contract level. A determination does not have to be made regarding the effect on all contracts collectively. In other words, the financing effects can be disregarded if they are immaterial at the contract level, even if the combined effect for a portfolio of contracts would be material to the reporting entity as a whole. While a reporting entity is not required to recognize the financing effects if they are immaterial at the contract level, a reporting entity is not precluded from accounting for a financing component that is not significant. Refer to Revenue TRG Memo No. 30 and the related meeting minutes in Revenue TRG Memo No. 34 for further discussion of this topic.
The revenue standard includes the following factors to be considered when assessing whether there is a significant financing component in a contract with a customer.

Excerpt from ASC 606-10-32-16

An entity shall consider all relevant facts and circumstances in assessing whether a contract contains a financing component and whether that financing component is significant to the contract, including both of the following:
a. The difference, if any, between the amount of promised consideration and the cash selling price of the promised goods or services
b. The combined effect of both of the following:
1. 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
2. The prevailing interest rates in the relevant market



A significant difference between the amount of contract consideration and the amount that would be paid if cash were paid at the time of performance indicates that an implicit financing arrangement exists. In some cases, the stated interest rate in an arrangement could be zero (for example, interest-free financing) such that the consideration to be received over the period of the arrangement is equal to the cash selling price. Management should not automatically conclude that there is no financing component in zero-percent financing arrangements. All relevant facts and circumstances should be evaluated, including assessing whether the cash selling price reflects the price that would be paid absent the financing. Refer to Revenue TRG Memo No. 30 and the related meeting minutes in Revenue TRG Memo No. 34 for further discussion of this topic.
The longer the period between when a performance obligation is satisfied and when cash is paid for that performance obligation, the more likely it is that a significant financing component exists.
A significant financing component does not exist in all situations when there is a time difference between when consideration is paid and when the goods or services are transferred to the customer. The revenue standard provides factors that indicate that a significant financing component does not exist.

Excerpt from ASC 606-10-32-17

A contract with a customer would not have a significant financing component if any of the following factors exist:
a. The customer 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.
b. A substantial amount of the consideration promised by the customer is variable, and the amount or timing of that consideration varies on the basis of the occurrence or nonoccurrence of a future event that is not substantially within the control of the customer or the entity (for example, if the consideration is a sales-based royalty).
c. 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 to either the customer or the entity, and the difference between those amounts is proportional to the reason for the difference. For example, the payment terms might provide the entity or the customer with protection from the other party failing to adequately complete some or all of its obligations under the contract.

4.4.1.1 Timing of control transfer is at customer's discretion

The effects of the financing component do not need to be considered when the timing of performance is at the discretion of the customer. This is because the purpose of these types of contracts is not to provide financing. An example is the sale of a gift card. The customer uses the gift card at his or her discretion, which could be in the near term or take an extended period of time. Similarly, customers who purchase goods or services and are simultaneously awarded loyalty points or other credits that can be used for free or discounted products in the future decide when those credits are used.

4.4.1.2 Consideration is variable and based on future events

The amount of consideration to be received when it is variable could vary significantly and might not be resolved for an extended period of time. The substance of the arrangement is not a financing if the amount or timing of the variable consideration is determined by an event that is outside the control of the parties to the contract. One example is in an arrangement for legal services when an attorney is paid only upon a successful outcome. The litigation process might extend for several years. The delay in receiving payment is not a result of providing financing in this situation. Another example is a license to a patented technology when the licensor is compensated based on a sales-based royalty that will be received over multiple years. Although the performance obligation is satisfied upfront, the delay in receiving payment is not the result of providing financing in the context of the revenue standard.

4.4.1.3 Timing difference arises for reasons other than financing

The intent of payment terms that require payments in advance or in arrears of performance could be for reasons other than providing financing. For example, the intent of the parties might be to secure the right to a specific product or service, or to ensure that the seller performs as specified under the contract. The effects of the financing component do not need to be considered if the primary intent of the payment timing is for reasons other than providing a significant financing benefit to the reporting entity or to the customer. Assessing whether there are valid reasons for the timing difference, other than providing financing, will often require judgment.
Any difference between the consideration and the cash selling price should be a reasonable reflection of the reason for the difference. In other words, management should ensure that the difference between the cash selling price and the price charged in the arrangement does not reflect both a reason other than financing and a financing.
Example RR 4-17 illustrates a situation in which a difference in the timing of payment and the timing of transfer of control of goods or services arises for reasons other than providing financing. This concept is also illustrated in Examples 27 and 30 of the revenue standard (ASC 606-10-55-233 through ASC 606-10-55-234 and ASC 606-10-55-244 through ASC 606-10-55-246).
EXAMPLE RR 4-17

Significant financing component — prepayment with intent other than to provide financing
Distiller Co produces a rare whiskey that is released once a year prior to the holidays. Retailer agrees to pay Distiller Co in November 20X1 to secure supply for the December 20X2 release. Distiller Co requires payment at the time the order is placed; otherwise, it is not willing to guarantee production levels. Distiller Co does not offer discounts for early payments.
The advance payment allows Retailer to communicate its supply to customers and Distiller Co to manage its production levels.
Is there a significant financing component in the arrangement between Distiller Co and Retailer?
Analysis
There is no significant financing component in the arrangement between Distiller Co and Retailer. The upfront payment is made to secure the future supply of whiskey and not to provide Distiller Co or Retailer with the provision of finance.

4.4.2 Significant financing component practical expedient

The revenue standard provides a practical expedient that allows reporting entities to disregard the effects of a financing component in certain circumstances.

ASC 606-10-32-18

As a practical expedient, an entity need not adjust the promised amount of consideration for the effects of a significant financing component if the entity expects, at contract inception, that the period between when the entity transfers a promised good or service to the customer and when the customer pays for that good or service will be one year or less.

The practical expedient focuses on when the goods or services are provided compared to when the payment is made, not on the length of the contract. The practical expedient can be used even if the contract length is more than 12 months if the timing difference between performance and payment is 12 months or less. However, a reporting entity cannot use the practical expedient to disregard the effects of a financing in the first 12 months of a longer-term arrangement that includes a significant financing component.
A reporting entity that chooses to apply the practical expedient should apply it consistently to similar contracts in similar circumstances. It must also disclose the use of the practical expedient, as discussed in FSP 33.4.
Some contracts include a single payment stream for multiple performance obligations that are satisfied at different times. It may not be clear, in these circumstances, whether the timing difference between performance and payment is greater than 12 months. Management should apply judgment to assess whether cash payments relate to a specific performance obligation based on the terms of the contract. It might be appropriate to allocate the payments received between the multiple performance obligations in the event payments are not tied directly to a particular good or service. Refer to Revenue TRG Memo No. 30 and the related meeting minutes in Revenue TRG Memo No. 34 for further discussion of this topic.
Question RR 4-5 addresses when a reporting entity can use the practical expedient.
Question RR 4-5
Can a reporting entity use the practical expedient to disregard the effects of a significant financing when a contract is explicit that it contains a financing, but the period of the financing is less than one year?
PwC response
Yes. The reporting entity may elect to apply the practical expedient if the difference between the timing of performance and timing of payment is one year or less.

4.4.3 Determining the discount rate

The revenue standard requires that the discount rate be determined as follows.

Excerpt from ASC 606-10-32-19

[W]hen adjusting the promised amount of consideration for a significant financing component, an entity shall use the discount rate that would be reflected in a separate financing transaction between the entity and its customer at contract inception. That rate would reflect the credit characteristics of the party receiving financing in the contract, as well as any collateral or security provided by the customer or the entity, including assets transferred in the contract.

Management should adjust the contract consideration to reflect the significant financing benefit using a discount rate that reflects the rate that would be used in a separate financing transaction between the reporting entity and its customer. This rate should reflect the credit risk of the party obtaining financing in the arrangement (which could be the customer or the reporting entity).
Consideration of credit risk of each customer might result in recognition of different revenue amounts for contracts with similar terms if the credit profiles of the customers differ. For example, a sale to a customer with higher credit risk will result in less revenue and more interest income recognized as compared to a sale to a more creditworthy customer. The rate to be used is determined at contract inception, and is not reassessed.
Some contracts include an explicit financing component. Management should consider whether the rate specified in a contract reflects a market rate, or if the reporting entity is offering financing below the market rate as an incentive. A below-market rate does not appropriately reflect the financing element of the contract with the customer. Any explicit rate in the contract should be assessed to determine if it represents a prevailing rate for a similar transaction, or if a more representative rate should be imputed.
The revenue standard does not include specific guidance on how to calculate the adjustment to the transaction price due to the financing component (that is, the interest income or expense). Reporting entities should refer to the applicable guidance in ASC 835-30, Interest—Imputation of Interest, to determine the appropriate accounting. Refer to Revenue TRG Memo No. 30 and the related meeting minutes in Revenue TRG Memo No. 34 for further discussion of this topic.

4.4.4 Examples of accounting for significant financing component

Example RR 4-18 and Example RR 4-19 illustrate how the transaction price is determined when a significant financing component exists. This concept is also illustrated in Examples 26, 28, and 29 of the revenue standard (ASC 606-10-55-227 through ASC 606-10-55-232 and ASC 606-10-55-235 through ASC 606-10-55-243).
EXAMPLE RR 4-18

Significant financing component – determining the appropriate discount rate
Furniture Co enters into an arrangement with Customer for financing of a new sofa purchase. Furniture Co is running a promotion that offers all customers 1% financing. The 1% contractual interest rate is significantly lower than the 10% interest rate that would otherwise be available to Customer at contract inception (that is, the contractual rate does not reflect the credit risk of the customer). Furniture Co concludes that there is a significant financing component present in the contract.
What discount rate should Furniture Co use to determine the transaction price?
Analysis
Furniture Co should use a 10% discount rate to determine the transaction price. It would not be appropriate to use the 1% rate specified in the contract as it represents a marketing incentive and does not reflect the credit characteristics of Customer.
EXAMPLE RR 4-19

Significant financing component – payment prior to performance
Gym Inc enters into an agreement with Customer to provide a five-year gym membership. Upfront consideration paid by Customer is $5,000. Gym Inc also offers an alternative payment plan with monthly billings of $100 (total consideration of $6,000 over the five-year membership term). The membership is a single performance obligation that Gym Inc satisfies ratably over the five-year membership period.
Gym Inc determines that the difference between the cash selling price and the monthly payment plan (payment over the performance period) indicates a significant financing component exists in the contract with Customer. Gym Inc concludes that the discount rate that would be reflected in a separate transaction between the two parties at contract inception is 5%.
What is the transaction price in this arrangement?
Analysis
Gym Inc should determine the transaction price using the discount rate that would be reflected in a separate financing transaction (5%). This rate is different than the 7.4% imputed discount rate used to discount payments that would have been received over time ($6,000) back to the cash selling price ($5,000).
Gym Inc calculates monthly revenue of $94.35 using a present value of $5,000, a 5% annual interest rate, and 60 monthly payments. Gym Inc records a contract liability of $5,000 at contract inception for the upfront payment that will be reduced by the monthly revenue recognition of $94.35, and increased by interest expense recognized. Gym Inc will recognize revenue of $5,661 and interest expense of $661 over the life of the contract.
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