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?
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?
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.