Significant financing components under the new revenue standard (ASC 606)

Video Jan 11, 2018

Watch our video on significant financing components under ASC 606 to learn more on key aspects to consider when assessing revenue contracts. These factors include length of time, reason for the timing of payments, and market interest rates. We also discuss situations where financing may not be significant to the contract, and a practical expedient.

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Hi, I’m Jamie Carlson, a senior manager in PwC's national office.

The new revenue standard is effective for many companies in 2018. Today, I'm here to highlight some reminders for evaluating significant financing components under the new standard.

The revenue standard requires companies to assess whether contracts contain a significant financing component.

These components can be explicitly stated or implied by the payment terms in a contract.

An example of this might be when the contract requires the customer to pay significantly after it receives the goods or services. In this situation, the customer could be receiving financing from the vendor.

On the other hand, if the customer makes an advance payment under the contract, the customer could be providing financing to the vendor.

A financing component is accounted for separately from the revenue transaction.

The amount of revenue recognized differs from the amount of cash received from the customer when a contract contains a significant financing component.

For customer financing, where payment is received by the vendor after performance, revenue recognized will be less than cash received. This is because a portion of the consideration received is effectively interest, and is therefore recorded as interest income.

For vendor financing, where payment is received by the vendor in advance of performance, revenue recognized will exceed the cash received, as interest expense will be recorded and increase the amount of revenue.

Assessing whether a contract contains a significant financing component will often require judgment. Companies should evaluate the difference, if any, between the amount of consideration in a contract and the cash selling price for those goods or services.

Companies should also consider the expected length of time between when a performance obligation is satisfied and when the customer pays for those goods or services, as well as prevailing market interest rates.

It is important to note that a significant financing component does not exist in all situations when there is a difference between when consideration is paid and when the goods or services are provided to the customer.

For example, a contract does not contain a significant financing component if:

  1. The timing of the transfer of the goods or services is at the customer's discretion
  2. A substantial amount of the consideration is variable and based on the occurrence of a future event that is outside the control of the parties to the contract, or
  3. There is another business reason why the negotiated payment terms do not match the timing of performance. 

Also, keep in mind, a company does not need to separately account for a financing component if it is not significant to the contract.

That means the effects of the financing would not materially change the amount of revenue that would be recognized under the contract.

Additionally, the standard includes a practical expedient that allows companies to disregard the effects of a financing component if the period between payment and performance will be one year or less.

For more information on significant financing components and other revenue topics, please refer to our Revenue guide available on CFOdirect.com.

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