Significant financing component
A significant financing component exists when the payment timing agreed by the parties gives the customer or the entity a significant benefit of financing. The transaction price is then adjusted for the time value of money. A practical expedient skips the adjustment when the gap between payment and transfer is one year or less.
Standard references
- ASC 606606-10-32-15 to 32-20 (32-18: one-year expedient)
- IFRS 15paragraphs 60–65
- Ind AS 115paragraphs 60–65
Worked example
Illustrative: a perpetual licence is delivered today; the customer pays $100,000 in two years. The rate the parties would use in a separate financing transaction is 5%.
- Present value: $100,000 / 1.05² = $100,000 / 1.1025 = $90,702.95.
- Licence revenue at delivery: $90,702.95.
- Interest income over two years: $100,000 − $90,702.95 = $9,297.05, presented separately from revenue from contracts with customers.
Result: $90,702.95 of revenue now and $9,297.05 of interest income over the payment period.
Illustrative figures for explanation only, not taken from a real contract.
Common mistakes
- Ignoring a financing component in multi-year upfront prepayments.
- Assuming every annual-in-advance SaaS invoice creates one; within one year the expedient usually applies.
- Using a risk-free rate instead of a rate reflecting the customer's credit.