Step 3 continued: financing components, noncash consideration and payments to customers

• Determine whether a contract contains a significant financing component
• Apply the one-year practical expedient and the factors that rule out financing
• Measure noncash consideration at contract inception
• Classify consideration payable to a customer as a reduction of revenue or a purchase

Significant financing component

Under 606-10-32-15, the entity adjusts the promised consideration for the time value of money when the payment timing agreed by the parties gives either party a significant benefit of financing. The financing can be explicit or implied by the terms. The objective is revenue at the cash selling price: what the customer would have paid in cash when the goods or services transferred.

Factors to weigh include the difference between promised consideration and the cash selling price, and the combined effect of the expected time between transfer and payment and prevailing interest rates.

Under 606-10-32-17, a contract does not have a significant financing component if any of these exist:

• the customer paid in advance and the timing of transfer is at the customer's discretion (for example, a prepaid card);
• a substantial amount of consideration is variable and depends on a future event outside the parties' control (for example, a sales-based royalty); or
• the difference between promised consideration and cash selling price arises for reasons other than financing, such as protection against the other party failing to perform, and the difference is proportional to that reason.

Practical expedient (606-10-32-18). The entity need not adjust if, at contract inception, it expects the period between transfer and payment to be one year or less. Disclose use of the expedient.

When an adjustment is required, use the rate that would be reflected in a separate financing transaction between the entity and the customer at inception (606-10-32-19). It reflects the credit characteristics of the party receiving financing. Do not update the rate for later changes in market rates. Interest income or expense is presented separately from revenue.

Financing can run in either direction. A large advance payment for delivery two years later means the entity is borrowing from the customer: revenue is grossed up and interest expense accrues.

Noncash consideration

Customers sometimes pay with shares, goods, equipment or services. As amended by ASU 2016-12, 606-10-32-21 measures noncash consideration at fair value at contract inception, the date the step 1 criteria are met. If fair value cannot be reasonably estimated, measure it indirectly by reference to the standalone selling price of the goods or services promised (606-10-32-22).

Later changes in fair value split two ways under 606-10-32-23:

• changes due to the form of consideration (the share price moves) are not included in the transaction price;
• changes for other reasons (the number of shares depends on the entity's performance) are variable consideration subject to the constraint.

If a customer contributes goods or services (materials, equipment, labor) to help fulfill the contract, the entity assesses whether it obtains control of them. If it does, they are noncash consideration.

Consideration payable to a customer

Under 606-10-32-25, consideration payable to a customer includes cash paid or expected to be paid to the customer or to the customer's customers, and credits, coupons or vouchers that can be applied against amounts owed. Examples: slotting fees, cooperative advertising, volume credits and payments to retailers who resell the product.

The default is a reduction of the transaction price. The exception is a payment for a distinct good or service the customer transfers to the entity, which is accounted for like any other purchase. If the payment exceeds the fair value of that distinct good or service, the excess reduces revenue. If fair value cannot be reasonably estimated, the whole payment reduces revenue (606-10-32-26).

When the payment reduces revenue, recognize the reduction at the later of when the entity recognizes revenue for the related transfer and when it pays or promises to pay (606-10-32-27). A promise implied by customary practice counts.

Use the significant financing component calculator to model the discounting.

Deferred payment terms on an equipment sale