What Is a Significant Financing Component?
A significant financing component exists when the payment terms of a contract give either the customer or the entity (supplier) a significant benefit of financing.
IFRS 15 then requires the promised consideration to be adjusted for the time value of money, so that revenue is recognised at the cash selling price at the date the goods or services transfer. The difference between that price and the amount paid is recognised separately as interest.
Which party is financed depends on when the cash arrives relative to the transfer:
| Customer pays after transfer | Customer pays before transfer | |
|---|---|---|
| Party receiving the financing | The customer | The entity |
| Revenue compared with cash | Revenue is less than the cash received | Revenue is more than the cash received |
| Interest recognised as | Interest income on the receivable or contract asset | Interest expense on the contract liability |
The basic entries for a single payment in advance and in arrears are set out in our guide to contract assets and contract liabilities. This article covers the judgements that come before those entries, and the more common cases of instalment sales and services paid for in advance.
Identifying a Financing Component
The financing may be explicit, such as a stated interest rate on deferred terms, or implied by the payment terms alone. IFRS 15 sets no percentage threshold for significance; entities weigh all relevant facts and circumstances, centred on three indicators:
- Time gap. A period of more than one year between transfer and payment strongly indicates significance. A period of one year or less can be ignored under the practical expedient.
- Price variance. A wide difference between the cash selling price and the promised consideration points to financing. A machine sold for 100,000 cash or 118,000 payable in two years is a clear case.
- Interest rates. Prevailing market rates determine the size of the time value of money effect. A long delay at low rates, or a moderate delay at high rates, can each be significant.
IFRS 15 treats the time gap and interest rates as a single combined factor, since neither determines the effect on its own. The absence of a price variance does not settle the question. Where an entity charges the same price whether the customer pays now or in two years, the time gap and interest rates can still indicate a significant financing benefit to the customer.
Significance is assessed for each individual contract. An entity with many small instalment contracts does not conclude that financing is insignificant because it is immaterial to the portfolio as a whole, although materiality still applies to the financial statements overall.
When No Significant Financing Component Exists
IFRS 15 identifies three situations in which a contract does not have a significant financing component, even where payment and transfer are far apart.
| Situation | Examples |
|---|---|
| The customer paid in advance and the timing of transfer is at the customer's discretion | Gift vouchers, prepaid airtime, loyalty points, prepaid service credits |
| A substantial amount of the consideration is variable, and its amount or timing depends on a future event not substantially within the control of either party | Sales-based royalties, success fees payable on an outcome outside either party's control |
| The difference between the promised consideration and the cash selling price arises for reasons other than financing | Retentions on construction contracts, upfront payments that secure the entity against the customer failing to complete the contract |
The third exclusion requires the difference to be proportionate to the stated reason. A retention of 10 per cent held until practical completion is consistent with protecting the customer against incomplete work. A 40 per cent deferral over five years is harder to explain on the same basis, and a financing component may exist alongside the protective purpose.
Variable consideration paid late
Variable consideration does not remove the adjustment on its own. Where a fixed fee and a success fee are both payable two years after delivery, the exclusion applies only if a substantial amount of the consideration is variable. Otherwise the transaction price, including the estimated variable amount, is discounted to the date of transfer.
The One-Year Practical Expedient
An entity need not adjust for financing if it expects, at contract inception, that the period between transferring a good or service and the customer paying for it will be one year or less.
The test measures the time between transfer and payment, not the length of the contract.
| Contract | Longest time between transfer and payment | Expedient available? |
|---|---|---|
| Three-year service, billed monthly in arrears | About one month | Yes |
| Goods delivered, payable in 12 monthly instalments | 12 months | Yes |
| Goods delivered, payable in 24 monthly instalments | 24 months | No |
| Two-year service, paid in full upfront | Up to 24 months for the final months of service | No |
The expedient is an accounting policy choice, applied consistently to contracts with similar characteristics, and its use must be disclosed.
Choosing the Discount Rate
The discount rate is the rate that would apply in a separate financing transaction between the entity and its customer at contract inception. It reflects the credit characteristics of the party receiving the financing, and any collateral or security provided.
- Where the customer is financed, the rate reflects the customer's credit risk, which is normally higher than the entity's own borrowing rate.
- Where the entity is financed, the rate reflects the entity's credit risk.
- Where a cash selling price is available, the rate that discounts the promised consideration to that price may be used, provided it is a reasonable reflection of a separate financing transaction.
- A rate stated in the contract is not used where it is below market. The difference between the stated and market rates is a reduction in the price, not a financing term. IFRS 16 imposes the same restriction on manufacturer or dealer lessors.
The rate is fixed at contract inception. It is not updated for later changes in interest rates or in the credit risk of either party.
Interest-free offers
A retailer sells furniture with a cash price of 42,000, or 24 monthly instalments of 1,750 at no stated interest. The market rate for a separate loan to the customer is 1.5 per cent a month. Discounting the instalments at that rate gives 35,053, which is the revenue recognised on delivery. The remaining 6,947 is interest income over the 24 months. The interest-free feature is a price concession of the same amount.
Example: Sale on Instalment Terms
An entity sells equipment that it would sell for 40,000 cash on delivery. The customer instead agrees to pay 24 monthly instalments of 2,000, beginning one month after delivery, a total of 48,000. The payment period exceeds one year, so the practical expedient does not apply. The rate that discounts the instalments to the cash price is 1.51 per cent a month, and the entity is satisfied that this reflects a market rate for the customer.
On delivery, revenue is recognised at the cash selling price:
| On delivery | Debit | Credit |
|---|---|---|
| Receivable (SFP) | 40,000 | |
| Revenue (P/L) | 40,000 |
Each month, interest is added to the receivable at the effective rate and the instalment received reduces it.
| Month | Opening balance | Interest income | Instalment | Closing balance |
|---|---|---|---|---|
| 1 | 40,000 | 605 | (2,000) | 38,605 |
| 2 | 38,605 | 584 | (2,000) | 37,189 |
| 3 | 37,189 | 563 | (2,000) | 35,752 |
| ... | ||||
| 24 | 1,970 | 30 | (2,000) | 0 |
| Total | 8,000 | (48,000) |
The month 1 entries are:
| Month 1 | Debit | Credit |
|---|---|---|
| Receivable (SFP) | 605 | |
| Interest income (P/L) | 605 | |
| Bank (SFP) | 2,000 | |
| Receivable (SFP) | 2,000 |
Of the 48,000 collected, 40,000 is revenue on delivery and 8,000 is interest income, of which 5,797 is recognised in the first 12 months. The receivable of 21,797 outstanding after 12 months is split between current and non-current portions in the statement of financial position. It is also subject to impairment under IFRS 9. Where the instalments are payable in a foreign currency, the receivable is also retranslated at each reporting date, as illustrated in foreign exchange differences under IAS 21.
Example: Service Paid in Advance
An entity sells a three-year maintenance contract and receives the full 108,000 on 1 January 2026. The service is delivered evenly over 36 months. Most of the service is delivered more than a year after payment, so the practical expedient does not apply. The rate for a separate borrowing by the entity is 0.75 per cent a month.
The entity is receiving the financing, so interest accrues on the contract liability. Each month:
- interest is added to the opening contract liability; and
- revenue is released by dividing the balance after interest by the months remaining at the start of the month.
| Month | Opening liability | Interest expense | Revenue | Closing liability |
|---|---|---|---|---|
| 1 | 108,000 | 810 | (3,022) | 105,788 |
| 2 | 105,788 | 793 | (3,045) | 103,536 |
| ... | ||||
| 36 | 3,897 | 29 | (3,926) | 0 |
| Total | 16,384 | (124,384) |
The month 1 entries are:
| January 2026 | Debit | Credit |
|---|---|---|
| Interest expense (P/L) | 810 | |
| Contract liability (SFP) | 810 | |
| Contract liability (SFP) | 3,022 | |
| Revenue (P/L) | 3,022 |
Two results follow from the method:
- Revenue exceeds the cash received. Total revenue is 124,384 against 108,000 received, with the 16,384 difference recognised as interest expense.
- Revenue rises each year although the service is delivered evenly. Annual revenue is 37,804, 41,350 and 45,229, because the undelivered portion carries interest until it is delivered. Interest expense falls over the same period, from 8,558 to 2,159.
Financing in Multi-Element Contracts
A financing component can relate to one performance obligation in a contract and not to others. The common case is a device supplied upfront with a service delivered over the same period, paid for in level monthly amounts.
- The service is delivered and paid for at the same time, so it has no financing component.
- The device is delivered on day one and paid for over the contract, so the customer is financed.
The transaction price is allocated to the performance obligations on the basis of stand-alone selling prices, measured at cash selling prices. Interest then accrues only on the portion of the receivable or contract asset relating to the device.
Where an entity concludes that the financing relates to only some obligations, it should be able to show that the payment timing corresponds to those obligations. Without that link, the financing is attributed to the contract as a whole.
Presentation
The effects of financing are presented separately from revenue from contracts with customers in the statement of profit or loss, as interest income or interest expense. Interest is recognised only to the extent that a contract asset, receivable or contract liability is recognised for the contract.
Under IFRS 18, interest expense on a contract liability is classified in the financing category. This is because it is identified for the purpose of applying IFRS 15, on a liability that does not arise from the raising of finance alone. Our guide to the IFRS 18 income statement categories explains that classification.
In the cash flow statement, interest accrued on a contract liability is non-cash and is adjusted for separately rather than left in the movement in the contract liability. The cash received under an instalment sale is a receipt from a customer in operating activities. See our article on cash flow statement adjustments.
The complete guide to IFRS 15 sets out where the financing adjustment sits within the step that determines the transaction price, alongside variable consideration and non-cash consideration.
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Conclusion
A significant financing component separates the price of goods or services from the price of credit. Revenue is measured at the cash selling price at the date of transfer, and the difference from the amount paid is recognised as interest income where the customer pays later, or interest expense where it pays in advance.
Three questions settle most contracts. Is the time between transfer and payment more than one year? Does one of the three exclusions apply, such as payment timing at the customer's discretion or terms that exist to protect against non-performance? And what rate would a separate loan between the parties carry at inception? Once those are answered, the mechanics are the same as for any amortised cost balance.
The same approach to discounting and interest underlies lease accounting. Our guides to calculating the lease liability and the interest rate implicit in the lease cover the IFRS 16 equivalent.
For clarification, guidance, or feedback on our article, please reach out to us at insight@leash.co.za.