Accounting: The Language of Business - Vol. 2 (Intermediate: Part 120)

Jim Rohn

"Don't wish it were easier, wish you were better"

 Revenue Recognition (Part G)

by

Charles Lamson

Step 3: Determine the Transaction Price (continued from Part 119)

Recall from Exhibit 8.1 from Part 114 and reintroduced below, the five steps in revenue recognition. In this post, we continue our discussion of Step 3.

Also recall from part 119 that the transaction price is the amount that an entity will ultimately recognize as revenue. Measuring the transaction price can be quite simple in some cases. For example, assume a customer shopping at a retail store selects and pays $100 cash for a new dress. The transaction price is $100. However, with complex transactions, determining the transaction price is involved. Sellers consider the effects of a number of different factors when determining the transaction price, including:

1. Variable consideration and constraining estimates of variable consideration

2. Any significant financing component in the contract

3. Noncash consideration

4. Consideration payable to a customer

In part 119, we discussed variable consideration and constraining estimates of variable consideration. This post discusses any significant financing component in the contract,

Significant Financing Component

In contracts when delivery of the goods or services occurs in advance of the payment, the seller is providing financing to the buyer. Alternatively, in contracts when delivery occurs well after payment, the buyer is providing financing to the seller. When the time lapse between payment and delivery is more than one year, entities are required to separate the revenue generated from the contract from the financing component if the financing component is significant at the individual contract level.

The rationale is that the seller should recognize revenue at the amount that properly reflects the price that a buyer would pay if payment occurred on the same date as delivery. In determining whether a significant financing component exists, the entity considers three factors:

1. The difference between the contract price and the cash selling price of the goods or services.

2. The length of time between delivery and payment.

3. The prevailing interest rate in the market.

Once an entity concludes that there is a significant financing component, it determines the transaction price by using the time value of money:

• If the delivery occurs before payment, the entity discounts the promise consideration amount back to the present value, using the same discount rate it would use if it entered into a separate financing arrangement.

• If delivery occurs after the payment, the entity determines the future value of the payment, using the same discount rate it would use if it entered into a separate financing arrangement.

The entity ultimately recognizes the transaction price as sales or service revenue and records the difference between the total contract price and the present or future value as interest revenue if the payment occurs after delivery or interest expense if the payment occurs before delivery.

 We present an example of a contract with a significant financing component in Example 8.9.

 

Example 8.10 provides an illustration of a scenario in which the delivery occurs after the payment. 

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 384-385*

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