QUESTION 26 Illustration 26–Accounting for significant financing component NKT Limited sells a product to a customer for $ 121,000 that is payable 24 months after delivery. The customer obtains control of the product at contract inception. The contract permits the customer to return the product within 90 days. The product is new and the entity has no relevant historical evidence of product returns or other available market evidence. The cash selling price of the product is $ 100,000 which represents the amount that the customer would pay upon delivery for the same product sold under otherwise identical terms and conditions as at contract inception. The entity's cost of the product is $ 80,000.The contract includes an implicit interest rate of 10 per cent (i.e. the interest rate that over 24 months discounts the promised consideration of $ 121,000 to the cash selling price of $ 100,000). Analyze the above transaction with respect to its financing component.

Solution

In this scenario, there is a significant financing component present as NKT Limited is effectively providing financing to the customer by allowing them to pay for the product 24 months after the delivery.

IFRS 15 provides that where a contract contains a significant financing component, the entity should adjust the promised consideration to reflect the time value of money. This adjustment is done by discounting the promised consideration to its present value using an appropriate discount rate, typically the interest rate that would be applicable in a separate financing transaction between the entity and its customer.

In this case, the contract includes an implicit interest rate of 10%, which is used to discount the promised consideration of $121,000 to the cash selling price of $100,000. The difference between these amounts, $21,000, is the financing income that NKT Limited is expected to earn over the 24 month period.

The financing component should be recognized as interest income over the period between when the product is transferred to the customer and when the customer pays for the product, using the effective interest method.

As the customer has the right to return the product within 90 days, NKT Limited should also consider the impact of this return right on the recognition of revenue. However, as the company has no relevant historical data or market evidence on the likelihood of returns for this new product, they may need to estimate the returns based on any available information.

In conclusion, NKT Limited will need to recognize the financing component of the contract and possibly adjust their revenue recognition based on the estimated returns.

 


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