QUESTION 29 Illustration 29–Withheld payments on a long-term contract ABC Limited enters into a contract for the construction of a power plant that includes scheduled milestone payments for the performance by ABC Limited throughout the contract term of three years. The performance obligation will be satisfied over time and the milestone payments are scheduled to coincide with the expected performance by ABC Limited. The contract provides that a specified percentage of each milestone payment is to be withheld as retention money by the customer throughout the arrangement and paid to the entity only when the building is complete. Analyze whether the contract contains any financing component.

Solution

In accordance with IFRS 15, a contract could contain a significant financing component if the timing of payments agreed upon in the contract provides either the customer or the entity with a significant benefit of financing. The standard suggests three factors to consider in determining whether a contract contains a financing component:

  1. The difference, if any, between the amount of promised consideration and the cash selling price of the good or service.
  2. The combined effect of both of the following:
  3. a. The expected length of time between when the entity transfers the promised good or service to the customer and when the customer pays for that good or service.
  4. b. The prevailing interest rates in the relevant market.

In the case of ABC Limited, the company is building a power plant over a period of three years, during which part of the payment is withheld and only paid upon completion of the building.

Given this, if the interest rates in the relevant market are substantial and the amount withheld is also significant, it is likely that this contract contains a significant financing component. This is because the customer is effectively using the money that would have been paid to ABC Limited (retention money) for other purposes during the construction period, which is a benefit equivalent to receiving financing.

However, the final determination would depend on a more specific assessment of the amounts involved, the prevailing interest rates, and the other contractual terms. It is also worth noting that if the arrangement is a customary business practice in the industry, it may not be deemed as a significant financing component.

Remember that IFRS 15 also provides a practical expedient that an entity need not adjust the promised amount of consideration for the effects of a significant financing component if it expects, at contract inception, that the period between the transfer of the promised good or service to the customer and when the customer pays for that good or service will be one year or less.

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