When does a contract have a significant financing component, and how does it affect revenue?

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AcadiFi · Accepted Answer

If the timing of payments provides the customer or seller with a significant financing benefit, the transaction price must be adjusted to reflect the cash selling price, and the difference is recognized as interest income (seller financed) or interest expense (buyer financed). The practical expedient allows you to ignore financing if the period between payment and transfer of goods is one year or less. Example: Meridon Industrial sells a $2,500,000 turbine with payment due in 3 years — no interim payments. Prevailing market rate is 7%. PV of payment = $2,500,000 / (1.07)^3 = $2,040,996. Revenue recognized at delivery = $2,040,996 (the cash-equivalent selling price). Over the next 3 years, interest income is accreted: Year 1 = $2,040,996 x 7% = $142,870; Year 2 = ($2,040,996 + $142,870) x 7% = $152,870; Year 3 brings the receivable to $2,500,000. Total interest income = $459,004. Separating revenue from interest is material for gross margin analysis: inflated revenue distorts ROIC comparisons with peers that use cash pricing. The discount rate should reflect the credit characteristics of the party receiving financing — not the seller's borrowing rate unless it's the same.

When does a contract have a significant financing component, and how does it affect revenue?

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