Significant Financing Component

For some transactions, the?receipt of the consideration?does NOT match the?timing of the transfer of goods or services to the customer?(e.g., the consideration is prepaid or is paid after the services are provided).

When the customer pays in?arrears but performance obligation has been satisfied, the entity is effectively providing financing to the customer and such will be treated as financial asset as per IFRS 9 Financial Instrument.

Conversely, when the customer pays in?advance but no performance obligation has been satisfied, the entity has effectively received financing from the customer and such will be treated as financial liabilities as per IFRS 9 Financial Instrument.

IFRS 15 Paragraph 60 provides following indications of a significant financing component:

·????????The difference between the amount of promised consideration and the cash selling price of the promised goods and services.

·????????The length of time between the transfer of the promised goods and services to the customer and the payment date.

Lets understand with two illustration:

Illustration: (Financing component)

Jumairah Development Company enters into a contract on 1st July 2023 with Mr. Ilias to sell a property. Control of the property will transfer to Mr. Ilias in two years (i.e., the performance obligation will be satisfied at a point in time). Jumairah Development Company determines that?11%?is the prevailing market rate of interest as set by the Bangladesh bank.

. The contract includes two alternative payment options:?

1.?????Payment of?Tk 24,348,673?now and property will be transferred after two years.

2.?????Payment of?Tk 30,000,000 after two years and Mr. Ilias now obtains control of the asset, or?

How these transactions are to be recognized as per IFRS 15?

1. If Mr. Ilias elects to pay?Tk. 24,348,673?now.

Jumairah Development Company concludes that the contract?contains a significant financing component?because of the length of time between when Mr. Ilias pays for the property and when Jumairah Development transfers the property to him, as well as the prevailing interest rates in the market. The length of time is 2 years between the amount of promised consideration and the cash selling price of the promised goods and services. (Indication as per IFRS 15). In substance, Jumairah Development has obtained a loan from Mr. Ilias and such will be considered as financial liability instead of revenue. IFRS 9 will come into effect here.

The following Journal entry are given below:

Journal entry as on 1st July 2023:

Cash Dr Tk. 24,348,673

Financial Liability (Loan) Cr Tk. 24,348,673

Journal entry as on 30th June 2024:

Interest Expense Dr 2,678,354 [Tk. 24,348,673 x 11%]

Interest Payable Cr 2,678,354

Journal entry as on 30th June 2025:

Interest Expense Dr 2,972,973 [Tk. (24,348,673+ 2,678,354) x 11%]

Interest Payable Cr 2,972,973

Finally, as on 30th June 2025, property will be transferred by Jumairah Development and revenues will be recognized. Financial Liability will be derecognized.

Financial Liability. Tk. [24,348,673+2,678,354+2,972,973] 30,000,000

Revenue Cr. Tk. 30,000,000

In substance, Jumairah Development has taken loan from Mr. Ilias in this case. Revenue has been recognized when performance obligation has been satisfied (at 30th June 2025).

2. Payment of?Tk 30,000,000 in two years and Mr. Ilias obtains control of the asset

In this case, Jumairah Development will get the payment after two years and Mr. Ilias will get control of the asset now. There is a financing component where Jumairah Development has performed their obligations but money will be received after two years. The consideration must be adjusted for the impact of financing transaction. Revenue is to be recognized now with the amount Tk. 24,348,673 (30,000,000 x 1/1.11^2) on 1st July 2023 along with debiting corresponding receivables.

The receivables are subsequently accounted for in accordance with IFRS 9 Financial Instruments.

Journal entry as on 1st July 2023:

Receivables Dr Tk. 24,348,673

Revenue Cr Tk. 24,348,673

Journal entry as on 30th June 2024:

Interest Receivable Dr 2,678,354 [Tk. 24,348,673 x 11%]

Interest Revenue Cr 2,678,354

Journal entry as on 30th June 2025:

Interest Receivable Dr 2,972,973 [Tk. (24,348,673+ 2,678,354) x 11%]

Interest Revenue Cr 2,972,973

Finally, as on 30th June 2025, money has been received by Jumairah Development and receivables will be derecognized. To be noted, Receivables is a financial asset here accounted as per IFRS 9.

Bank Dr. Tk. [24,348,673+2,678,354+2,972,973] 30,000,000

Receivables Cr. Tk. 30,000,000

The unwound discount 11% increases the receivables amount for two years and after two years, the receivables will be encashed. In substance, customer has taken up a loan from Jumairah Development and therefore, receivables had been recognized. After two years, the cash has been recognized by derecognizing the receivables and there has been interest revenue for two years due to unwinding of discount.