Discounting of Sales in Terms of IAS 18/IFRS for SME

If the inflow of cash or cash equivalents is deferred, the fair value of the consideration receivable is less than the nominal amount of cash and cash equivalents to be received, and discounting is appropriate. This would occur, for instance, if the seller is providing interest-free credit to the buyer or is charging a below-market rate of interest. Interest must be imputed based on market rates. [IAS 18.11]

If there was no intention at the time of the sale to grant credit of any type - interest free for example - [IAS 18.11][IAS 18.11] - does not apply.

The question arises as to why would the standard say "if material" when one would have to calculate it to see if it is material. There would be no object in it as IFRS applies only to material ietms in any case. There is a very good reasons why IFRS says what it does.

One cannot create interest where there is none to be measured. For management to be able to split the revenue with interest; management must have included upfront a portion (small or large) to take care of those slow payers. This is what management usually do when they sell to persons who do not have good credit records. To account for the risk of non payment they inflate the selling price with an interest component. It is only under those circumstances where one can split revenue with interest. Where management do no do this there can be no split and any non payment is an impairment indicator - it is not a reason to split revenue with interest. One cannot discount debtors and creditors at year end under IAS 18.11. This is done under IAS 39 and what is discounted is the future cash flows that may be collected. This is an impairment test and nothing else.

When one looks at the langauge created in IAS 18.11 - if the seller is providing interest-free credit to the buyer - one can see that it is written in the present tense and not the past tense. One cannot in the future and the go backward to decide there is financing transaction when there was none in the first place. There has to be a financing transaction at the beginning of the sale. There is no such thing as a financing transaction after the sale (unless management grant deferred payments at some later stage and then include an interest component). If the buyer takes extended credit terms without agreement with the seller this is not an indicator of financing but an indicator of impairment. 

The word "material"means material at the time of the contract of sale. Interest must be a material component of the selling price. Where interest is included in the selling price the seller is concerned with credit risk. It is only when this is done does IAS 18.11 apply.

However - IRBA raise findings as to indicate the above message was not considered in the working papers. They are correct of course. Please do not calculate splits between revenue and interest when you are not supposed. This is also an issue as IRBA will say you do not understand the standards.

The question arises as to whether this applies to purchases. There is no standard that requires this. So please do no discount purchases. However IAS 2 says:

An entity may purchase inventories on deferred settlement terms. When the arrangement effectively contains a financing element, that element, for example a difference between the purchase price for normal credit terms and the amount paid, is recognised as interest expense over the period of the financing. ​This means as above that unless there is an interest component in the price of purchase this provision of IAS does not apply. There must be deferred settlement terms agreed upfront - otherwise this provision of IAS 2 does not apply. 

IN FACT THIS APPLIES TO ANY AGREEMENT OF PURCHASE AND SALE - IF THERE IS NO AGREEMENT UPFRONT OR THE PURCHASE/SELLING PRICE DOES NOT INCLUDE INTEREST THEN THERE IS NO FINANCING TRANSACTION. WHERE THE SELLER AND ONLY THE SELLER (NOT THE BUYER) DECIDES TO NOT TO PAY ON TIME IE TAKE EXTENDED CREDIT TERMS WITHOUT AGREEMENT - THIS IS AN INDICATOR OF IMPAIRMENT AND NOT AN INDICATOR OF FINANCING.

Its a bit DIFFERENT under IFRS for SME:

If payment is deferred beyond normal payment terms, there is a financing component to the transaction. In that case, revenue is measured at the present value of all future receipts. The difference is recognised as interest revenue.

Here it is clear that extended credit terms is a condition of the split between revenue and interest. However this is only done at the time when EXTENDED CREDIT TERMS ARE GRANTED. They have to be granted by the seller and no taken without agreement by the buyer. The right to deferrment rests with the seller and not the buyer. One then only discounts those proceeds that are still owing at the time of the granting of the extended terms. In other words the debtors at the time. One would split interest and revenue. If the seller does not want to grant the extended credit terms then there is an impairment instead of a split. 

The key words are "If payment is deferred" - one does not have to be an expert in the English langauge to read this as - only when one knows whether payment is deferred.