In some cases, an entity may accept a lower price than what is stated in the contract. This situation could occur because the entity wants to encourage the customer to keep making purchases, because the entity is trying to gain market share, or because the customer has expressed dissatisfaction with the goods. This lower price is a common form of variable consideration known as a price concession. This article explains how to account for price concessions based on the customer’s expectation and the specific facts and circumstances of the transaction. The article also provides specific examples for different price concession scenarios, and it outlines the differences between price concessions under Accounting Standards Codification (ASC) 605 and ASC 606.
Whereas other forms of variable consideration may be explicitly stated in the contract, price concessions are frequently implied or assumed. ASC 606-10-32-7 outlines two price concession scenarios that constitute variable consideration: (1) the customer expects a price concession and (2) the facts and circumstances indicate that the entity intends to offer a price concession.
Under the first scenario, the customer could expect that the entity will accept less consideration than the price in the contract because of the entity’s “customary business practices, published policies, or specific statements” (ASC 606-10-32-7a).
If the customer has a valid expectation of a price concession, then the entity should apply the variable consideration guidance and reduce the transaction price to reflect the amount of consideration expected to be received. This concession could be referred to using different names such as discount, rebate, refund, or credit.
Example 1 – Customer Expectation
Company X sells 2,000 computers for $500 each to Customer Y, a new customer, for a total transaction price of $1,000,000. Company X has made price concessions in the past. Because of Company X’s customary business practices, Customer Y has an expectation that the entity will offer a price concession. Due to rapid changes in technology, Company X determines that it is willing to accept a total transaction price of $700,000 for the 2,000 computers.
Analysis: Since it is likely that Company X provides a price concession and accepts a price lower than $1,000,000, then the consideration is variable. Company X expects to be entitled to $700,000, and this amount is not constrained under the variable consideration guidance. Company X, therefore, should adjust the transaction price down to the expected amount of $700,000.
Under the second scenario, the facts and circumstances of the transaction could indicate that the entity intends to offer a price concession. The facts and circumstances must be carefully considered because it is sometimes difficult to differentiate between implicit price concessions and impairment losses. These “facts and circumstances” could be the customer’s ability to continue as a going concern, customer cash flow problems, customers entering a new region with a poor local economy, high competition in the market, or the customer’s limited experience. The Financial Accounting Standards Board (FASB) did not develop any detailed guidance for distinguishing between price concessions and impairment losses, but the following examples may be helpful.
Example 2 – Price Concession
Toy Maker Inc. enters into a contract with Plastic Company to buy $300,000 of plastic to make children’s toys. Toy Maker Inc. is in its third year of business and its first two years were cash flow negative. Toy Maker expects to grow, however, and is forecasting positive future cash flows and positive net income by year 4.
Plastic Company intends to offer Toy Maker a reduction in price in order to keep the supply relationship alive. Plastic Company knows that Toy Maker might not be able to afford the full $300,000 price now but Plastic Company wants to forge this relationship in order to obtain more business in the coming years. As a result, Plastic Company reduces the transaction price to $100,000. Is this adjustment an implicit price concession or an impairment loss?
Analysis: This adjustment is an implicit price concession. Plastic Company is offering this price concession for the purpose of forming and keeping alive a customer relationship. Positive forecasts for Toy Maker give Plastic Company confidence that Toy Maker will enter into future contracts with Plastic Company. Although Toy Maker’s operations are currently cash flow negative, Plastic Company offers the reduction in price because the facts and circumstances of the transaction lead them to believe that Toy Maker will be a profitable company in the future. Consequently, Plastic Company should account for the price reduction as a price concession rather than an impairment loss.
Example 3 – Impairment Loss
Furniture Company enters into a contract with Lumber Company to buy $300,000 of wood to make specialty cabinets. Furniture Company is experiencing economic difficulties and has some cash flow problems. Because of the heightened competition in the local furniture industry, Furniture Company is struggling to stay cash flow positive.
Based on the credit risk of Furniture Company, Lumber Company determines it might only receive $250,000 from Furniture Company. This adjustment is made after contract inception. Lumber Company is willing to accept this risk because Lumber Company would have sufficient margin on the sale of wood to cover the risk of loss. Lumber Company has not offered price concessions to furniture companies in the past. Is this adjustment an implicit price concession or an impairment loss?
Analysis: This adjustment in price is an impairment loss. In this situation, Lumber Company has analyzed the credit risks of Furniture Company and is collecting the highest amount of consideration that it can from Furniture Company. Lumber Company does not expect Furniture Company to continue as a going concern for much longer. Lumber Company would not normally offer such a concession, but because of the unique facts and circumstances of this situation it must reduce the transaction price and account for the reduction as an impairment loss.
As the entity considers the possibility of an impairment loss, it must also consider the probability of collecting the consideration. If it is not probable that the entity will collect the consideration to which it is entitled then the transaction does not meet the criteria for a contract with a customer found in ASC 606-10-25-1. For instance, in example #3 if Plastic Company determined that it was not probable that the entity would collect the reduced price of $250,000 from Toy Maker Inc. then a contract would not exist and Plastic Company could not account for the transaction under ASC 606. (For information on differentiating between a price concession and an uncollectible amount, see Collectibility.)
Comparison to 605
Under ASC 605, entities also evaluate the history of price concessions, but ASC 606 makes a few changes to the existing guidance. Under ASC 605, if the entity has a history of price concessions then it might conclude that the price of the arrangement is not “fixed and determinable” as a result (ASC 605-10-S99-1). In this case an estimate for the price concession is not made at the onset of the contract, but revenue is recognized as payment becomes due, assuming the other revenue recognition criteria have been met. In contrast, under ASC 606, the entities must determine the amount of consideration to which they expect to be entitled, and for which it is probable that a significant revenue reversal will not occur as the contract is made. They will recognize the estimated amount when (or as) the performance obligation is satisfied, rather than later as payment becomes due.
Entities must determine whether they intend to offer a price concession or whether the customer has a valid expectation of a price concession. Entities must also consider special facts and circumstances such as customer cash flow problems, economic difficulty, or high competition in the marketplace to evaluate the likelihood of a price concession. If an entity determines that there is an explicit or implicit price concession, then the consideration is variable, and the entity must reduce the transaction price to the amount to which it expects to be entitled. If the entity determines that it is not probable that it will collect the consideration then it cannot account for that portion of the transaction price under ASC 606.
- ASC 606-10-25-1, ASC 606-10-32-7, 606-10-55-99 to 55-101.
- EY, Financial reporting developments: “Revenue from Contracts with Customers.” Revised October 2018. Section 5.1.1 “Forms of variable consideration.”
- KPMG, Issues In-Depth: “Revenues from Contracts with Customers.” May 2016. Section 5.3.1 “Variable consideration (and the constraint).”
- PWC, “Revenue from contracts with customers.” August 2016. Section 126.96.36.199 “Price Concessions.”