There is a significant difference in accounting for a price concession and an impairment loss. And we are not even close, it is even worse….
What about an implied price concession?
Construction companies have a certain capacity of daily production/construction – OK, there is some flexibility by hiring temporary construction workers, but there is an end to that – ‘They are never there when you need them’. As a result construction companies with a small sales funnel or an irregular distribution over time in working on the live construction contracts may be willing to offer an implied price concession to win a construction contract to avoid a larger loss in not filling their (minimum) capacity. Implied price concession or Impairment loss
It may also be that the construction company offered a competitive construction quote following an aggressive path to growth or to enter into a new market segment. Anyway a loss is not always what it seems at first sight….
What follows is a discussion on price concession in IFRS 15, which shows the differences, being an implied price concession results in a lower transaction price and as a result lower revenue, while an impairment loss is ‘Cost of sales’, OK also something to not be happy about but at least your revenue is still there….
Why the hassle?
Revenue is an important benchmark in the construction industry – it is considered as evidence that a construction company should be able to conduct construction assignments of a certain size and complexity. Implied price concession or Impairment loss
An entity will need to exercise judgement when considering the terms of the contract(s) and all of the facts and circumstances, including implied contract terms. Step 3 of the revenue recognition model requires a company to determine the transaction price of a contract. At times, a company may accept a price lower than is stated in the contract because the customer has experienced dissatisfaction with goods or services, the company is trying to gain market share, or the company is trying to build a relationship with the customer in expectation of future business. This practice of accepting a price lower than the stated transaction price is called a price concession and is a common form of variable consideration.
The potential for a price concession may be explicitly detailed within a contract, or it may be indicated or implied by an entity’s expected behaviour. A transaction contains a price concession when ‘it is expected that the entity will offer a price concession’ or ‘other facts and circumstances indicate that the entity’s intention, when entering into the contract with the customer, is to offer a price concession to the customer.’ Implied price concession or Impairment loss
The example case
Blueberry, Inc. (Blueberry) is in the business of creating video game console add-ons to enhance the user’s gaming experience. Blueberry has been in business for fifteen years and has developed significant market recognition for its creative and high-quality console add-ons.
To sell products to its customers, Blueberry uses multiple distribution channels, including direct sales at local stores and through its website. To reach more customers, Blueberry contracts Dyno-matic Distributors, LLC (Dyno) to sell console add-ons to non-local customers and retailers. Because each console add-on that Blueberry sells is unique, Blueberry creates a new contract with Dyno for each new console add-on. Each contract contains a price protection agreement clause, indicating that Blueberry will offer a price concession to Dyno if the end customers are no longer buying the product for more than the contract price per product. Historically, Blueberry has consistently offered price concessions to Dyno. Implied price concession or Impairment loss
On December 15, 20X7, Blueberry entered into a contract with Dyno to receive $20 million for the sale of 500,000 of its newly developed virtual reality headsets ($40 per headset). The contract extends for the later of December 31, 20X8, or until all headsets are sold. At the inception of the contract, Blueberry needs to determine the transaction price of the contract.
Blueberry explicitly includes a price concession within the contract with Dyno by including the price protection agreement. Were this provision not included, the contract still contains an implicit price concession because Blueberry has a history of offering price concessions to Dyno in other contracts. Because the contract contains a price concession, Blueberry must reduce the transaction price at the inception of the contract by the amount of the expected price concession. Implied price concession or Impairment loss