Rebates and discounts IFRS 15 and IAS 2

This article refers to discounts for inventory sales regulated in IFRS 15 and discounts for inventory purchases under IAS 2.

IFRS 15 radically changed how the revenue from ordinary activities should be recognized

Discounts under IFRS 15 are recognized as using as a reference the performance obligations established in a contract and based on the independent sales prices of said obligations.

If the term performance obligations are unknown to you, you can read the following post, where we explain this concept in detail.

On the other hand, there is the concept of independent sales prices. 

This term refers to the price at which an entity would sell a separate good or service to a customer.

This price includes discounts, returns, refunds, credits, price reductions, incentives, performance bonuses, penalties, or other similar elements.

I'm interested in the discount

Example IFRS 15 using discounts​

An entity sells three types of products.

The unit sales price each product sold to the public is shown below:

Product A: $700

Product B: $600

Product C: $ 800

Total: 2,100

A general rate for the three products of 1,700 dollars is established within the negotiations with the client.

This means that the discount provided to the client is 400, which is equivalent to the difference between the independent sales price sum of the three products and the global price established in the agreement.

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There are two ways to distribute the discount among the three products: 

The first is established in paragraph 81 of IFRS 15 and the second is regulated in paragraph 82 of this same standard.

Paragraph 81 IFRS 15: The entity allocates the transaction price to each performance obligation based on the relative independent selling prices of the various underlying goods or services.

This paragraph is used when each product sold represents a single performance obligation.

To know if a product or service represents a single performance obligation, each good or product must be different, and for each good or service to be different it must be separately identifiable.

That is, no product must have interdependence with another.

If an entity concluded that product B should be sold together with product C because they represent a comprehensive service, the company would conclude that there would only be two performance obligations, the first consisting of product A and the second made up of product B and C.

In this case, paragraph 81 would not be used, but 82.

But for now let’s focus on the first option, that is, where each product represents a unique performance obligation.

The allocation of the discount using the paragraph 81 would be as follows:

Discount allocation = Independent sale price / sum of the three products without discounts X agreed global price.

Product A = 700 / 2,100 X 1,700 = 567

Product B = 600 / 2,100 X 1,700 = 486

Product C = 800 / 2,100 X 1,700 = 648

Total: 1,700

As can be seen, the sale prices of each product have changed as a result of the application of the discount.

That is, product A that had an independent sale price of 700, now with the discount allocation, the transaction price is 567.

The same happens with products B and C now have a transaction price of 486, 648 respectively.

As can be seen, the sum of the transaction prices of each product results in the global price charged to the customer for 1,700.

Now let’s assume that products B and C are sold together because they represent a single performance obligation:

The independent sale prices are the same in before example.

Product A: $700

Product B: $600

Product C: $800

Total: 2,100

However,  the entity regularly sells products B and C at a global price of 1,000.

Of this way, the company has evidence the full discount should be allocated to commitments to transfer products B and C in accordance with paragraph 82 of the IFRS 15

Paragraph 82 IFRS 15: is used when 3 requirements are met:

  • The first requirement is that the entity regularly sells each good or service of different of  independently.

This is evidenced by the fact  the entity sells products A, B and C using the following sales prices: 700, 600 and 800 respectively

  • The other requirement is that the entity also regularly sells on a stand-alone basis a bundle or bundles of some of those distinct goods or services at a discount to the stand-alone selling prices of the goods or services in each bundle.

This is evidenced by the fact that the entity sells the products B and C at a price of 1,000, that is, a price that includes a discount.

  • And the last requirement is that the discount attributable to each group of goods or services described in the previous paragraph is substantially the same as the contract discount.

That is, this is evidenced at the time of adding the prices of performance obligations.

Performance Obligation 1: Product A: 700.

Performance Obligation 2: Product A and B: 1,000

Total: 1,700 which is equal to the contract price

When paragraph 82 is used, the discount is assigned to one or more performance obligations, but not all.

The contract requires the entity to transfer control of Products B and C at different times.

Then the distributed amount of 1,000 is assigned individually to the commitment to transfer product B with a stand-alone selling price of 700 and product C with a stand-alone selling price of 800 as follows.

Sales prices for independent products B and C: 1,500

Product B: 467 = (700 / 1500X1.000)

Product C: 533 = (800 / 1500X1.000)

Product A: 700

Product B: 467

Product C: 533

Total with discount: 1,700

Sales volume discounts

When an entity grants discounts for a volume, it should review paragraphs 56 to 58 of IFRS 15.

There, reference is made to the concept of constraining estimates of variable consideration.

This means that a company should include within the transaction all price or price part of the amount of the variable consideration estimated under paragraph 53, only to the extent that it is highly probable that a significant reversal of the accumulated revenue recognized will not occur when uncertainty about the variable consideration is subsequently resolved.

A significant reversal of income is the process by which an entity sells a certain product and has evidence to establish that the discounts granted by the entity will be used by the customer.

When this occurs, IFRS 15 determines that an entity should not recognize the totality income but the income, including said discount granted by the company.

In other words, if an entity establishes with a third party the delivery of a certain discount for the sale of merchandise and the company estimates the client will take said discounts, there is evidence to set out that there may be a significant reversal of income from ordinary activities.

Let’s look at the following example:

In January of year 1, a company signed a contract with a pharmaceutical company for numerous medical equipment sales to $2,000 per equipment.

If the customer purchases more than $800 units in the year, the company will retroactively grant a discount of $300 to the unit sale price.

In the first quarter, the customer purchases 250 units.

Based on units sold in the first three months, the company considers that surely the customer will not acquire more than 800 units in the year.

For this reason, the entity set out that it is unlikely that a significant reversal of the amount of revenue from ordinary activities could occur.

In this way, the entity recognizes income from ordinary activities for 500,000 (2,000X250)

At the end of June, the units acquired by the pharmaceutical company increased by 400 units, that is, an accumulated 650 units in the first 6 months.

In light of the new facts, the entity estimates that the customer’s purchases will exceed the threshold of 800 units in the year and, therefore, a retroactive reduction of the price per unit to $1,700 will be required.

Due to new events, the entity must reassess its estimate and determine whether there may be a significant reversal of revenue.

Therefore, the company recognizes  income from ordinary activities as follows:

Example1

Consequently, the revenue for the first 6 months amounts to 500,000 + 605,000 = 1,105,000.

Throughout the year, the entity must review whether the estimate of the reduction in the transaction price as a result of the application of the discounts has not changed.

Discounts on inventory purchase

Discounts in the purchase of inventories are regulated in IAS 2.

Paragraph 11 of this standard establishes that the cost of an inventory is composed of the purchase price, import duties, non-recoverable taxes, directly attributable costs, discounts, and rebates.

Discounts are of two types: volume and prompt payment.

Volume discounts example:

An entity purchases inventory at a unit price of 600, and the supplier grants the entity a 15% discount on orders of more than 200 units.

The company purchases 400 units.

In this way, the entity will recognize inventory for 204,000 (510X400).

The unit price of 510 is the purchase price, including the 15% discount.

Example of a cash discount.

On January 1 of year 1, a company purchases 700 units at a unit price of 350; if the company pays for the inventory in less than 60 days, the supplier grants a discount of 20%.

The company pays for the inventory on January 30.

The accounting recognition is as follows:

Example2 (1)
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