Rebates, chargebacks and returns

What are the main gross-to-net deductions?

• Chargebacks: a wholesaler buys at list price and sells to a hospital or pharmacy that has a contract with the manufacturer at a lower price; the manufacturer reimburses the wholesaler the difference.
• Government rebates: amounts payable to government health programmes based on their patients' use of the drug, often set by statute.
• Commercial rebates: amounts payable to insurers and pharmacy benefit managers for placing the drug on their formularies.
• Wholesaler discounts and fees: prompt-payment discounts and fees for distribution and data services.
• Returns: credits for expired or damaged product returned under the company's returns policy.

Why do payments to governments and insurers reduce revenue?

The manufacturer's customer is the wholesaler, but IFRS 15 treats consideration payable to a customer as including amounts paid to other parties that buy the company's goods from the customer. Rebates to insurers, benefit managers and government programmes are part of the price concessions in the chain of distribution, not payments for distinct goods or services, so they reduce revenue rather than being expenses. Wholesaler fees reduce revenue too, unless they pay for a distinct service at fair value. See variable consideration.

Rebates and chargebacks: a gross-to-net bridge

A manufacturer sells packs of a medicine to wholesalers at a list price, US$ 100 million in total. It estimates the deductions it will pay on those sales, based on contract terms, expected utilisation by each channel and historical claims.

Only 61% of gross sales is revenue. Each deduction is an estimate at the time of sale, updated as claims arrive, and changes in estimate adjust revenue in the period they are made. Because rebate claims can arrive more than a year after the sale, the liabilities at any date are large and judgemental.

How are the deductions estimated?

Using the expected value method across large populations of claims, based on contract terms, the mix of patients by payer, the time lag between sale and claim, inventory held by wholesalers and pharmacies, and historical experience. The constraint on variable consideration means the company includes only the amount it is highly probable will not reverse, so where claims experience is limited, such as for a new launch or a new government programme, the estimates are often more cautious.

How are returns of expired product accounted for?

For expected returns, the company recognises a refund liability and reduces revenue. Under IFRS 15 it would also recognise an asset for the right to recover returned goods, but returned medicines are usually expired and destroyed, so the asset is nil and the cost of the product stays in cost of sales. Returns rights often last months beyond expiry, so the estimate covers sales made long before. See returns and refunds.

How are the liabilities presented?

Deductions the customer will settle by paying less, such as chargebacks and prompt-payment discounts, reduce trade receivables. Amounts payable to parties other than the customer, such as government and commercial rebates, are presented as liabilities, often called accrued rebates or refund liabilities. Companies disclose the movements in these balances and the sensitivity of revenue to the estimates. See pharma accounting.

How does US GAAP compare?

ASC 606 applies the same principles, and US companies, which face the largest gross-to-net gaps, often disclose a roll-forward of each category of deduction. The economics in other markets are usually simpler, with more of the price set directly by governments.

This guide is general information. It is not tax or legal advice for your situation.