As part of the contracts with wholesale customers, a pharmaceutical company agrees to reimburse wholesalers for the difference between the gross sales price at which a pharmaceutical company sells its products to the wholesalers (WAC) and the prices of the products charged at the time of resale by the wholesaler to the end distributor (pharmacy, hospital, etc). This difference is known as a chargeback.
Chargebacks often represent the largest reduction in the “gross to net” product sales calculation on the financial statements of a pharmaceutical company. Additionally, on the balance sheet, the allowance for chargeback provisions related to channel inventory, which is inventory sitting with the wholesaler awaiting further distribution, will also be among the largest reductions in determining the net amount of accounts receivable. Channel inventory consists of products on the shelves of the end distributors that have yet to be sold, through to the ultimate retail customer.
In computing the provision for a chargeback allowance, the Company will generally use significant estimates including the amount of channel inventory, the expected chargeback per unit, and anticipated future price changes. All, ultimately used in determining proper revenue recognition.
To ensure chargebacks are being accurately and timely recorded, implementing a thorough and efficient charback system is crucial for pharmaceutical companies. Often, small and midsized organizations will utilize a manual chargeback system which will generally require the wholesalers to provide various schedules and computations to the accounting/finance team of the pharmaceutical company. As you can imagine, these schedules can contain significant amounts of data and transactions and since it isn’t always efficient or even feasible to review every single transaction line, it becomes challenging to verify the total amount of the chargebacks. In many cases, pharmaceutical companies leverage various third-party logistic companies and their technology to ensure proper adherence to contract rates and, thus, compute chargebacks with more accuracy than in a manual review. In our experience, as a company grows, it may be worthwhile to consider implementing a comprehensive automated chargeback system. An automated chargeback system will allow management to retrieve up to the minute, accurate data regarding chargeback balances while also reducing the risk of chargeback overages due to oversight. Furthermore, automated chargeback systems allow more successful chargeback matching, more comprehensive data retention and support for resolving discrepancies that may occur.
Regardless of the specific chargeback system utilized, it is crucial that a pharmaceutical company continually update and match chargebacks to sales, regardless of the materiality of the chargebacks. Unmatched and unreconciled chargebacks will continue to grow and create long term issues with the validity of accounts receivables and net sales reported in the Company’s financial statements. Additionally, improper matching of chargebacks could negatively impact the Company’s ability to dispute incorrect chargeback requests from wholesalers which could potentially result in delays in collecting account receivable balances.
If you have any questions related to chargebacks or any other life science or pharmaceutical matter, please contact your WilkinGuttenplan advisor.