The Operation of the Interchange Standards: Conclusions Paper 3. Accounting Basis

3.1 Issue for consultation and proposed options

The Bank consulted on changing the accounting basis by which net compensation is calculated, from a ‘quasi-cash’ approach[10] to an accruals approach. The alternative option was to maintain the status quo. The primary objective of the proposal was to reduce compliance costs by allowing regulated entities greater scope to draw more directly on their financial accounts prepared in line with generally accepted Australian accounting principles when calculating their net compensation position.[11] The proposal specified that the accruals methodology used for determining compliance must allocate benefits to, or between, reporting periods in a manner consistent with the purpose and intent of the Standards.

In broad terms, cash accounting recognises benefits when they are paid or received, whereas accrual accounting recognises benefits when they are earned or accrued, regardless of whether they have actually been paid or received. One potential drawback of an accruals approach is that it introduces greater variability in the way benefits can be recognised. The Australian Accounting Standards Board (AASB) Accounting Standards[12] provide an appropriate starting point for determining how to allocate benefits to reporting periods for the purpose of calculating net compensation.[13] The proposal noted that an entity's decision to change from one accruals treatment to another from one reporting period to the next could have the purpose or effect of avoiding the Standards. For this reason, the Bank proposed that entities not be able to do this without prior written permission from the Bank.[14] More generally, it noted that guidance may be required to provide clarity over which accruals treatments are consistent (or inconsistent) with the purpose and intent of the Standards.

3.2 Stakeholder views

Stakeholder feedback indicated widespread support for the move to an accruals approach for determining net compensation. Almost all respondents indicated that a shift to an accruals approach would reduce their compliance costs. No entities expected a material increase in compliance costs from this change.

Many respondents considered the accruals accounting treatments allowable under the Australian Accounting Standards (AAS) to closely, or completely, align with the purpose and intent of the interchange standards. However, one entity raised concerns that there might be an AASB allowable accounting treatment for upfront incentive payments that is inconsistent with the purpose and intent of the Standards. Several entities requested further clarification on how the proposed accruals approach would operate in practice. This included, in some cases, a request for specific guidance on: which accruals treatments the Bank views as being consistent (or inconsistent) with the purpose and intent of the Standards; and whether entities should apply a consistent accounting approach across Issuer Receipts, Issuer Payments, and different scheme-issuer agreements for Benefits that are of a similar nature to each other. One stakeholder raised the idea of drawing on financial accounting prepared using US Generally Accepted Accounting Principles (GAAP) rather than AAS (or equivalent). Its rationale was that it has a US-based parent and prepares its financial accounts on a US GAAP basis, so the use of these accounts would reduce compliance burden. It indicated that it had not found any differences material to the calculation of net compensation from using US GAAP versus AAS.

A few entities opined that schemes and issuers should not always be required to seek permission from the Bank to change from one accruals methodology to another – for example, in situations where the change in methodology is a result of a change to an AAS. However, these stakeholders agreed that changes to accounting standards are known well in advance of their implementation date, and that there is unlikely to be any practical difficulty seeking permission from the Bank in this circumstance.

Two entities proposed alternative bases for determining net compensation compliance. These were: (1) that the compliance requirement be assessed on net compensation over the life of a contract, rather than over annual reporting periods, such that an entity could use either a cash or an accruals approach and reach the same determination on their compliance status; and, (2) that compliance should be determined on a fully-cash basis over a two-year rolling period, which should be retrospectively applied to the commencement of the Standards in 2016. The rationale for the latter suggestion was to remove the ability for entities to allocate large upfront payments over more than two periods. This entity was concerned that the ability to allocate upfront payment over numerous periods created an un-level playing field between schemes with differing ability to provide large upfront payments (and relatedly, the ability to enter into longer-duration contracts).

3.3 Assessment and Conclusion

In view of the broad support from stakeholders, the Bank will proceed with the proposal to require net compensation to be calculated on an accruals basis as set out in the consultation paper (Proposal 1). Further guidance in relation to the operation of the accruals approach is likely to be helpful to stakeholders, and is provided in Box B below and Appendix B.

In relation to other issues raised in consultation:

  • It seems reasonable to expect that entities should apply a consistent accounting treatment across Issuer Receipts, Issuer Payment and all of its scheme-issuer agreements. ‘Cherry-picking’ different accounting treatments for Benefits that are similar in their substance and ‘fact pattern’ may have the purpose of avoiding the Standards, in which case the anti-avoidance clause of the Standards would be relevant.
  • It is reasonable to retain the proposed requirement that schemes and issuers must not change accounting methodologies from one reporting period to the next, without prior written permission from the Bank. In the Bank's view, this requirement is necessary to prevent possible circumvention of the Standards. Moreover, most of the small number of objections to this proposal related to the situation where a change in methodology arises from a change in an Accounting Standard. In this case, stakeholders indicated that requesting prior permission from the Bank for this reason was unlikely to be of any practical difficulty given that changes to accounting standards are consulted on and known well in advance of their implementation date.
  • A requirement only that there be no net compensation over the life of an issuing contract, rather than no net compensation in each reporting period, would create the risk of substantial non-compliance being revealed only at the end of the contract period. In the intervening period, there would be the potential for this non-compliance to have had a material market impact, to the detriment of complying entities and likely increasing payment costs in the economy.
  • Given the broad support for a shift to an accruals approach, the alternative proposal for compliance to be determined on a fully-cash basis over a two-year rolling period, would be unlikely to receive material support from other stakeholders. In addition, while the Bank acknowledges that schemes may differ in their ability to provide large upfront payments, the cash approach proposed may not enable the recognition of upfront payments to be adequately aligned to their economic substance.
  • The Bank considers the AAS to provide an appropriate starting point for allocating benefits to reporting periods for the purpose of calculating net compensation.[15] Where an entity wishes to use an accounting standard (that is not equivalent to the AAS), such as US GAAP, it should provide an additional attestation to the Bank that discloses the recognised accounting standards they have used, and that the use of these accounting standards in calculating net compensation had no material impact on their compliance status relative to if they had used AAS.

Finally, the Bank observes that it is possible that in some cases a treatment permitted under AAS may not be an appropriate treatment for the purposes of calculating net compensation. [16] The Consultation Paper noted that entities need to be aware of this, and ensure the treatment used for determining net compensation is consistent with the Bank's Standards. If there is no treatment that is both consistent with AAS and consistent with the purpose and intent of the Standards, then entities would need to deviate from accounting standards when determining net compensation.[17]

Some minor technical revisions to the variations have been made to improve the clarity or the operation of the revised Standards as they relate to accrual accounting, and are set out in a marked-up version of the variations available on the Bank's website.[18] These relate to:

  • Modification of text relating to Benefits that meet the Incentive Test in (ii)(B) of the definition of Incentive Test, changing ‘list, standard or usual price’ to ‘Regular Price’.
  • Addition of the defined term ‘Regular Price’.
  • Modification of text relating to Fair Value to allow for both initial and subsequent measurement dates. The rationale for this modification is discussed in section 7.3.
  • Inclusion of ‘paid’ in addition to ‘payable’ in 5.2(b) to reflect that in some circumstances amounts will have already have been paid.

Conclusion: Accounting Basis

Adopt Proposal 1.

The Bank's Standards No. 1 and No. 2 of 2016 will be modified to require an accrual approach to be used to allocate Issuer Receipts and Issuer Payments to, or between, reporting periods in a manner consistent with the purpose and intent of the Standards, such that in determining net compensation certifying entities have more scope to draw on information from financial accounts prepared in line with generally accepted Australian accounting principles. Compliance would not be permitted on a cash or quasi-cash basis.

Box B: Applying Accrual Accounting Concepts to the Calculation of Net Compensation

The AAS provide considerable direction and guidance in relation to the preparation of financial reports on an accruals basis. Under the varied Standards, schemes and issuers will, in most cases, be able to draw more directly on their financial accounts prepared in line with the AAS. However, the interchange standards serve a different purpose from the preparation of financial accounts. Schemes and issuers must satisfy themselves that any accounting treatment used in the assessment of net compensation compliance is consistent with the scope, purpose and intent of the interchange standards. In some cases, it may be appropriate to use one accounting approach for financial reporting and another for net compensation compliance reporting. The Bank expects that entities would only deviate from the approach used for their financial reporting when such an approach is not consistent with the Standards, and not for other reasons. The Bank may query accounting treatments used for net compensation compliance purposes and require entities to demonstrate that the treatments used are consistent with the Standards.

The Bank makes the following observations about how entities should apply the following accounting concepts in the context of the net compensation provisions:

  • Identification of ‘the customer’: AASB 15 Revenue from Contracts with Customers[19] (and its equivalent IFRS 15) speaks to the identification of the customer in a transaction, which in turn influences the accounting treatment applied. In the context of the net compensation requirements, the customer should always be considered to be either the issuer or the scheme (that is, the administrator of the scheme or its associated entities), and not some other third party, such as a merchant or cardholder.
  • Materiality: Materiality should be determined in the context of whether a payment or other Benefit is material to the entity's compliance with the net compensation requirements of the Standards (rather than if it is material for financial reporting purposes).
  • Probability threshold for recognition: The AAS guidance sets a high threshold for recognition of ‘variable consideration’ as revenue. Under AASB 15 estimates of variable consideration in revenue are only included when an entity has a ‘high degree of confidence’ that revenue will not be reversed in a subsequent reporting period. For the purpose of calculating net compensation, it is likely to be more appropriate for an entity to apply a ‘more probable than not’ threshold for recognition of a Benefit it may receive. The greater the Benefit, the greater the diligence an entity should undertake assessing this probability.
  • Financing component: For some transactions, the receipt of the consideration does not match the timing of the transfer of goods or services to the customer (for example, the consideration is prepaid or is paid after the services are provided). AASB 15 provides guidance on determining whether such transactions have a significant financing component and, if so, how it should be recorded. The Bank's view is that the AABS 15 approach is unlikely to be inconsistent with the intent of the interchange standards, but notes that any materiality considerations should be made in relation to the effect on an entity's net compensation compliance position.
  • Estimates (forecasts) and true-ups: Entities should use their most accurate estimates (forecast), rather than a conservative or aggressive, estimate. This should be a robust exercise. This is consistent with AASB 15. True-ups should be recognised in the period when actuals are known.

  • Fair Value: In the Bank's view, Fair Value as defined in the varied interchange standards is consistent with the use of AASB 13 Fair Value Measurement[20] (or its equivalent IFRS 13), with only a small number of exceptions (for example, in relation to the first measurement date for Fair Value). Subject to any express requirement in the Standards, the Bank expects entities to take guidance from AASB 13 in determining Fair Value for the purposes of calculating Net Compensation. Considerations set out in section 7.3 of this Paper are also relevant for determining Fair Value.

    The Bank notes that under AASB 13 measurement of non-financial assets must reflect the highest and best use of the asset from the perspective of market participants, and that entities must give preference to using observable inputs, and that the hypothetical transaction on which the fair value measurement is based must be between market participants that are independent of each other, but knowledgeable about the asset.

    As part of a broader agreement, a scheme may provide an issuer with a fixed amount of credits with which it can purchase particular goods or services. In determining the Benefits to be recorded in relation to such credits, the Bank observes that it is more clearly consistent with the purpose and intent of the Standard for entities to consider all credits provided whether they are used or not, than to ‘write-off’ any unused credits. The expiration of credits may not necessarily change whether consideration has been received and is available to the issuer. This notwithstanding, the most appropriate treatment will depend on the specific facts and circumstances of the arrangement.

  • Restatement of financial accounts: Entities cannot retrospectively restate their compliance status for previous reporting periods. Consistent with this, and the requirement that all Issuer Receipts and Issuer Payments must be allocated to a reporting period, an entity should not revise its net compensation position for previous reporting period, even if it has restated its financial accounts.
  • Apportionment across reporting periods: An even (or pro-rata) approach to apportionment over relevant reporting periods is likely to be of less concern to the Bank than an apportionment that has a steep or unusual profile. Clause 5.2(e) of the varied Standards sets out how a Benefit may be apportioned over multiple reporting periods (if that Benefit relates to more than one reporting period). A pro-rata approach must be used if an allocation on that basis would fairly and reasonably align the Benefit to the activity to which the Benefit relates. If a pro-rata approach does not achieve this, then an entity must use some other approach that does. Entities are expected to be able to provide reasonable justification for their accounting treatments, including that the treatment is consistent with the purpose and intent of the interchange standards.

Endnotes

The current standards are consistent with Issuer Receipts and Issuer Payments (the two components of net compensation) being calculated on a cash basis, with an exception for Benefits that span more than one reporting period, for example a lump-sum ‘signing bonus’ paid to an Issuer for entering into a contract with the scheme. In this case, subparagraph 5.2(e) of the current standards allows such a Benefit to be allocated across the relevant reporting periods based on the number of months in each reporting period, subject to some further conditions. This quasi-cash approach was originally chosen as it was viewed as being both straightforward and broadly consistent with the nature of benefits typically provided by schemes to issuers. [10]

Conceptually, an accruals approach could also improve the operation of the Standards as it allows for the net compensation calculation for each reporting period to be less affected by (potentially arbitrary) delays or advances in the timing of when cash payments are paid or received. [11]

Known as the Australian Accounting Standards (AAS). [12]

AASB Accounting Standards (Tier 1) adopts the International Financial Reporting Standards (IFRS). [13]

In addition, for the avoidance of doubt, the Bank proposed to clarify in the Standards that an amount treated as an Issuer Payment in one reporting period cannot be included as such in a subsequent period, and that incentives that meet the definition of an Issuer Receipt must be included in a reporting period that occurs during the life of the contract. [14]

This preference for AAS (and its equivalent IFRS) is broadly consistent with the approach taken by ASIC in relation to reporting under the Corporations Act 2001. Under section 296 of the Corporations Act, financial reports must comply with accounting standards made by the AASB under section 334 of that Act. ASIC notes that IFRS, to which AAS has been equivalent since 2005, is also acceptable. ASIC guidance specifies that entities are permitted to present non-IFRS financial information prepared under the generally accepted accounting principles of another jurisdiction in their annual reports, but not in financial reports unless it is necessary to give a true and fair view of the entity's financial position and performance. Where it is necessary to use non-IFRS financial information, ASIC indicates that the information should not be presented in a misleading manner, and the basis used should be clearly described. [15]

This observation reflects the fact that the purpose and intent of accounting standards may differ from the purpose and intent of Standards No. 1 and No. 2. [16]

Consequently, in this circumstance entities will not be able to draw directly, and without adjustment, on their financial accounts to determine net compensation. [17]

See Comparison of the Standards (as amended) to the version proposed in the Consultation Paper (https://www.rba.gov.au/payments-and-infrastructure/review-of-card-payments-regulation/pdf/comparison-of-standards-to-version-in-consultation-papers-2019-05-31.pdf). [18]

See AASB 15 Revenue from Contracts with Customers, Australian Accounting Standard Board, Melbourne, December 2018. [19]

See ‘AASB 13 Fair Value Measurement’, AASB, Melbourne, August 2015. [20]