The Operation of the Interchange Standards: Conclusions Paper Appendix B: The Application of Accrual Accounting to the Calculation of Net Compensation

This Appendix contains 4 case studies. In each, the Bank sets out an example of an accounting treatment that it considers likely to be consistent with the purpose and intent of Standards No. 1 and No. 2 of 2016. Some of the case studies provide commentary on accounting treatments that would be of concern to the Bank. The examples and commentary are not necessarily exhaustive. The case studies use as their starting point the Australian Accounting Standards, and take the perspective of the issuer in a scheme-issuer arrangement. The commentary draws on the observations in Box B, regarding the application of accounting concepts to the calculation of net compensation. For example, the observation that 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 a third party, such as a merchant or cardholder.

The Bank notes that these case studies are stylised scenarios and the appropriate accounting treatment of any actual set of flows will depend on the specific facts and circumstances of those flows.^[37] The case studies and commentary do not constitute accounting advice.

Case study 1: Sign-on bonus

The scheme commits to make an upfront payment to the issuer for signing an issuing contract with the scheme (a ‘sign-on bonus’). The payment is not linked to contract performance. The issuer receives the sign-on bonus as a cash payment when the contract is signed.

Commentary

As required under AASB 15, the issuer should consider the performance obligations in the contract to which the payment relates, regardless of the timing or name of the payment. In this case, the issuer should conclude that the payment is not linked to any ‘distinct’ performance obligations in the contract. Accordingly, the performance obligations align to the whole contract tenure and, correspondingly, the payment relates to the life of the overall contractual relationship between the issuer and the scheme.

For the treatment to be consistent with the interchange standards, the payment should be allocated on a pro-rata basis over the life of the contract. One exception is where the issuing contract spans more than 10 years, as set out in clause 5.2(e). It would clearly be inconsistent with the interchange standards to apportion the sign-on bonus in a manner specifically intended to achieve a particular net compensation position in one or more reporting periods. Here, the anti-avoidance clause of each Standard would be relevant.

In assessing the value of the sign-on bonus for the purposes of determining net compensation, it would be appropriate for the issuer to assess whether the sign-on bonus contained a ‘significant financing component’ (as defined in AASB 15).^[38] If so, it would be consistent with the purpose and intent of the interchange standards to include the financing component in value of the benefit recorded to determine net compensation.

Case study 2: Migration benefit

A payment of a fixed amount from the scheme to the issuer which is described as covering part or all of the issuer's costs associated with switching from one scheme to another (for example reissuing cards and internal technology system changes). These migration costs are only incurred in the first year of a multi-year issuing contract. A cash payment is made to the issuer upfront.

Commentary

As in case study 1, the issuer should consider the performance obligations in the contract associated with the ‘migration benefit’ payment, regardless of the timing or name of the payment. In the context of the interchange standards, it may well be reasonable – depending of the specifics of the agreement – for the issuer to conclude that there are no distinct performance obligations in the contract on the grounds that the payment (and the migration services the issuer is effectively providing the scheme in exchange for that payment) relates to the use of the scheme's brand over the life of the contract. If the issuer makes this determination then, as in case study 1, the migration benefit should be allocated over the life of the contract (although it may not be allocated among more than 10 consecutive reporting periods). The interchange standards require the allocation to be on a pro-rata basis if an allocation on that basis would fairly and reasonably align the benefit to the activity to which it relates. If it does not, an allocation method that does achieve this can be used.

Alternatively, it may well be reasonable – depending of the specifics of the agreement – for the issuer to conclude that there are distinct performance obligations in the contract in relation to the migration benefit payment. In this case, the Bank would expect the issuer to match the allocation of the migration benefit to the relevant distinct obligation.

As in case study 1, it would be consistent with the purpose and intent of the interchange standards for the issuer to consider if there was a significant financing component arising from the migration benefit.

Case study 3: Estimates and accounting (or book entry) true-ups

The issuer earns a cash incentive from the scheme where the value of the incentive is a fixed percentage of the issuer's transaction volumes for period 1. For its period 1 accounts, the issuer estimates the value of this incentive payment, as the exact magnitude of its transaction volumes (and hence the magnitude of the incentive) will only be known in reporting period 2. In reporting period 2, the value of the incentive is calculated and the incentive is paid; the estimate of the incentive that the issuer entered into its accounts is found to be incorrect, accordingly a ‘true-up’ is required.

Commentary

It is consistent with the purpose and intent of the Standards for the issuer to use its best estimate of the incentive (that is, the extent of variable consideration) it is likely to receive (and ultimately retain once actuals are verified) in any given reporting period. The issuer will put considerably more effort and diligence into forming its estimate of the incentive where the incentive is expected to be large and/or material in relation to the issuer's net compensation position. In this case, the issuer would, in forming its estimate, consider factors within the issuer's control (for example, marketing spend), those factors not within the Issuer's control (for example, market forces, customer behaviour) and historic experience.

The issuer could choose not to use the same threshold of meeting revenue recognition in AASB 15 guidance (that is, a high degree of confidence that revenue would not be reversed in a subsequent reporting period), but rather use a ‘more probable than not’ threshold, which implies a greater than 50 per cent likelihood of the incentive payment being received.

The issuer records the true-up in the subsequent reporting period or when the benefit of hindsight is achieved.

It would not be consistent with the purpose and intent of the Standards for the issuer to use either an overly conservative or aggressive estimate; nor for the issuer to have failed to form a reasonable basis for its estimates.

Case study 4: Pre-payment of incentives and cash clawbacks

The issuer earns a cash incentive from the scheme if the issuer reaches a transaction value target for card transactions made in reporting period 1. The value of the incentive is a fixed dollar amount known by both parties in period 1. But the scheme and issuer only know if the target is reached in the following period.

Period 1: The scheme pays 50 per cent of this incentive to the issuer at the beginning of period 1 (before either party knows whether the target has been reached).

Period 2: Both parties learn whether the issuer reached the target for reporting period 1. If the target is reached, the remaining 50 per cent of the incentive is paid to the issuer in reporting period 2. If the target is not reached, the scheme can require the issuer to pay back the pre-paid incentive (that is, it can clawback the incentive). The clawback is at the discretion of the scheme. That is, the scheme may elect not to enforce the clawback.

Commentary

As in case study 3, it is consistent with the purpose and intent of the Standards for the issuer to use its best estimate of the incentive (that is, the extent of variable consideration) it is likely to receive (and ultimately retain, once actuals are verified) in any given reporting period, independent of the amount received in earlier periods that remain subject to claw back. The issuer will put considerably more effort and diligence into forming its estimate of the incentive where the incentive is expected to be large and/or material in relation to the issuer's net compensation position. In this case, factors the issuer should consider include (but are not limited to):

1. the likelihood of achieving the target, including appropriate weighting to those factors within the issuer's control (for example, marketing spend), those factors not within the issuer's control (for example, market forces, customer behaviour) and historic experience.
2. the likelihood and magnitude of clawback being enforced, with due consideration of historic experience with each relevant scheme.
3. completing a probability weighted multi-scenario analysis, consistent with other forecasts used by the Issuer.

The issuer could choose not use the same threshold of meeting revenue recognition in AASB 15 guidance (that is, a high degree of confidence that revenue would not be reversed in a subsequent reporting period), but rather use a ‘more probable than not’ threshold, which implies a greater than 50 per cent likelihood of the incentive payment being received.

It would not be consistent with the purpose and intent of the Standards for the issuer to use overly simplified assumptions in making its forecasts, for example for it to:

• assume targets will not be achieved; or
• assume targets will be fully achieved,

without any reasonable basis.

Endnotes

The case studies are considered in isolation. In practice, an issuer would consider, in their totality, the contract(s) that exist between it and the scheme when determining the appropriate treatment. [37]

That is, whether, by receiving the payment up front, the issuer has received a significant implicit financing benefit. [38]