Credit card arrangements are complex and involve multiple parties, typically the card-issuing bank, the merchant acquirer, the payment network, the merchant and the cardholder. There are various forms of credit card arrangement, and the parties commonly enter into different agreements with each other, each of them being components of, and necessary to the overall execution of, credit card transactions.
The analysis below sets out the key factors to consider in the steps highlighted in the table above.
Step 1: Identify the contract(s) with the customer
Who is (are) the customer(s)?
The new standard requires an entity to identify the contract with the customer. As part of this step, an entity must determine which party is its customer. A customer is defined as ‘[a] party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration’. This is an area of judgement that has ramifications throughout the revenue model, and it might significantly affect how the new standard is applied in this area.
A contract is defined in IFRS 15 as an agreement between two or more parties that creates enforceable rights and obligations. This contract can be written, oral or implied by an entity’s customary business practices. A written contract that creates enforceable rights and obligations will exist between the bank and the cardholder under which the bank will provide services, sometimes in exchange for annual and other fees. It might be more difficult to ascertain whether a contract that creates enforceable rights and obligations exists between the bank and other parties to the arrangement, such as the merchant, and what services are delivered, and to which party, in exchange for interchange fees.
Management will need to apply judgement to determine which party is, or which parties are, the bank’s customer(s) based on their specific facts and circumstances.
Identifying the customers is particularly relevant where the arrangement involves loyalty plans for which the bank is a principal (see ‘Principal versus Agent’ below). Where a bank concludes that the cardholder is the only customer, it has to consider whether the interchange fee is received for services delivered to the cardholder. This might result in some of the revenue from interchange fees being allocated to the obligation to satisfy the loyalty points and deferred until those points are redeemed.
Step 2: Identify the separate performance obligations in the contract
What are the different performance obligations that exist in the contract(s) with the customer(s)?
For each of its identified customers, the bank will need to assess the specific terms of each of its contracts to identify all of its performance obligations, because these will drive when and how revenue is recognised.
The new standard requires an entity to assess the services promised in a contract with a customer, and to identify as performance obligations those services that are distinct. A service is distinct if:
- The customer can benefit from the service either on its own or together with other resources that are readily available to the customer; and
- The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract.
Paragraph 29 of IFRS 15 provides additional factors to consider when assessing (b) above.
If a service is not distinct, the entity must combine the services until such a point that a bundle of services is viewed as distinct. In some cases, this will result in all services being combined into a single
The customer’s perspective should be considered when assessing whether a promise gives rise to a performance obligation. Therefore, conclusions regarding which party is the customer (see step 1 above) are likely to impact this determination.
The following are some of the services that might exist in a contract with a cardholder:
- Issuance of loyalty points (which are options to acquire goods/services for free or at a discount in the future), usually based on the monetary volume of card transactions;
- Payment processing service;
- Insurance (for example, home insurance) where the bank is not the insurer; for situations where the bank writes the insurance, the accounting is outside the scope of IFRS 15 and the contract is accounted for in accordance with IFRS 4;
- Ancillary services (for example, access to lounge areas in airports);
- Fraud protection; and
- Processing of certain transactions, such as purchases in a foreign currency and cash withdrawals.
Banks might offer more than one credit card product to customers (for example, a basic and a premium product). It is likely that the performance obligations identified will differ depending on the nature of the product, which might affect the pattern and timing of revenue.
Step 4: Allocate the transaction price to separate performance obligations
How should fees received be allocated to each of the performance obligations?
The transaction price is allocated to each performance obligation based on the relative stand-alone selling prices of the goods or services being provided to the customer.
The bank will usually have a published price list that provides evidence of the relative stand-alone selling prices for some of the goods or services being provided to the customer. Banks might have to estimate the stand-alone selling price of some other goods or services.
The allocation of the transaction price to each of the separate performance obligations will not necessarily be required where there is more than one performance obligation but the performance obligations are all satisfied at the same time or evenly over the period.
Other areas to consider:
- Is the bank the principal or agent in the loyalty arrangements?
Another important consideration is determining whether the bank is the principal or agent in relation to loyalty arrangements. The guidance on assessing whether an entity is principal or agent has changed under IFRS 15, and so entities will need to reassess whether they are principal or agent under the new standard.
An entity is the principal in an arrangement if it obtains control of the goods or services of another party in advance of transferring control of those goods or services to a customer. The entity is an agent if its performance obligation is to arrange for another party to provide the goods or services. An entity will need to evaluate if and when it obtains control. If an entity obtains legal title of a product only momentarily before the title is transferred to the customer, this does not necessarily indicate that the entity is acting as the principal in the arrangement. Where another party is involved in providing goods or services to a customer, an entity that is a principal obtains control of any one of the following:
- A good or another asset from the other party that it then transfers to the customer;
- A right to a service to be performed by the other party, which gives the entity the ability to direct that party to provide the service to the customer on the entity’s behalf; or
- A good or service from the other party that it then combines with other goods or services in providing the specified good or service to the customer.
Assessing these indicators for loyalty arrangements is complex and will depend on a number of factors. The bank will typically be principal where it redeems the points itself and controls the related goods or services before they are delivered to the customer. More judgement is typically required where the points are redeemed by a third party, and the bank should consider whether it controls the goods or services before they are transferred to the customer.
If the determination of whether the company controls the specified good or service (that is, whether it is a principal) is unclear, the company should evaluate the following indicators:
- Primary responsibility for fulfilling the promise;
- Inventory risk; and
- Discretion in establishing price.
Whether a bank is principal or agent will determine whether the bank recognises revenue for the amounts collected from cardholders, or whether it recognises revenue only for its commission for arranging transactions on behalf of other suppliers. It will also affect the timing of revenue recognition in some cases.
Where the bank is acting as an agent, it will have to remit some of the fees that it collects (if any) to a third party (the principal for the obligation to provide goods/services to the cardholder, or the award plan operator). The transaction price is only the commission retained by the bank (in other words, revenue is recognised net of the amounts paid to the principal). If the bank is agent and its only obligation is in respect of issuing the points, revenue will be recognised once the points have been issued.
Where the bank is the principal, it will recognise as revenue the gross amount paid and allocated to the performance obligation. It will also recognise an expense for the direct costs of satisfying the performance obligation. Where the bank is the principal, the revenue allocated to the performance obligation to redeem the loyalty points is deferred until the points are redeemed.
- What is the impact on revenue of cash rewards offered by a bank to a credit card customer?
Under IFRS 15, the bank accounts for consideration payable to a customer (such as a cashback award) as a reduction of the transaction price, and therefore of revenue, unless the payment to the customer is in exchange for a distinct good or service that the customer transfers to the bank.
Consideration payable to a customer includes cash amounts (including credit or other items, such as a coupon or voucher) that can be applied against amounts owed to the bank and that the bank pays, or expects to pay, to the customer.
- How should a bank account for the loan commitment included in credit card contracts?
The promise to provide financing to the cardholder is a loan commitment. Banks should assess, based on their specific facts and circumstances, whether part of the fees received under the arrangement should be considered as a commitment fee received by the bank to originate a loan. We expect that this will not generally be the case. However, where it is, and if it is probable that the bank will enter into a specific lending arrangement, the fee would be within the scope of IFRS 9 (that is, the fee would be an integral part of the EIR of the loan).