Buy now, pay later: merchant discount, receivable and late fees

A BNPL provider typically pays the merchant the purchase price less a merchant discount and collects the full price from the customer in a few interest-free instalments. Almost all of its income is the merchant discount plus late fees, so the question of whether that discount is yield on a financial asset (IFRS 9, recognised over the short life of the receivable through the effective interest rate) or consideration for a service to the merchant (IFRS 15, often recognised at the point of sale) decides the timing of revenue, the line in which it is presented, the initial carrying amount of receivables and therefore the reported margin and growth. The answer depends on the contract structure and must be documented, not assumed from what competitors report.

Does the provider originate the credit directly with the customer, or does it buy a receivable that the merchant created? What does the merchant receive for the discount: guaranteed payment, transfer of credit risk, settlement services, marketing to the provider's customer base, increased basket size? Is any part of the discount refundable if the customer returns the goods or cancels? What would a market participant pay for the customer receivable alone, given its tenor, expected losses and the absence of interest? Are late fees fixed amounts per missed instalment, are they capped by regulation, and are they collected in practice? Are receivables held to collect, or regularly sold to funding partners or under forward-flow agreements, which affects the business model?

1. Identify the instruments: a financial asset (the right to collect instalments from the customer) and a contract with the merchant.
2. Recognise the customer receivable at fair value on initial recognition; for a short interest-free receivable this is close to, but below, the amount the customer owes, reflecting time value and credit risk.
3. Compare that fair value with the cash paid to the merchant. If the merchant pays the discount for distinct services (payment guarantee, settlement, marketing, customer acquisition), the part of the discount that exceeds the difference between the receivable's face amount and its fair value is consideration for those services under IFRS
4. 4. If the arrangement is in substance a purchase of a receivable at a discount with no distinct service to the merchant, the whole discount is part of the effective interest rate and is recognised over the life of the receivable.
5. Recognise IFRS 15 merchant revenue when the related service is delivered, usually at the point of sale for payment and settlement services, with a refund liability for discounts refundable on returns.
6. Recognise late fees under IFRS 9 when the customer misses an instalment and the fee becomes contractually due, unless they were included in the expected cash flows used to set the effective interest rate, and include the fee balance in ECL.
7. Recognise a 12-month ECL allowance from day one.

Measure the receivable initially at fair value and subsequently at amortised cost where the business model is hold to collect, accreting the difference between initial carrying amount and contractual instalments as interest income over the expected life (often six to twelve weeks). Fair value is a Level 3 estimate based on expected collections, expected losses and a market discount rate, and the assumptions should be consistent with the ECL model. IFRS 15 merchant revenue is measured at the allocated part of the discount, reduced by expected refunds. Late fees are measured at the contractual amount, with ECL on the fee balance reflecting their lower collection rate.

Disclose: (1) the accounting policy for merchant discounts, including the judgment on the split between effective interest and IFRS 15 service revenue; (2) interest income calculated using the effective interest method separately from IFRS 15 merchant revenue and from late fee income; (3) the fair value assumptions used at initial recognition; (4) refund liabilities for returns and cancellations; (5) ECL inputs, staging and the loss allowance reconciliation for the BNPL book; (6) whether receivables are sold to funding partners and the effect on the business model assessment.

• Recognising the whole merchant discount as revenue on the day of sale without testing whether any part is yield on the receivable
• recognising the receivable at the full amount owed by the customer while recording the discount as upfront revenue, which overstates both the asset and day-one profit
• presenting merchant discounts and late fees together as interest income without analysis
• recognising late fees that are waived as a matter of practice
• ignoring refunds of merchant discounts on returned goods
• omitting day-one ECL because the tenor is only a few weeks
• classifying receivables at amortised cost when most are sold shortly after origination