Dealer commissions and manufacturer subsidies in the effective interest rate

Auto and durable-goods finance is sold mainly through dealers and brokers, who are paid a commission per contract, and manufacturers frequently fund 0% or low-rate campaigns by paying the finance company a subsidy. Expensing commissions upfront understates profit in growth years and overstates it later; booking subsidies as income on receipt overstates profit at origination and leaves the loan earning below-market interest for the rest of its life. Both items change the effective interest rate of the loans they relate to, and both create reversal exposure when loans are settled early.

Is each dealer or broker commission paid only if a specific contract is booked, so that it is incremental and directly attributable to that loan? Are there volume bonuses, marketing contributions or fixed monthly fees to dealers that would be paid whether or not a given loan is originated? Is any commission clawed back if the customer settles early or defaults within a set period? For subsidised campaigns, who pays the subsidy (manufacturer, dealer, or the finance company's own parent), is it paid upfront or over time, and is any part refundable on early settlement? Does the finance company provide anything to the manufacturer in return for the subsidy other than offering the subsidised rate to customers?

1. For each payment to a dealer or broker, test whether it is incremental and directly attributable to the origination of a specific loan; if so, it is a transaction cost and is added to the initial carrying amount of the loan.
2. Payments that would be made regardless of whether a particular loan is originated (fixed retainers, general marketing support, staff incentives not tied to individual contracts) are expensed as incurred.
3. Assess volume bonuses separately: where they can be reliably attributed to the loans that triggered them, they are generally treated as transaction costs of those loans; otherwise they are expensed.
4. Recognise a subsidy received from a manufacturer or dealer that compensates for a below-market customer rate as part of the consideration for originating the loan, deducted from the loan's carrying amount, so that the loan's effective interest rate reflects the subsidised yield.
5. Confirm that the net initial carrying amount (cash paid less subsidy, before transaction costs) is consistent with the fair value of the loan; a large difference indicates that part of the payment relates to something else.
6. Recompute the effective interest rate including transaction costs and subsidies, and recognise interest income over the expected life.
7. On early settlement, recognise the unamortised balance in profit or loss, net of any commission clawback or subsidy refund.

The loan is measured initially at fair value plus transaction costs. In a subsidised campaign, the cash paid for the asset less the subsidy received normally approximates the fair value of the below-market loan; the effective interest rate is the rate that discounts the customer's contractual instalments to that net amount plus capitalised commissions. Subsequent measurement is at amortised cost. Where commissions or subsidies are paid or received over time, or are refundable on early settlement, the expected amounts are included in the cash flows used to determine the effective interest rate, and changes in estimates are handled through the catch-up adjustment.

Disclose: (1) the accounting policy for dealer and broker commissions and for manufacturer or dealer subsidies, including which payments are treated as transaction costs; (2) the effective interest income on subsidised portfolios; (3) the unamortised balance of deferred commissions and subsidies included in the carrying amount of loans, if material; (4) arrangements with manufacturers or dealers that are related parties; (5) the judgments applied to volume bonuses and to subsidies that are refundable on early settlement.

• Expensing per-contract dealer commissions immediately
• capitalising fixed dealer retainers or general marketing contributions that are not tied to individual loans
• recognising the manufacturer subsidy as fee income on receipt
• recognising the subsidised loan at its face amount with no adjustment, so that 0% interest is reported for the whole term
• amortising capitalised items straight-line over the contractual term instead of through the effective interest rate over the expected life
• failing to write off unamortised balances on early settlement
• ignoring clawbacks and refunds when estimating cash flows