Accounting for credit card fees

Jean Chidley's Profile

Accounting For Credit Card Fees

Is anyone aware of an accounting policy statement supporting treatment of credit card fees as an offset against revenue (e.g., cost of services sold) as opposed to an operating expense?  Our company treats credit card fees this way but I need to pull together a policy memorandum supporting that treatment.

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Good morning. My hospital records the credit card fees as an operating expense. This handling developed from relative amounts and the nature of our business - the credit card fees are a very small fraction of our expenses, and, as a hospital, our cost of sales relates more to medical suuplies.

I hope this helps.

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I suggest you read this EITF and make a case for either gross or net reporting.

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Thanks, great suggestion.

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I found this free recorded webinar titled "Leveraging Analytics & Managing Debit Card Merchant Fees" which covers many aspects of this topic:

http://www.proformative.com/resources/managing-debit-and-credit-card-merchant-fees-webinar-video

Proformative also has a

"Free Guide To Accounting Resources"

http://www.proformative.com/resources/accounting-resources-guide

It's a handy list of resources for further info on accounting questions of all kinds.

I hope it helps!

Best... Sarah

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I've never previously heard of a company classifying credit card fees directly against revenue. Here are a few thoughts pro/con.

Pro : Would want to see this on a seperate GL account or P&L Line item, treated as a sales discount/allowance. The argument here might be valid if you are following some cash method of accounting for revenues.

The Sales Discount/Allowance approach would seem to be the only potential argument. However, would expect SD&A's to be related to customer volumes, special deals, promotional pricing, sales price adjustments to resolve an issue with a customer to collect payment (in lieu of becoming a bad debt).

Cons : My experience in a variety of industries has been for this to be a G&A line item expense. It is variable in nature, driven by revenue and payment type mix. Have even gone as far to isolate on the GL account level each credit card type for the merchant processing fees, i.e. MV/Visa, AMEX, Discover, etc.

I consider credit card fees to be similarly related to collection fees/costs. In accepting credit cards, the business has decided to absorb these processing costs as a convenience to the customer, and as a way to turn sales into cash quickly vs. doing some direct AR billing, which can put at risk ever collecting the revenue from the sales, leading to another G&A line item costs for Collection Expenses and Bad Debts.

When/if you reserve for and/or write-off bad debts, where is this being classified. In following your company's accounting treatment vs. revenue for credit card fees, to be consistent, would expect bad debt accounting processes to hit revenue classification, which I think is a mistake.

Bad Debts - Once the goods or services have been delivered, you have a valid sale. This issue is collection of cash. The only instance to reduce revenue I've done is where the Sales Dept has decided to adjust prices or invoice amount to settle a dispute (quality, quantity, continuing relationship, etc.) But if Sales is not willing to do this, stands by the validity of the sale, revenue should not be impacted, the write-off cost goes to a SG&A expense classification. Since the credit card fees intent partially at least is to avoid this, why would this be a revenue reduction?

Also, ask the question - whenever you get a Credit Card charge back that the company "eats", how is this transaction recorded? Under what your company does to reduce revenue for the credit card fees, do they "unwind" the revenue, or classify this as a write-off. If hitting revenue, the COGS still exists.

Next would be accounting for and reconciling Sales Tax Liability. On the credit card charge back, Sales Taxe liablity is typically (or should be) reduced. You don't have to pay for sales taxes that you ultimately did not collect.

I like to be able to reconcile Sales Tax return receipts to revenue line items, without any significant distortion or complexitites. Credit card fees charged vs. revenue (an not isolated at the GL account level) are likely to create this reconciliation complexity.

Do you accept personal checks at the point-of-sale. If so, do you use a check acceptance approval service. Most of these typically run 2%-3% of the check amount, very similar to the cost of credit card fees. If you do this, how are these fees accounted for, should be the same as the credit card fees?

Hope this helps, Randy

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Randal - your reference to Sales Tax recovery caught my eye. We don't currently do this. I don't think it would be material to our business but I sure don't see the point in leaving cash on the table. In your experience, is this a normal and accepted (by state tax authorities) practice?

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Recording credit card fees netted against revenue strikes me as a cash-basis method of accounting, but it can later create a number of issues. You would need to ensure that returns / refunds are handled similarly. Also, credit card fees are different depending on the card type (VISA, AMEX, etc.) in addition to specific card characteristics (loyalty rewards card, CVV2 verification, etc.). This makes the handling of the discount at a transactional level extremely difficult - typically recorded once the credit card settlement statement is received.

Given all of this, I don't know what you gain by recording sales net of the discount. Practically, the discount is a cost of doing business - like staffing a collections department would be for open AR. Also, this would have a tendency to mask the opportunity to mitigate this cost when it is wound tightly into the sales side of the business. Many online businesses, for example, are turning to ACH-based methods of payment. Depending on how it is constructed, the cost of these range from a very small transaction fee to typical credit-card discount rates. Meanwhile, private-label cards with short-term financing options can offer very low discount rates on 90 day SAC type arrangements. I would find it more difficult to manage a dynamic payment method portfolio if it were wound tightly into sales.

Randy also raises a good point around credit-card chargebacks and chargeback recovery. If all of this is wound tightly into sales, I don't think it ultimately gets the attention deserved. Cash is indeed king, but financial classification and reporting is also about management of cash inflow and outflow streams.

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We do expense our credit card fees as an offset within our cost of sale account (and we are accrual base accounting). However, we leave our revenue at gross and then offset all of our costs for revenue to get to our gross margin.

Our P&L looks like:

Revenue:
Business Line 1 $500.00
Business Lien 2 $700.00
Gross Revenue: $1200.00

Cost of Sale:
Business Line 1 ($50.00)
Business Line 2 ($75.00)
Total COS: ($125.00)

Gross Margin: $1,075.00

Thanks,
Katie

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Topic Expert
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Jean,

Most if not all of our clients have an operating expense line for card processing fees whether they sell a product or service. You ask an interesting questions...I've asked our accounting firm for some additional guidance. I'll let you know what I hear.

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As long as you are recording the credit card fees as they are incurred and matching time period of recording fees against the relative revenue I don't think you have a GAAP or IFRS problem other than if the amount is material you might need to disclose the treatment in audited statements as this would not be the NORMAL classification. Since this is not a common practice, which would cause you to have gross profit percentages that were skewed and not comparable to industry norms, but it obviously won't change the bottom line net income.

Assuming you are US based you might also cause a red flag with the IRS as gross profit percentage is one of the criteria they measure to determine which companies to audit.

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In a public co., our classification of credit card fees was as operating expenses (even if it was variable, based upon volume of transactions) was ok. Our external auditors agreed that it was similar to 'freight out' expenses.

Chargebacks, etc. were classified as 'Returns and allowances', a direct contra- to Revenues. A case can be made to call it 'bad debt' and include in COS, thereby grossing up revenues.

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Business expenses are classified as Cost of Good Sold (COGS), Selling or General & Admin (G&A). COGS is deducted from Revenues to get Gross Profit. Operating expenses are either Selling or G&A expenses. Selling expenses include freight out, credit card processing fees, advertising, marketing/promo, etc. So, credit card processing fees are an operating expense.

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Why should your business accept credit cards?

Why Accept Credit Cards? Every Business needs to accept credit cards for payment in today With a troubled economy consumers want choices when it comes making payments. All to often businesses lose customers when they don't accept credit cards as a from of payment. Let's take a closer look at this: A dry cleaning customer does $200.00 per month in dry cleaning their suits. The Dry Cleaner does not accept credit cards and tells the customer there is an ATM machine across the street; the customer never goes to that try cleaner again. Here are some of the excuses that businesses have for not accepting credit cards and when you think about it the business owner is stepping over a $200.00 sales just to save .40 cents.

'All my customers know me and I've never accepted credit cards"; "Credit cards acceptance is cost to much my customers pay cash" OK, you get the idea that accepting credit cards is an important door to your cash flow ad growing your business. By not accepting credit cards your business can only lose money and customers.

Now lets understand the process of accepting credit cards correctly and cost effectively.

There are two parts to accepting credit cards:

1) Your need a way to accept and process the credit card: ( Credit Card Machine, Online Processing, Virtual Terminal)

2) Their is a Rate you pay fro each transaction ( example : 1.69% and .19 Cents)

First let's take a detailed look at number 1

The Credit Card Machine:

There are many types of credit card terminals on the market today. Many of them are used, refurbished and Non PCI Compliant. My advice is to only get a brand new credit card terminal that is 100% PCI complaint. Here are the best terminals that are PCI compliant FD100 FD100ti FD200 FD300 FD400When you operate an old terminal you risk the terminal not qualifying the credit cards correctly resulting in penalty surcharges up to 5% on top of your rate. All it takes is a burnt out magnetic stripe reader to cause you to get a higher rate with out you knowing about it.  Also if your terminal doesn't prompt you questions like - address and Zip code' for keyed in entries you will receive a penalty surcharge. Just know that your old terminal that you've had for many years which works just fine may be causing you to pay higher rates.

Rate:

Rate is the most confusing part of accepting credit cards, the goal of this information is to explain things in a easy to understand way, so I will keep it simple.Visa and Master Card are an association and they set the interchange rates on every card type. Your credit card processing company must pay those fees on your behalf.  So let's say the interchange rate for a Visa Corporate Card type 1 is 2.25% and .10 your credit card processing company will mark up that rate by a certain amount of basis points and that's called the discount rate. So you might see that for a Visa Corporate Card Type 1 your credit card processing company charged you 4.00% and .25 for the transaction. The end result is the credit card company made 3.75% and .15 in profit on that corporate card transaction. So how do you know what is the profit on each? You don't unless you really know how to read a credit card processing statement well. Good luck! It's really confusing to read a credit card processing statement and all statements are designed differently and again unless your more than a pro you will have a hard time trying to figure out your rates.

The easiest way to get an idea of your bundled rate is by dividing the your fees by the amount your processed and move the decimal point two to the right.

ExampleTotal Fees $800 Total Amount Processed = $20000 800 divided by 20,000 = 4% (which is a very high rate)

There are 3 ways credit card processing companies will usually set your rates up. Lets take a look at them. Most of the time believe it or not the business is set up incorrectly causing the merchant to pay high surcharges and fees. This is usually due to an inexperienced sales rep. most sales reps are poorly trained and hit the feild without knowing what their doing, it's important to have a knowledgeable sales rep. If they can't read your statement and explain to you where it really makes sense then chances are you will pay more than you should.

Rate Type 1: Rate Plus Transaction:

Rate Plus transactions is perfect for your business if you process monthly up to $50,000 and most of your cards are swiped at your terminal. Since there are many different card types out there and you have no control over which credit card type your customer will pay you with their will be a enhanced bill-back for cards that are not qualified If your business type is a retail store this is perfect for you.

Type 2 3 tier

Qualified Rate - Cards that are considered qualified ; present and swiped ( locked into a rate)

Mid Qualified Reward Cards and Keyed in entries ( locked into a rate)

Non Qualified ; Corporate cards, cards your old terminal did not qualify correctly due to the magnetic reader -or just Non Qualified.

Type 3 - Interchange Plus -

Interchange Plus is for business processing over $100K per month.  example 40 basis points over the interchange rate. There are also Visa and MC assessment fees added in.

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Credit card fees are typically accounted for as operating expense. There is no explicit phrase in either GAAP or SEC specifying accounting for credit card fees by entities accepting cards as payment. Most organizations charge the same price for cash or credit card transactions. with the fees on card transactions considered the cost of accepting that form of payment, and a contributor to increased margins from sales greater that "cash only" may generate. Offsetting against revenue is genrally not permitted and other topics. freight for example, are explicitly addressed by SEC guidance. Ratios based on sales will be distorted if credit card fees are offset. The practice is not "preferable".

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Barrett's answer is spot on. I would call it an operating (selling) expense. The unanswered questions are: Are you a public reporting company, how material is the amount and what do your auditors say about the practice?

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Barret, Thanks for your comment. I'm working on a transportation project, again, and I'd like to get the extra expense (approx.2% of sales) out of G&A. You comment, in addition to Lynn's up above Kevin's below make it clear that this should be a selling expense.

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Ken,

Yes, it is normal to obtain a refund of sales taxes paid on bad debts. Most states require the bad debt to be listed as a deduction, and not simply report net sales. California has a separate section of their returns for deductions, which includes sales for resale and BD. Florida allows bad debt deductions on line 6 = deductions, with a time limit of one year after the debt has been written off for Federal tax purposes.

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While following GAAP is important, it is more important for company management purposes that the fees be recorded in such a way that they provide useful management information. I recommend that processing fees be recorded in a separate account and not as an offset to income. In this way, you can track your fees. You not only want to know the amount you're spending on credit card processing, but you want to make sure that you're continuing to be charged a fair percentage.

Where you classify the expense is different story. I've put them in at least three different places depending upon the client: as a sales expense, as a cost of sales or as G&A.

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If you are considering classifying credit card fees as a cost of sale, seems you would classify bank fees there as well -- seems like a slippery slope. We keep them all in operating expense for our outside reporting, but for certain management reports I show them as cost of sales.

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I disagree, that you can subtract Credit card fees, and calculate Sales Tax on left over amount. When I pay with credit card at the store, Sales tax collected on full purchase amount, and should be submitted as collected from the customer.

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The IRS allows you to deduct certain expenses from your total income to arrive at taxable income, which is the portion of your earnings that is subject to tax. Some of these expenses include your payments of interest on a mortgage and for business loans. However, when you use a credit card for personal purchases, the interest you pay is nondeductible personal interest.

What is personal interest

Personal interest is interest you pay for goods and services you don't use for work or business-related purposes. Although not an exhaustive list, common examples include buying clothes, electronic equipment, cars and food using a credit card. When you make monthly payments that include interest, it is always nondeductible personal interest. This remains true even if you use the credit card to subsidize the purchase of your home.

If you use a credit card for business purposes. Generally many companies, whether a corporation or sole proprietorship, use credit cards to purchase equipment for use in the business, to buy necessary supplies and for many other daily transactions. When you use a credit card in this way, the interest payments you make on the credit card are deductible as a business expense. This means that you can reduce the amount of your business earnings that are subject to tax for these interest payments. However, if you use the credit card for both business and personal purposes, you need to insure that you only deduct the interest that accrues on the business-related purchases.

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Interesting, I didn't notice any alluding to the fact the credit cards are just another form of factoring and should be treated as such. Thus the credit card fee is interest charged and is an expense.

What ever you call the fee is up to you, but it is an expense.

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