GAAP Chats: The 411 on Buy Now, Pay Later Loans
GAAP Chats: The 411 on Buy Now, Pay Later Loans

GAAP Chats: The 411 on Buy Now, Pay Later Loans

The following content is a detailed outline of Episode 4 of the GAAP Chats podcast. It does not represent a full transcript of the show. You can listen to the full audio here. 


Mike: It’s layaway for the 21st century and it slaps, especially among millennials and Gen Zers. I’m talking about the buy now, pay later (or BNPL) market which allows consumers to split a purchase of anything, from consumer goods, to travel, and even take-out food orders, into 4 equal installments. But before you drag it saying, in your best crotchety old man voice, “They should just pay cash and learn to live below their means!”, to which they’d reply “OK, boomer!”, especially considering that the industry is expected to have a compound annual growth rate of 45% over the next 10 years. This staggering growth rate is fire and has attracted some of the biggest players on the planet. Can you say Apple? Join Chris and I on this journey as we learn more about the buy now, pay later industry, including how it works, who uses it, its key players, and the accounting and regulatory issues facing these entities.

Mike: Welcome to GAAP Chats, the podcast dedicated to all things accounting, brought to you by GAAP Dynamics. I’m your host, Mike Walworth and with me, as always, is my faithful partner, Chris Brundrett. We hope you’ll join us on our journey today as we share our passion for accounting and help change the way you train.

Chris: Nice intro. Trying to use all your Gen Z slang, huh? So, what are “buy now, pay later” loans? I didn’t even really know it existed until you told me we were doing a podcast on it!

Mike: “Buy now, pay later” (or BNPL) is a form of consumer credit. It’s like old-fashioned layaway plans, except instead of Sears keeping the bicycle in the warehouse until you finish paying, you get the bike immediately.  At its core, BNPL is a short-term consumer installment loan that lets customers divide a retail purchase, say clothing, into multiple, equal payments, with the first payment due at checkout. The remaining payments are billed to their debit or credit card (or a bank account) until their purchase is paid in full.

Chris: That’s interesting. Our generation remembers some of those layaway plans that some of the big department stores had. We’ll see if this is similar to what we experienced. How did you come up with the topic?

Mike: I was reading an article in The Atlantic titled The ‘Buy Now, Pay Later’ Bubble is About to Burst and thought it would be a cool topic, especially since I really didn’t know much about the industry.  One of things that drew me there is that the first line of the article explains that you can now pay for a sandwich using Buy Now, Pay Later options.

Chris: If I wanted to, how would I get a BNPL loan?

Mike: If you make a purchase, either online or at a retailer, there usually is an option to use a BNPL service offered by one of the major providers of such loans like Affirm, Afterpay, or Klarna. In other words, when you make a purchase, you can pay for it using cash, check, debit card, credit card or a buy now, pay later option. In fact, I just noticed when purchasing my Zyn online that I could also pay for it using Klarna!

Chris: Buying nicotine replacement pouches on layaway. What a world! Why wouldn’t I just use a credit card?

Mike: You would, but perhaps the person we’re talking about doesn’t have a credit card. In that article we were talking about,  a  Harvard economist quoted in that article notes that “most of the people that use buy now, pay later either don’t have or don’t use a credit card.” In fact, about half of BNPL users are 33 years old or younger, and, according to this economist, many Gen Zers are skeptical of credit cards.

Chris: Why are they skeptical of credit cards?

Mike: Maybe because they’ve seen their family or friends drowning in credit card debt. Did you know that the average U.S. household has $6,000 in credit card debt?

Chris: Seems about right.

Mike: And, according to a McKinsey survey, roughly 60% of credit-card holders don’t pay the full amount on their monthly bills. As a result, traditional credit card companies earn a tremendous amount of revenue from interest and late fees charged to consumers.  And these BNPL companies are using this in their marketing. This is from Affirm’s website:

"No fees, no gotchas, no surprises. We’re making it easier to make smart choices with your wallet. So you can get the things you love without the things you don’t. Unlike most credit card companies, we’re here to help you. Not to profit off mistakes or misfortune. When you win, we win."

Mike: And this from Klarna’s website:

"No interest. No catch. Buy now, pay later is an alternative to credit cards and gives you the flexibility to shop what you want, when you want, without breaking the bank. When you split the cost of your purchases into 4 smaller payments with Klarna, you’ll never pay an interest. Ever."

Chris: Wait! You mean consumers don’t get charged interest.

Mike: That’s right and this is the real allure for consumers who use this service. The most popular product offered by these companies requires customers to pay off their purchase in 4 equal installments. The first installment, or 25% of the total purchase price, is due at purchase, with the rest due in three additional, equal installments, required every two weeks. Therefore, the terms of these loans are very short, around 6 weeks. However, just like the advertising states, customers only pay the total amount of the purchase with zero interest. I should note that many of these companies do offer interest-bearing installment plan options with various durations, so not all of their financial products are interest free.

Chris: So are the ones that charge interest a longer duration?

Mike: Yes, they would be a longer duration. Some of them are just like credit cards. Klarna even has a credit card. But others are a longer duration, maybe three or four months. In those they do charge interest. 

Chris: What happens if you miss a payment? I imagine they can’t come and get that product from you. It’s not like those traditional layaway plans where you didn’t get the items until they were completely paid for. So what happens when a payment is missed? Are there late fees?

Mike: Some of these companies, like Afterpay and Klarna do charge late fees. Here’s Klarna’s disclosure on their website:

"A Late Fee of up to $7 may be charged if any scheduled payment remains unpaid after 10 days (this will never exceed 25% of your Installment Payment amount)."

Mike: However, other BNPL companies like Affirm, do not. They don’t charge any late fees. This is from Affirm’s Form 10-K:

"Our company is predicated on the principles of simplicity, transparency, and putting people first. Since our founding, we have charged $0 in late fees for missed payments. We never profit from consumers’ mistakes, and we are always transparent in our product offerings. By adhering to these principles, we have built enduring, trust-based relationships with consumers and merchants."

Chris: So, how in the world do these companies make money? I am assuming they are not doing it for charity. 

Mike: From the retailers. BNPL providers can offer no interest loans because they charge the merchants a fee. Based on my research, this fee can be up to 3 to 4 times the average credit-card processing fees charged by Visa, Mastercard, and American Express.

Chris: Whoa! That’s a lot. I know merchants are unhappy about credit card processing fees. I have seen some smaller merchants recently charging less if you pay cash rather than using a credit card because it eliminates the fee for them. So, if the average credit card processing fee is like 2-4%, these BNPL firms are charging retailers up to 10%?

Mike: Yeah, I saw something on NPR that they’re charging somewhere between 4 and 9.5%. So that 10% estimate isn’t all that off. 

Chris: Why would retailers accept that much of a “haircut” on goods they sell? They already complain about traditional credit card processing fees, sometimes offering discounts for paying in cash. Why would they be interested in doing this, and why wouldn’t they just pass this cost on to the rest of us?

Mike: Well, go back to our conversation a few moments ago about the people that use this service. Remember it's primarily used by people that either don’t have or don’t use credit cards, which might be for a host of reasons, including no or bad credit. Therefore, hypothetically, these are “new” sales that retailers would not have had (at least that is what these BNPL companies are pitching to merchants). And, yes, like all costs, they presumably are passed on to the consumer in the form of higher prices.

Chris: How do these firms decide who they will extend credit to?

Mike: When you apply for the typical product offered by these firms, like the buy now and pay in 4 equal installments plan, they usually run a “soft credit check” just to help them confirm that you pay your bills on time and doesn’t impact your credit score.

Chris: Is a “soft credit check” like what we run on prospective employees?

Mike: You got it! Here’s how Experian, one of the 3 main credit bureaus, explains it:

"A soft inquiry, sometimes known as a soft credit check or soft credit pull, happens when you or someone you authorize (like a potential employer) checks your credit report. They can also happen when a company such as a credit card issuer or mortgage lender checks your credit to pre-approve you for an offer. Soft inquiries don’t impact your credit scores because they aren’t attached to a specific application for credit."

Mike: In contrast, a “hard inquiry” generally occurs when a financial institution, such as a lender or credit card issuer, checks your credit when making a lending decision. Hard inquiries will stay on your credit report for two years, but their impact on credit scores is typically minimal and will only last a few months.

Chris: So it’s not like with financing a car, which will perform a hard inquiry. Got it, but do the credit bureaus know if customers have taken out these BNPL loans?

Mike: At first they don’t. But, if you don’t pay, you better bet that these companies will report your nonpayment to the credit bureaus.

Chris: Well, that sucks. You mean that if I don’t pay it negatively affects my credit, but, if I pay on time, it doesn’t help me? 

Mike: That’s right. And that’s one of the dangers of these products for consumers. You don’t get credit for on-time payments to help build your credit score, which as you and I know, is very important in life. In the fine print of Klarna’s legal terms it says that “you are hereby notified that a negative credit report reflecting on your credit record may be submitted to a credit reporting agency if you fail to fulfill the terms of your credit obligations.”

Mike: In addition, because the credit bureaus don’t know about the loans, a borrower could, hypothetically, take out a bunch of these BNPL loans at one time, say around Christmas to pay for expensive gifts for your family and friends, but then, when it’s time to pay the piper, you can’t pay, default on your loans, and it wollups your credit. And that’s a ding that will stay on your credit report for some time!

Chris: For some people that is a big deal. For others, they don’t really care about their credit report. I do want to ask you, Mike. Who is on the hook? With traditional financing, like buying a car, if you don’t pay the bank is going to come and repossess that vehicle. The bank is then gonna try to sell the car and try to recoup as much of the principal as they can. But, for these BNPL options, what happens if a borrower defaults. 

Mike: These BNPL companies are the ones on the hook. They are the ones that extended the credit. Just like a bank, if you don’t pay they are going to try to recoup their losses where they can. It goes into the fees that are paid by merchants. 

Chris: Oh, so now it makes sense why they are charging these higher fees to the merchants. This is all statistics and models. They know if they charge a higher rate, they’ll come out ahead even with defaults on payments. You mentioned that these firms do offer more traditional financing options. How do those differ from their typical buy now, pay later product?

Mike: In this case, it would be more akin to a credit card, where interest and late fees are charged for unpaid balances. In this case, the BNPL company would run a “hard inquiry” and report your payments, good and bad, to the various credit bureaus.

Chris: Makes sense. Who are the key players in the BNPL market and how big is the market?

Mike: The key players operating in this industry include Affirm, Afterpay, and Klarna. Other BNPL companies include PayPal, Laybuy, Payl8r, Perpay, Quadpay, Sezzle and Splitit.

Mike: Based on total users, Klarna is currently the most popular BNPL service provider and has approximately 147 million active users. Affirm is the second largest with 11.2 million active users, and Afterpay is third with about 10.5 million active users.  With respect to the size of the market, according to Allied Market Research, the global buy now pay later market size was valued at $90.7 billion in 2020, and is projected to reach $3.98 trillion by 2030, growing at a compound annual growth rate (CAGR) of 45.7% from 2021 to 2030. This astronomical growth has garnered the attention of some rather big companies including Amazon and Apple. For example, Apple just rolled out a program, “Apple Pay Later,” which lets its customers split a purchase into four equal installments over six weeks with no interest or fees to pay. Sound familiar?

Chris: If Amazon and Apple are “all-in,” it sounds like it is not just a passing fad.

Mike: I think that’s right. Let’s look at the U.S. market share. From 2019 to 2021, the total value of BNPL loans originated in the U.S. grew by more than 1,000 percent, from $2 billion to $24.2 billion. A lot of that is driven by the coronavirus pandemic. Sounds impressive, but it's still a long way off from reaching credit card levels. Currently BNPL loans represent only 2% of total e-commerce transactions in the United States. Compare that to Sweden, where BNPL loans represent a staggering 23% of all e-commerce transactions. By the way, Sweden, by far, is the country where this is the most popular. Other countries where this is popular include Germany, Norway and Finland.

Chris: Aren’t these companies an example of what is known as “FinTech?”

Mike: I think so. According to Columbia University, “FinTech” is a catch-all term referring to software, mobile applications, and other technologies created to improve and automate traditional forms of finance for businesses and consumers alike.” And based on reviewing these companies’ websites, I think that is what they would consider themselves.

Chris: That means they aren’t regulated like traditional banks.

Mike: That’s correct and, as a result, there aren't a lot of consumer protections out there. However, due to the rise in popularity and growth of these firms, they have certainly drawn the attention of regulators. An article in Forbes dated October 19, 2022 said that the U.S. Consumer Financial Protection Bureau plans to start regulating the industry. The CFPB released a study in September identifying several risks to using BNPL, including a lack of consumer protections, the ease of debt accumulation and the potential for data harvesting. As a result, they say they will issue guidance or a rule to align sector standards with those of credit card companies.

Mike: This industry has also drawn the attention of lawmakers. A January 14, 2023 article in the Albuquerque Journal noted that BNPL service Afterpay decided to leave the state, joining other providers that avoid New Mexico due to state regulations. The article goes on to say the new state regulation does not prohibit BNPL providers - it merely regulates them and other loan providers, setting at 36% interest cap, and limiting late fees. Although Afterpay does not charge interest on its installments, it does enforce late fees.

Chris: So, let’s dive into the main players. First, Klarna. What can you tell me about them?

Mike: Klarna was Founded in 2005 in Stockholm, Sweden, Klarna now has 150 million total active customers, including 25 million in the U.S., processing 2 million transactions per day. As we stated early, it is the largest BNPL company based on active users. It is a private company, but it is backed by some pretty heavy hitters including Visa and Sequoia Capital, among others.

Chris: What about Affirm?

Mike: Unlike Klarna, Affirm is a publicly traded company headquartered in San Francisco. Founded in 2012, the company launched its IPO on Nasdaq and went public on January 13, 2021. Initially pricing its shares at $41, it closed that day at $96.36. The stock reached its highest level on November 5, 2021 when it closed at $164.23 on November 5, 2021.

Chris: What’s the stock at now?

Mike: It closed on January 13, 2023 at $12.88, so considerably lower than its all-time high reached only 14 months earlier.

Chris: “Considerably lower” is being generous! It’s down over 90%!! I definitely want to talk about the current market environment, but first, let’s round out the top 3. What about Afterpay? 

Mike: Afterpay is an Australian FinTech company founded in 2014. Interestingly, Afterpay was acquired by Block (formerly Square) on January 31, 2022. Square was the payments firm of Twitter and was co-founded by Jack Dorsey, Twitter’s former CEO before the man-child Elon Musk took over.

Chris: What? You don’t like Elon?

Mike: Not at all. He’s definitely smart, but I think he is a narcissistic jerk, like someone else I’m not very fond of, but that’s a topic for another podcast!

Mike: Anyway, Square shareholders approved an all-stock purchase of Afterpay for $29 billion, based on the the price of their shares at the time, but by the time the deal closed, Block’s stock had dropped so much that the price tag was only $13.9 billion based on the 113,387,895 shares offered according to regulatory filings.

Chris: Let’s talk about the current market environment and its impact on these companies. What have you learned?

Mike: The valuations for these companies are way down! That Forbes article I cited early published in October stated that BNPL companies Affirm and Zip are down 70%, and Klarna’s valuation fell more than 80% in July.

Chris: Makes sense, they are facing some strong economic headwinds.

Mike: Sure, but it's more than that. Remember who uses these loans. Gen Zers. And, as is the case with young credit-card holders, BNPL users under 25 have the highest default and delinquency rates. Not a good sign going into a recession! 

Chris: It would be interesting to see how the current market environment has impacted their financials, especially the allowance for credit losses.

Mike: Well, Klarna is a private company, so good luck with that. Afterpay was acquired by a subsidiary of Block, so it might be hard to find transparent information regarding just the BNPL piece of the business. However, Affirm is a publicly traded company, so I did a little digging into their SEC filings.

Chris: What did you find?

Mike: Well, their most recent Form 10-K is for the year ended June 30, 2022, their fiscal year end. And the most recent financial information was filed in their first quarter Form 10-Q for the quarter period ended September 30, 2022. Long story short, the information is nearly 4 months old. I also looked at the first quarter’s analyst presentation.

Chris: You are such an accountant! Enough disclaimers. Give me the deets!

Mike: Well the first interesting thing is that they were presenting growth in gross merchandising volume, one of their key performance indicators, excluding Peloton. As noted in that article in The Atlantic, at the height of the pandemic, Peloton represented 30% of Affirm’s revenue…and we know what’s been happening with Peloton.

Chris: Yeah, it cycled right off a cliff!

Mike: No doubt. Also interesting that, although Affirm and all BNPL companies are known for their “Pay in 4” product, nearly two-thirds of their transactions represent interest-bearing products. And, actually, looking at their revenues, it is about evenly split between merchant fees and interest income. 

Chris: Sounds like the “no interest” motto, especially with the slow paying Gen Zers, isn’t exactly a winning business strategy!

Mike: Yeah, right. Also interesting is the fact that, since their IPO, they have never shown a GAAP profit. They lost $707 million for the year ended June 30, 2022 and an additional $251 million in the first quarter ended September 20, 2022. It’s definitely going in the wrong direction. Their net income chart since their IPO looks like what a good chart should look like in reverse! And, the net loss is continuing to grow. 

Chris: So, circling back to one of our previous episodes, I’m guessing they have non-GAAP profit.

Mike: Kind of. For a few of the quarters, they showed an adjusted operating income just barely in the black, but most quarters they lost money, even on an adjusted basis. But, it was better than the GAAP net loss. And their delinquency rates are definitely going up, nearly doubling as compared to the prior year first quarter!

Chris: With delinquency rates going up, I would imagine that their allowance for credit losses has increased as well.

Mike: You’d think that, but you’d be wrong! Even though delinquency rates have doubled, there hasn’t been a corresponding increase in the allowance for credit losses, which has remained flat. Consider this: At September 30, 2021, the company showed loans held for investment totaling $2.2 billion and an allowance for credit losses of $152 million. That’s a ratio of 6.7%. However, at September 30, 2022, loans held for investment increased 19.5% to $2.7 billion, but the allowance for credit losses was only $153 million. It had only gone up $1 million. The ratio of allowance for credit losses to loans decreased to 5.7%.

Chris: I wonder how they explain that! 

Mike: Here’s their explanation in their latest Form 10-Q:

"Provision for credit losses expense remained relatively comparable period over period with a slight increase of $0.6 million for the three months ended September 30, 2022, compared to the same period 2021, primarily due to growth in the volume of loans held for investment, offset by improvements in the credit quality of loans outstanding and updates to the assumptions used in our credit loss valuation model, including a refinement to the application of our stress loss multiple. Total loans held for investment was $2.7 billion and $2.2 billion as of September 30, 2022 and 2021, respectively. The allowance for credit losses as a percentage of loans held for investment decreased from 6.8% as of September 30, 2021 to 5.7% as of September 30, 2022."

Chris: Well, well. “Updates to the assumptions…” and “...a refinement to the application of our stress loss multiple.” I can AFFIRM that someone can expect an SEC comment letter!

Mike: That’s kind of funny! We have an eLearning course available related to ASC 326 which governs the accounting for the allowance for credit losses under U.S. GAAP. 

Chris: So, what’s the final verdict? Should people use BNPL loans?

Mike: My personal opinion is no, unless (1) what you are buying is a NEED, as opposed to a WANT, and (2) you are absolutely, 100% sure that you’ll have the money to make the payments.

I think the website NerdWallet sums it up best:

"NerdWallet recommends using BNPL only for necessary expenses, like a mattress for your apartment or a computer for school. Though the plan may seem simple and low-cost, you’re still taking on debt, and it’s rarely a good idea to go into debt for a nonessential purchase.

If you’re struggling to pay your bills or start an emergency fund, steer clear of buy now, pay later. Because of its convenience, it’s easy to overspend with BNPL. If that happens, you may incur high fees or be sent to collections, which will hurt your credit score."

Chris: That’s sound advice. And NerdWallet sounds a bit like your dad! That’s all for this episode of GAAP Chats, your source for all things accounting.  Notes and resources from today’s episode are linked in the description and as always you can find us online at, and @gaapdynamics across social media. It’s never too late to become a GAAPologist! Head over to our website and subscribe to our blog so that you’re the first to know what’s new with GAAP Dynamics.

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