accounting for customer loyalty
DESCRIPTION
accounting for customer loyaltyTRANSCRIPT
IFRIC 13: accounting for“customer loyalty programmes”
Sandra Chapple, Lee Moerman and Kathy RudkinSchool of Accounting and Finance,
University of Wollongong, Wollongong, Australia
Abstract
Purpose – The purpose of this paper is to present the views and challenges from a range ofaccounting professionals, regulators and preparers with the introduction of a standardised approachto accounting for customer loyalty programmes (CLPs). It aims to highlight the ambiguities of theclassification of commercial transactions, particularly the nature and timing of revenue recognition.
Design/methodology/approach – Comment letters in response to the exposure draft D20 CLPs areanalysed together with an exposition of the effect of International Financial Reporting InterpretationsCommittee (IFRIC) 13 on an early adopter, Qantas airlines.
Findings – Despite limited support for the consensus view advocated in D20, the InternationalAccounting Standards Board (IASB) has upheld the deferred revenue approach consistent with theanticipated outcome of the IASB and Financial Accounting Standards Board revenue recognitionproject.
Research limitations/implications – The paper analyses the characteristics and views oflobbyists using the IFRIC process. The use of other discourse methodologies may present issues ofpower within this process.
Practical implications – The paper highlights how the implementation of IFRIC interpretationshas the potential to alter reported financial results.
Originality/value – The paper highlights the lobbying process and interpretation process at aninternational level. It also illustrates how companies can engage accounting interpretations to manageearnings, particularly in times of economic challenges.
Keywords Customer loyalty, Accountancy, Lobbying, Australia, Airlines
Paper type Research paper
1. IntroductionSince 1 July 2008, with early adoption permitted, reporting entities in Australia havebeen required to apply International Financial Reporting Interpretations Committee(IFRIC) 13 customer loyalty programmes (CLPs)[1] (IFRIC, 2007) in an attempt tostandardise alleged widespread and divergent accounting practices for CLPs (IFRIC,D20 BC2). IFRIC 13 is an example of the move to fair value accounting for revenuerecognition, whereby the CLP component of a sale transaction is deferred. CLPs aregenerally established by entities to encourage customers to buy their goods and services.Customers may accumulate points or awards and redeem them in the future, often from arange of options offered by the entity or a third party. Alternatively, points or awardsmay be linked to certain custom over time, or offered as a welcome customer incentive.The implications for the timing and amount of revenue recognition following adoption ofIFRIC 13 has had a significant impact on reported results, particularly in the airlineindustry (Picker et al., 2009).
IFRIC 13 only applies to schemes where an entity grants awards to its customersas part of a sales transaction and the awards are subsequently redeemed for free
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Accounting Research JournalVol. 23 No. 2, 2010pp. 124-145q Emerald Group Publishing Limited1030-9616DOI 10.1108/10309611011073232
or discounted goods or services. IFRIC 13 does not apply to other types of schemeswhere incentives are offered in the absence of a sale, or where award credits are soldseparately. IFRIC 13 also includes schemes where a third party is obligated to supplythe goods or services.
An award related to a CLP must be categorised as either an asset, liability, revenue orexpense to enable representation on a firm’s financial statements. This categorisationassigns importance and relevance to some matters and objects, constructing a financialreality (Young, 2003). This construction, however, is controversial as items are“prodded, probed and snipped, and made to fit into these categories”; categories whichthemselves are “ambiguous and highly adaptable” (Young, 2003, p. 621). The ambiguityof categorising and measuring economic phenomena is highlighted in the case of CLPs.The obligation to supply awards can either be treated using a provisioning approach or adeferred revenue approach. This choice has been interpreted by the IFRIC as a revenuerecognition issue but it could equally be interpreted as a cost/provision issue within therequirements of International Accounting Standard (IAS) 37: Provisions, ContingentLiabilities and Assets. IFRIC 13 provides guidance on the recognition of revenueconsistent with IAS 18: Revenue, “in a way that reflects our view that loyalty awards areseparate goods or services for which customers are implicitly paying” (InternationalAccounting Standards Board (IASB), 2007b). Thus, entities are required to use thedeferred revenue approach, whereby a proportion of sales consideration is allocated to aliability account, and the revenue subsequently recognised when awards are laterredeemed by the customer.
This treatment is a move towards that anticipated in the revenue recognition projectof the IASB and Financial Accounting Standards Board (FASB) (2009). This project,initiated in September 2002, represents a major change in the approach to revenuerecognition, from a risk and returns model to that of an asset/liability model. Under thisnew approach revenue is recognised when an entity’s net position increases, at the timethat it transfers goods and/or services to a customer. In the case of CLPs, revenuerecognition occurs when the customer redeems the awards. The revenue recognitionproject also heralds a move towards fair value measurement of revenue and hasparticular ramifications for those entities currently using the cost/provision method forCLPs where awards are measured at the often insignificant cost of satisfying theobligation.
Alternate interpretations have the potential to alter the redistribution of wealth insociety, bringing both costs and benefits to diverse stakeholders. Since the timing andamount of revenue recognised in a particular period has economic consequences, thestandard-setting process is designed to consider the opinions of various stakeholders(Rappaport, 1977). The IFRIC process of promulgating an interpretation includesinvitations to stakeholders to comment on an exposure draft of proposed changes. Theambiguities encountered by practitioners and their advisers in the interpretation ofaccounting standards, in particular with respect to the commercial practice of CLPs,are explored by reference to the comment letters received in response to the DraftInterpretation D20: Customer Loyalty Programmes (IFRIC, 2006a).
The next section provides an overview of the literature on lobbying of accountingstandard setters, and the emergent research questions. Section 3 provides backgroundinformation on the IFRIC with specific reference to IFRIC 13, followed by a discussionof the method used to analyse the comment letters in Section 4. Section 5 provides
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an analysis of the data, with reference to organisational type and geographical area. Thediscussion in Section 6, explores the impact of IFRIC 13 on an early adopter, Qantas,Australia’s international airline.
2. Standard setting as a processThe study of IFRIC 13 is an example of accounting change in action and the process ofpromulgating an interpretation of existing accounting standards. There have beennumerous calls for such studies. Young (1994) advocated the importance of studyingchanges in accounting recognition practises, proposing that accounting problems arenot there waiting to be resolved, but rather, are actively constructed by multipleoccupants in a regulatory space. Young (1994) argues that standard setters must createchange to mediate the divergence between the interface of accounting principles andelements and the practice of accounting. Bradbury (2007) extends this argument, notingthat as IFRIC interpretations have the same authority as an International FinancialReporting Standard (IFRS), they bestow significant power on those who influence IFRICinterpretations. Interpretations signal an omission or flaw in the logic and cohesion ofexisting accounting standards that cannot be mitigated by professional judgement andhave the potential to undermine a principles-based approach. Therefore, as Bradbury(2007) argues, the interpretation process is significant because it provides a window intothe “IASB world” (Bradbury, 2007, p. 120).
Comment letters document the interpretation process and users’ attributesand participation in the standard setting process. Masocha and Weetman (2007) claimattention to textual analysis of documents such as published letters ofcomment, increases the explanatory power of an analysis. Companies use diverse andnon-observable lobbying methods including auditor appeals and private meetings withstandard setters. Therefore, comment letters can be regarded as a good proxy for thedirect corporate lobbying activity to which the standard setter is subjected (Georgiuo,2004).
Grinyer and Russell (1992) found that those who write comment letters were seekingto further their economic position, and that such lobbying pressures can negate efforts toproduce standards that are consistent with accounting concepts. Larson (1997)examined the characteristics of corporations that lobbied the IASC between 1989 and1994, finding that lobbying of the IASC was done by very large corporations andmultinationals. Responses were overwhelmingly from developed countries, questioningthe accessibility of the comment letter process to emerging countries. MacArthur (1999)investigated the impact of cultural factors on the submission of comment letters findingthat cultural and economic differences between groups constrain harmonisation ofaccounting standards. Therefore, categorisation of comment letters and their particularperceptions of the issues are important to document the attributes and breadth of thoseparticipating in this process. This study analyses the technical arguments andthe perceived impact on practice as presented in the comment letters by lobbyists ofIRFIC 13.
It is important to undertake specific case study research of accounting change in itscontext, and apply the concept of phronesis or the analysis of what is rational andpractical in a specific context, to make research more relevant (Cooper and Morgan,2008). The analysis of IFRIC 13 and its associated comment letters contributes to the casestudy literature of accounting standard setting in action (Young, 1994; Bradbury, 2007;
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Masocha and Weetman, 2007; Cooper and Morgan, 2008). This study identifies theinterests and attitudes of the commentators on IFRIC 13 and documents the practicalimplications for revenue recognition of the proposed interpretation. In doing so, itprovides an example of users’ participation in a standard setting process, exposingunderlying assumptions that contribute to the notion of revenue recognition.
3. Background and IFRIC 13: CLPsThe trustees of the International Accounting Standards Committee Foundation (IASCF)established the IFRIC in March 2002 to act in conjunction with the IASB to improvefinancial reporting through timely identification, discussion and resolution of financialreporting issues (IASCF, 2007). The IFRIC reviews newly identified reporting issues inexisting IFRS in order to reach a consensus on appropriate treatments that are said to beconsistent with IFRS and the framework (IASCF, 2007)[2].
The French standard setter, Conseil National de la Comptabilite (CNC), requestedclarification of the accounting treatment for CLPs in 2005. Despite the joint FASB andIASB engagement in a project on revenue recognition staff from the CNC were invited toprepare an issues paper for the IFRIC to provide timely guidance on divergentaccounting practice (IFRIC, 2005). The IFRIC subsequently discussed issues relating toCLPs (see Appendix 1 for a list of meetings) and the Draft Interpretation D20 wasreleased for comment in September 2006. A total of 59 submissions were received by thedue date of 6 November 2006 (Appendix 2). It should be noted that IFRIC interpretationsdo not always proceed to the issuing of a final interpretation, however, in the case ofCLPs, IFRIC 13 was approved by the IASB in June 2007. IFRIC 13 is substantivelyconsistent with D20 with some minor concessions in response to concerns raised bycommentators to the draft interpretation, such as the change from measurement ofawards at “relative fair value” to “fair value”, and removal of the reference to intangibleassets (Figure 1).
D20 proposed two accounting treatments for CLPs and a hybrid approach reflectinga choice dependent upon the commercial reality of the entities allocating andredeeming award credits.
The IFRICs preferred treatment, the consensus view, relies upon an interpretation ofIAS 18 paragraph 13, which states that the recognition criteria for revenue, in relation togoods and services, are usually applied separately to each transaction. However, in somecases there is a requirement to recognise the substance of the transaction by identifyingthe separate components of a single transaction. Therefore, where a sales transactioninvolves the issue of an award arising from a CLP, the initial transaction is divided intotwo components. Each component of the sale is allocated a proportion of theconsideration according to their relative fair value. The amount allocated to the awardcomponent is deferred and recognised as revenue when the awards are subsequentlyredeemed. This treatment is commonly referred to as the deferred revenue approach(D20 BC5, or Option 2 in Figure 2).
The cost/provision approach relies upon an interpretation of IAS 18 paragraph19, which states that “revenue and expenses that relate to the same transaction or otherevent are recognised simultaneously”. This interpretation would apply, for example, towarranties provided on the sale of goods. The total consideration for the sale of goods orservices is recognised as revenue at the time of sale with a corresponding provisionraised for the estimated future costs of supplying the awards in accordance with IAS 37.
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Figure 1.Timeline of IFRIC/IASBmeetings and other keyevents
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This interpretation forms the basis of Option 1 (D20 BC4) and treats CLP awards as akinto marketing expenses.
Option 3 (D20, BC6) offers a choice of treatment between the deferred revenue andcost/provision approach. This choice is dependent on the nature of the CLP, the value ofthe award credit and the entity providing the reward. The deferred revenue approachmeasures the liability arising from future redemption at fair value or selling price, whilethe cost/provision approach measures the liability based on the expected cost ofsupplying the award (IASB, 2007b). For reporting entities the “interpretation may resultin a significant change in the point in time at which revenue is recognised” and for “largeand complex programmes, initial application [. . .] can be a very time-consumingexercise” (Ernst & Young, 2007).
4. MethodThis study uses the data contained in the following sources: the 56 comment lettersavailable in response to D20 (out of a total of 59 comment letters, three were not availableon the IASB web site); the relevant 2006 and 2007 IFRIC and IASB meeting updates andobserver notes (Appendix 1); and the text of D20 and IFRIC 13.
Figure 2.D20 options
D20 options
Recognition and measurement ofobligations to supply goods and
services to customers if theyredeem “award” points
Option 1 (D20 BC4)
Cost/provision approach.Award recognised as an expense andmeasured in accordance with IAS37;
that is, at cost of satisfying obligation.Based on assumption that CLPs are
marketing tools
Uses IAS18, paragraphs 16 and 19 asguidance for interpretation
Option 2 (D20 BC5)
Deferred revenue (liability) approach.Awards granted as an element of market
exchange, which are separatelyidentifiable components of initial
transaction (sale). Measured at fair value
Uses IAS18, paragraph 13 as guidancefor interpretation
Option 3 (D20 BC6)
Mixed approach
Accounting treatment depends on the natureof CLP – either relative value or the nature ormethod of supplying rewards
Insignificant valueand/or goods or serviceprovided by third party
Significant value and/orgoods or service providedby entity
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The 56 comment letters were read by two researchers independently. Each submissionwas allocated to a predefined organisational type; professional accounting bodies,professional accounting firms, national standard setters, stock exchange regulators,banks, airlines, other business, actuaries and other business. These were furthercategorised by geographical representation: Asia, Australia, Europe, North America,Russia, Scandinavia and South Africa. This was done manually, and summarised on anexcel spreadsheet.
While content analysis can focus on the different units of discourse, e.g. sentence orparagraph level, the unit of analysis in this study was the entire comment letter. Thecommentators were weighted evenly and each submission counted as a single response.However, the researchers acknowledge, as in the case of International Organization ofSecurities and Exchange Commissions (IOSCO) as a peak representative body, eachcomment letter may have represented the views of several constituents. Codingidentified support for the key proposals of D20, namely whether award credits issuedpursuant to a CLP constituted a separate component of the initial sales transaction. If thesubmission supported the consensus view, two further issues were identified; first, howmuch of the consideration should be allocated to the award and secondly, when revenueshould be recognised.
Where commentators articulated an explicit preference for one of the three options(Figure 2) it was noted. Where exclusive or explicit support for an option was absentthe researchers made a decision based on the narrative, e.g. if arguments were aroundmateriality, then it was assumed that the commentator accepted the consensus sinceimmaterial CLPs are not subject to the interpretation. On the other hand, ifcommentators gave approval for the consensus but further argued that this situationonly applied to certain types or the nature of the CLP, e.g. goods supplied in the normalcourse of business, then this was classified as support for the mixed approach. Onlythree comment letters were omitted: one was contradictory in the response; another didnot give a preference; and, IOSCO was explicitly non-committal as they represented alarge diverse constituency. Table I provides an analysis of comment letters accordingto preferred option.
Table II presents the number of commentators that responded to D20 byorganisational type and geographical region. Two of the professional accounting bodieswere also national standard setters (South African Institute of Chartered Accountantsand Hong Kong Certified Practicing Accountants) and one, the Chartered Institute ofManagement Accountants based in the UK, was classified with European organisations.The professional accounting firms in most instances are global firms but were classifiedaccording to the source of the comment letter. National standard setters include urgentissues groups, technical advice groups and emerging issues task forces. A list ofsubmissions is listed in Appendix 1. Additional issues raised in the comment letterswere identified and analysed, as shown in Table III. Further, the texts of the IFRICmeeting papers, D20 and IFRIC 13 were reviewed to identify arguments developed andused to substantiate or reject available options.
5. Data analysisTable II categorises the comment letters by organisational type and by geographicregion.
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5.1 Organisational typeThose organisations representing the accounting profession, namely the professionalbodies and public accounting firms, contributed 19 comment letters or 34 per cent of thetotal. The “Big 4” accounting firms, namely KPMG, Deloitte Touche Tomatsu, Ernst &Young and PriceWaterhouseCoopers all submitted letters, along with the French firmMazars, consistent with previous practice noted by Larson (2007). All of these firmshave representatives on the IFRIC. When combined with the national standard setters,the percentage of comment letters submitted by accounting interests increased to63 per cent of the total. This result may be compared with that of Larson (2007) in which47 per cent of the all comment letters to IFRIC draft interpretations 1-18 came from asimilar group of constituents. This reflects a high concentration of responses from theaccounting profession, with the technical and financial resources available for this typeof endeavour. It does, however, challenge to some extent the legitimacy of the IASB andthe IFRIC, by failing to engage a broad range of stakeholders in the standard settingprocess (Larson, 2002, 2007). Surprisingly, comment letters from other constituentgroups were less forthcoming given the potential economic consequences of alternativeaccounting treatments on financial statements. This may be explained by the findingsof Durocher et al. (2007) that suggest participation in a standard setting process isinfluenced by the perception of one’s ability to participate adequately, and one’sknowledge of the process and justification of the proposed standard.
There were only five responses from banks or banking representative groups, withfour supporting the cost/provision approach. The four supporting banks were allEuropean, and they provided five arguments to support their preferred option (BC4):the commercial reality of CLP is that of incentive (CL23, CL37); the option is easier toapply in practice (CL2, CL23, CL32, CL37); the treatment is consistent with practice
Option 1cost/
provision
Option 2deferredrevenue
Option 3mixed
approachOption not specified/
ambiguous Total
Accounting professionProfessional bodies 4 5 4 0 13Public accounting firms 0 3 3 0 6RegulatorsNational accounting standardsetters 5 4 6 1 16Stock exchange regulators 0 0 1 1 2PreparersBanks 4 1 0 0 5Airlines 3 0 0 0 3Other business/businessrepresentative groups 1 2 6 0 9Actuaries 0 0 0 1 1UsersNoneOthersAcademics 0 0 1 0 1Total 17 15 21 3 56
Table I.Analysis of comment
letters: preferred options
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Cat
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22
61
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113
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314
15
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Notes:
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Table II.Categorisationof submissions by typesand geographicalrepresentation
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outside D20 (CL2, CL37); the value of awards is insignificant in comparison with thesales transaction as a whole (CL23); and the benefits of the advocated treatment wouldnot outweigh costs, such as costs required by significant system changes (CL32). Thisgroup provided limited support for the interpretation as proposed in D20, notingcommercial “reality” as a significant barrier to implementation.
Nine responses were received from the business sector (excluding airlines andbanks), and included representative groups such as G100 in Australia, UNICE (Europe)and the 100 Group of Finance Directors in the UK. In total, six out of nine businessgroupings supported the mixed approach where discretion should be left to theindividual preparer.
5.2 Geographical representationA total of 31 of the comment letters, or 55 per cent came from Europe. This is consistentwith the findings of Larson (2007), where 57 per cent of the comment letters on IFRICinterpretations 1-18 came from European constituents. These results indicate the extentto which European countries participate in this aspect of the standard setting process.Viewed in conjunction with European representation on IFRIC during the period ofdeliberations on CLPs (five out of 12 members were European[3]), it is suggested that theEuropean contingent had significant opportunity to voice their opinion on the CLP issue.It should be noted, however, that the Europeans were not united in their preferences,with an even spread across the three options.
Letters from Asian nations represented just over 12 per cent of the total responses,exceeding those of all other geographic regions apart from Europe. Six werefrom national standard setters and professional bodies, reflecting the move towardsincreased involvement at the international level of standard setting and programmes
Assumptions offair valueestimates Scope
Costsversus
benefits
Customerrelationships andintangible assets
Treatment ofthird-party
transactions
Accounting professionProfessional bodies 8 4 3 2 3Public accountingfirms 6 4 0 2 2RegulatorsNational accountingstandard setters 7 3 5 4 4Stock exchangeregulators 1 0 0 1 0PreparersBanks 0 1 2 0 1Airlines 3 1 2 1 1Other business/businessrepresentativegroups 3 5 1 0 2Actuaries 1 0 0 0 0OthersAcademics 0 0 0 0 1Total 29 18 13 10 14
Table III.Analysis of comment
letters: additionalidentified issues
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for convergence/adoption by all of these countries over the 2011-2012 period(Deloitte, 2009).
The North American contingent, including IOSCO, contributed only four commentletters. This is not unexpected given earlier evidence of a poor response rate to previousdraft interpretations (Larson, 2002, 2007). While IOSCO declined to commit to onealternative, the North Americans supported the deferred revenue approach.
5.3 Accounting treatment – option 1, 2 or 3?Seventeen of the D20 commentators favoured Option 1 (the cost/provision approach),with the common view that the nature of the awards are akin to marketing expenses.Commentators questioned whether the anticipated implementation costs of the deferredrevenue approach would be offset by benefits, such as greater relevance of information,especially when the cost/provision approach is already widely used in practice.
In total, 15 of the 56 commentators preferred Option 2, the deferred revenue approach(D20 Consensus). In some cases, support was tempered by acknowledgement of thepractical difficulties anticipated with implementation, particularly regarding timing ofrevenue recognition (see CL6 in Appendix 1), determining fair value (CL21 and CL38)and separating the components of the initial sale (CL46). In defending its choice, theIFRIC states that:
Incentives to customers can be distinguished in substance from marketing expenses.Marketing expenses are incurred independently of a sales transaction, to secure thattransaction. Incentives to customers are part of the sales transaction itself – whether theyreduce the consideration receivable or increase the goods and services deliverable, they areelements of the market exchange between the entity and its customers (IASB, 2007a, p. 18).
The IFRIC also notes that “the goods or services for which the loyalty points can beredeemed are inherently completely independent of the goods and services delivered inthe initial sale” (IASB, 2007a, p. 19) and that while awards are typically of low value,the nature of the transaction affects substance, not value (IASB, 2007a).
Option 3 (the mixed approach) attracted support from 21 of the D20 commentators.It allows for a choice between the deferred revenue approach and the cost/provisionapproach. Several commentators suggested that if awards are supplied by the entity aspart of its normal activities, then the deferred revenue approach is appropriate. If awardsare supplied by a third party, or are not part of the entity’s normal business activities,commentators argued that they should be treated as a marketing expense. Somecommentators also suggested that where awards are insignificant in value andincidental to the sale of goods or services, they should be treated as a marketing expenseor as a deduction from revenue (trade discount or rebate). However, this argument issuperfluous as immaterial awards are not subject to the scope of the interpretation inaccordance with the materiality guidelines in IAS 8 Accounting Policies, Changes inAccounting Estimates and Errors.
Several commentators[4] noted that in the context of the current joint project betweenthe IASB and the FASB on revenue recognition, IFRIC 13 may be premature orredundant. The European Telecommunications Companies (CL10) suggested that suchan interpretation, when made “prior to the development of a comprehensive frameworkfor multiple component sales”, could have “far reaching effects for other componentsales”. However, given the long-term timeframe of the revenue recognition project,
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an interim solution may “improve the way that IFRS are implemented in the short term”(European Financial Reporting Advisory Group, CL55, p. 4).
Table III summarises additional issues identified in the comment letters, which areclassified according to type of organisation.
The predominant concern for all groups were the assumptions associated with fairvalue estimation. Numerous commentators also sought clarification on the scope ofD20 and raised concerns about the costs versus benefits of implementing the preferredapproach.
5.4 Assumptions of fair value estimates and timing of revenue recognition
The fair value of the consideration received or receivable in respect of the initial sale shall beallocated between the award components, i.e. the goods and services sold and the awardcredits granted (D20, paragraph 5).
Implementing the guidance, especially regarding forfeitures and the time value ofmoney, was problematic for many of the commentators[5]. Commentators indicated thatthe IFRIC was too prescriptive in proposing the use of relative fair value as a means ofallocation. Deloitte (CL31) noted that IAS 18 Revenue, paragraph 9 states that revenueshould be measured at fair value, not relative fair value. Ernst & Young (CL38)suggested that the choice of method should be left to the discretion of entities. Inresponse, the IFRIC modified the final interpretation to fair value, with the subsequentchoice of variables left to professional judgement (IASB, 2007b). In instances where thefair value of award credits are not directly observable, IFRIC 13 BC12 indicated thereshould be an application of an alternative allocation method. The appendix to IFRIC 13provides application guidance in estimating the fair value of award credits.
Recognition of deferred revenue occurs when award credits are redeemed (D20,paragraph 8). Commentators sought clarification on how to recognise revenue offorfeited awards and changes in expected forfeiture rates. According to the final IFRICInterpretation, “the amount of revenue recognised shall be based on the number of awardcredits that have been redeemed in exchange for awards, relative to the total numberexpected to be redeemed” (IFRIC 13, paragraph 7).
5.5 ScopeCommentators sought clarification on the types of schemes covered by the IFRICInterpretation. For example, UBS (CL32) discussed schemes offered by financialinstitutions where customers are given awards, such as reductions in interest charges onloans. Commentators also drew attention to schemes where awards could be redeemed torepay outstanding loan balances or redeemed for cash. The scope of IFRIC 13 was limitedto include only awards granted as part of a sales transaction (paragraph 3 (a)). The finalinterpretation specifically brought credit card providers within this scope (BC4).
Nine commentators requested that schemes which offered awards by way of goods orservices not supplied in the ordinary course of business (for example, an airlinesupplying electrical appliances) be scoped out of the Interpretation. The IFRIC notesthat:
[. . .] it could be argued that the awards may not be the main activity of the entity, but theyare supplied on a recurring basis in the course of its ordinary activities, as an (albeit small)component of its sales to customers (IASB, 2007a, p. 21).
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Thus, regardless of the nature of the goods and services provided in satisfaction of theaward, if the award is granted as part of the initial sales transaction, then it will fallwithin the scope of IFRIC 13.
5.6 Costs versus benefitsThe cost of implementation versus the benefits of relevant and reliable information wasan issue for commentators, especially for standard setters and professional accountingbodies, attracting 13 responses (Table III). The National Accounting Standards Board ofRussia argued that in assessing an entity’s liabilities, users are interested in theresources available to settle future obligations (CL58). Similarly, the Danish AccountingStandards Committee (CL46) suggested that the D20 approach would lead to significantcosts for preparers, with only limited benefits for users. The IFRIC acknowledges that:
[. . .] there might be system costs, but [. . .] most of the variables that have to be estimated tomeasure the amount of revenue to allocate to award credits. . .also have to be estimated tomeasure the future cost of fulfilling the obligation (IFRIC, 2007, p. 1).
In its discussion of cost-benefit issues, the IFRIC concedes that IFRIC 13 “proposesrelatively complex accounting treatments for transactions that are often immaterial”(IFRIC, 2007, p. 27). Within the final IFRIC 13 Interpretation, cost/benefit issues wererelegated to the basis of conclusions (BC10; BC11).
5.7 Other issuesWhile the focus of D20 is on revenue recognition, the IFRIC acknowledged the potentialfor asset recognition in the case of CLPs. Only one (CL19) submission concurred that anintangible asset could arise if the specific benefits of a particular customer campaigncould be separately identified. The IFRIC deleted this section in the final interpretation,acknowledging that IAS 38 was “peripheral to the issue” and it was “very unlikely”that an intangible asset would arise (IFRIC 13, BC22(c)).
IFRIC 13 paragraph 8 addresses the supply of awards by third parties and stressesthat the accounting recognition of revenue depends on whether the entity is collectingconsideration for the awards on its own account or as an agent for the third party[6].Revenue is thus recognised when the third party is obliged to supply the awards andentitled to receive the consideration. Another unresolved issue raised byD20 commentators is the difficulty in recognising revenue recognition when a CLPhas multiple participants, and customers have multiple options for award redemption.
5.8 AirlinesCLPs gained prominence through the airline industry. The general public perceivesfrequent flyer schemes as marketing incentives which are “multibillion dollar assets” forairline companies (Sheehan, 2008). Three comment letters came from airlines (CL20,CL22, CL35), and other commentators made several references to the airline industry(CL12, CL14, CL16, CL34, CL42, CL55). All three commenting airlines supported thecost/provision approach[7]. Each airline presented different arguments for retainingtheir current accounting practice of accruing costs. Finnair (CL20) noted that frequentflyer points are primarily granted on distance travelled, not on value of the salestransaction. In addition, where different carriers are responsible for different legs oftravel, no direct relationship exists between the revenue and the award.
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South African Airways (CL22) suggested that awards are granted to customers asmarketing expenses to encourage ongoing sales. As highlighted by British Airways(CL35), the seats typically offered under these programmes are usually excess and ofminimal cost to the airline. Factors such as route, time of flight, time of reservation andvarious promotional activities of the airlines also impact on the fair value of the award.
The Airline Accounting Guideline issued by the International Air TransportAssociation (IATA) in conjunction with KPMG (IATA, 1995) acknowledges thecost/provision and the deferred revenue approaches, but favours the former. Theguideline states that “Frequent Flyer Programmes (FFPs) have now been introduced bymany international airlines, principally to induce higher levels of repeat business”(IATA, 1995, paragraph 1.1). It adds that “the extent of marketing benefits [by theairline] is partly dependent on its ability to handle extra traffic generated by the FFP[frequent flyer program], whilst not displacing fare paying passengers” (IATA, 1995,paragraph 1.4). Further, “it is recognised that airlines [. . .] are committing themselves tofuture liabilities arising from servicing the FFP” (IATA, 1995, paragraph 1.5), and thathistorically, airlines have used the incremental cost (cost/provision) approach (IATA,1995, paragraph 5.4)[8].
6. DiscussionThe opportunity for submission of comment letters in response to D20 is an example ofthe international standard-setting forum for voicing stakeholders’ interests. Theinterpretation process highlights the challenges of classification faced by standardsetters in their attempts to codify commercial practices, particularly the ambiguities ofimplementing IAS 18 with respect to CLPs. The process of interpretation supportsYoung’s (2003, p. 621) assertion:
With each issuance of a new standard, new items are called expense and revenue or assetor liability; new things are measured; and new things are disclosed. As these things are fittedinto the old categories, the categories are stretched and perhaps twisted and are themselvesaltered – subtly at times and not so subtly at other times.
Despite compelling arguments presented by commentators, the IFRIC maintained itsinitial stance of treating CLPs as a revenue recognition issue. Since 1 July 2008, an entitymust account for its award credits as deferred revenue measured at the fair value of thesubsequent reward. At the time of redemption this revenue is recognised. This approachrequired a decision by the IFRIC on whether to classify CLP awards as an expense,revenue, asset or liability. The ensuing classification has economic consequences interms of revenue recognition and the subsequent timing of reported income, asdemonstrated by the early adoption of the IFRIC 13 and subsequent effects of deferredrevenue on the reported results of Qantas, discussed below.
The airline sector offered limited support for the adoption of IFRIC 13, noting“commercial reality” as a significant barrier to implementation. Qantas as an earlyadopter of IFRIC 13 experienced a material impact on its reported financial results. Forthe half-year ending December 2007, net assets declined by 8 per cent, and profit after taxdeclined by 14 per cent. Similarly, in the half-year period ending December 2007,net assets were reduced by 9 per cent and profit after tax fell by 7 per cent (Qantas, 2007).These impacts are the direct effect of adoption of IFRIC 13 as revealed in Note 8: Changein Accounting Policy:
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The previous accounting policy created a provision for the cost of the obligation to providetravel rewards [. . .] The provision was calculated as the present value of the expectedincremental cost (being the cost of meals and passenger expenses) of providing the travelrewards.
The new Qantas Group accounting policy requires [. . .] the value attributable to the flight isthen recognised on passenger uplift, whilst the value attributed to the awarded points isdeferred as a liability until the points are ultimately realised (Qantas Airways Limited, 2007,p. 17).
In 2007, Qantas created a separate operating segment for its frequent flyer programmein anticipation of a sale to external parties. While the proposed sale has beenpostponed, the airline has reported segment financial information which reveals adifferent story to the economic impact to the one described above.
Within the context of declining profits in the airline industry, due in part to rising fuelcosts and the recent HINI Influenza 09 virus (Qantas Airways Limited, 2009a), in an“earnings sense the Frequent Flyer tail is wagging the Qantas dog” (Knight, 2009, p. 5).In July 2008, Qantas relaunched the Frequent Flyer segment including “AnySeat Awards” to increase redemptions and thus the recognition of deferred revenue.A 20.8 per cent improvement in revenue was recorded for the half-year ending December2008 as a result of the new programme. Following changes to revenue recognition on1 January 2009, Qantas anticipates “higher earnings for approximately 2 years” (QantasAirways Limited, 2009b, p. 8). By the year ending 30 June 2009, benefits arising fromchanges in accounting estimates ($147 million) and increased redemption revenue($237 million) contributed to the profit before tax of $384 million, a 64 per cent increase(Qantas Airways Limited, 2009b) from 2008 for the Frequent Flyer programme (QantasAirways Limited, 2009a). The Frequent Flyer segment contributed $310 million to theconsolidated profit before income tax and net finance costs of $203 million of Qantas(Qantas Airways Limited, 2009b). The impact of this CLP has been significant for Qantasin a period of economic challenges for the airline industry. Qantas was also accused of“fattening up for sale” the Frequent Flyer programme by increasing membershipthrough partnerships with the supermarket chain Woolworths, and eliminating the creditcard provider as a third party supplier of points (Knight, 2009, p. 5).
7. ConclusionThe IFRIC’s classification of award credits as deferred revenue was controversial, with38 of the 56 commentators rejecting the IFRIC’s preferred treatment. The approachadvocating an accounting treatment that depended on the commercial reality or natureof the CLP (Option 3) was dismissed by the IFRIC although it was the most popularchoice by the commentators. The review of the D20 interpretation process highlightsthe commitment of the IFRIC to adhere to the asset/liability model of revenuerecognition and fair value measurement, foreshadowing the outcome of the IASB andFASB revenue recognition project. Commentators lobbying the IFRIC also highlightedimplementation problems of its preferred approach. The development of IFRIC 13reveals the ambiguities associated with applying accounting standards to commercialpractices.
This analysis of IFRIC 13 demonstrates the complexities of revenue recognition andhighlights the role of interpretation in determining accounting classifications. D20 andIFRIC 13 involve complex arguments for the classification of economic phenomena.
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The economic consequences of changes to accepted practice as a result of the IFRIC13 determination is illustrated from the perspective of the early adopter, Qantas and themanagement of its Frequent Flyer programme to support reported earnings.
Notes
1. Released in August 2007 as Australian Accounting Standards Board (AASB) Interpretation13 for adoption by reporting entities from 1 July 2008 under AASB 1048: Interpretation andApplication of Standards, September 2007.
2. According to IAS 1 Presentation of financial statements, interpretations issued by IFRIC areconsidered to have the equivalent authority of both IFRS and the former, IAS.
3. European IFRIC members 2006/2007: Jeannot Blanchot – France, Claudio De Conto – Italy,Jean-Louis Lebrun – France, Ken Wild – UK, Ian D Wright – UK (IASC Foundation AnnualReport 2006, 2007).
4. CL2, CL3, Cl4, CL10, CL12, CL13, CL22, CL25, CL41, CL47 and CL51.
5. CL11, CL12, CL21, CL22, CL29, CL30, CL34, C35, CL36, CL49, CL51, CL55 and CL56.
6. For example, situations arise where an airline provides not only reward flights, but alsoaward credits on behalf of other airlines (CL22). The nature of the relationship is determinedby the contractual arrangement between the CLP and third-party supplier. If the entity actson its own behalf, then it accounts for the allocation of revenue from award credits andrecognises revenue when it fulfils its obligation. If the entity acts as an agent for a thirdparty, revenue arises from providing an agency service to the third party, and is the netamount retained by the entity; that is, the consideration allocated to the award credits lessthe amount payable to the third party (IFRIC 13 BC20).
7. South African Airways acknowledged that there may be situations where the deferredrevenue method might be appropriate.
8. For an example of changes to airline financial statements see Picker et al. (2009, pp. 134-9).
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(Appendices follows overleaf.)
Corresponding authorLee Moerman can be contacted at: [email protected]
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To purchase reprints of this article please e-mail: [email protected] visit our web site for further details: www.emeraldinsight.com/reprints
Appendix 1. IFRIC/ IASB updates and observer notes for meetingsUpdates on IFRIC meetings given to the IASB:
November 2005.
January 2006.
March 2006.
May 2006.
July 2006.
January 2007.
March 2007.
May 2007.
Published by IASC Foundation, London, available at: www.iasb.org/CurrentþProjects/IFRICþProjects/Updatesþonþ IFRICþmeetingsþgivenþ toþ theþ IASB.htm
IFRIC information for observers: customer loyalty programmes:
January 2006 (Agenda paper 8).
March 2006 (Agenda paper 8).
May 2006(Agenda paper 3).
July 2006 (Agenda paper 2/2(i)/2(ii)).
Published by IASB, London, available at: www.iasb.org/Archive/Archive%20IFRIC%20Meetings%20-%20Agenda%20Papers.htm
IFRIC meeting summaries and observer notes: customer loyalty programmes:
January 2007 (Agenda papers 3/3(i)/ 3(ii)).
March 2007 (Agenda papers 2-2(v)).
May 2007 (Agenda paper 2).
Published by IASB, London, available at: www.iasb.org/CurrentþProjects/IFRICþProjects/IFRICþ 13þ Customerþ Loyaltyþ Programmes/Meetingþ Summariesþ andþObserverþNotes/Meeting þ Summariesþ andþObserverþNotes.htm
IASB meeting summaries and observer notes: customer loyalty programmes:
June 2007 (request for Ratification of Interpretation: Agenda papers 7A and 7B).
Published by IASB, London, available at: www.iasb.org/CurrentþProjects/IFRICþProjects/IFRIC þ 13 þ Customer þ Loyalty þ Programmes/Meeting þ Summaries þ and þ ObserverþNotes/MeetingþSummariesþ andþObserverþNotes.htm
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Appendix 2
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Customer loyaltyprogrammes
143
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