Reference no: EM132101539

Case Study - Accounting for frequent flyer points: fact or fiction

Accounting requirements under IFRS have changed the way airlines account for frequent flyer points.  In the past, deferred cost accounting practices were used.  Under this method, the upfront sale of points o banks, credit card companies, mortgage brokers and general retailers was recorded as revenue in the income statement at the time of sale.  The expense related to the sale, that is the cost of travel, was recorded at a later period, when the airline provided the travel service, or gave up the 'free' seat.

The Australian Financial Review (AFR) reported in December 2004 that the sale of points to third parties, rather than giving them away to loyal customers, made the schemes profitable for Qantas and major network carriers in the United States and Europe.  The newspaper claimed that when Qantas sought additional debt or equity capital, it would have to treat its frequent flyer point liability on the same basis as other global firms, in the name of equality and transparency.

Qantas responded immediately to the AFR articles.  The company stated that a establishes a liability and takes a charge to the profit and loss account for the cost of providing a 'free' sear at the time the frequent flyer revenue is received, not when Qantas gives up the 'free' sear (the cost/provision approach). The company said it complies with Australian accounting standards and would comply with international accounting standards when they were introduced.  It would not have to change its accounting practices when it next sought to raise capital.

From 1 July 2008 Qantas must apply IFRIC 13 Customer Loyalty Programmes. The interpretation applies to the recognition and measurement of obligations to supply goods and services to customers if they redeem 'award' points.  IFRIC 13 requires the deferred revenue approach.  Building on IAS 18 paragraph 3, the interpretation views awards granted as separately identifiable components of an initial transaction (in Qantas's case, the sale of an airline ticket).  The ticket sale is split into two components, the provision of service and the associated award.  The revenue allocated to the award is deferred and recognized when the reward is redeemed.  The award is to be measured at fair value and measurement guidance is included in the interpretation.

1. Describe the accounting process used to account for frequent flyer points prior to the adoption of IFRS. How was the matching principle breached by this practice?

2. How could companies benefit from this accounting practice? Consider both the short and long term.

3. Why was Qantas keen to correct the errors reported in the AFR article?

4. Explain the difference between the cost/provision and the deferred revenue approaches.

5. What impact do you expect adopting the deferred revenue approach to have on Qantas's financial statements?