Accounting for Frequent Fliers Harvard Case Solution & Analysis

QUESTION 1:           How should frequent flyer plans (FFPs) be accounted for under GAAP?  Support your position with citations from the applicable authoritative pronouncements and other relevant resources.

ANSWER 1:

The Frequent Flyer Plan was then used by the airline industry where airlines offer loyalty programs to their customers in terms of mileage. In this program, a customer pays for the mileage he flew. For this program, the accounting standard under the GAPP are followings with the codifications: The Codification is 908-605 for Airlines.

TREATMENT OF FREQUENT FLYER PLANS UNDER GAAP:

According to the GAAP, it offered specific guideline to recognize the loyalty program in the financial statements such as balance sheet, income and financial disclosure sheets. In addition to treating the FFP, there are two approaches used in the GAAP, such as Incremental Cost/Provision approach and Deferred Revenue approach.

Incremental Cost approach:

In this approach, the loyalty program in terms of nature considered as a marketing expense and for that a company must directly recognize the payments received during the same period when a customer earned the points from the loyalty program. On the other hand, the company also generates the provision for the future obligation in terms of cost towards company’s customers.

Various practices have developed regarding determining the cost such as an incremental cost and full cost estimation. In addition to the incremental approach, loyalty program cost is recognized as Cost of Goods sold in the program. On the other hand, the full cost approach is used for the fair value of the loyalty program. Using these approaches it eliminates the liability of the airline company towards the redemption of customer’s earned points while availing the air services.

Deferred Revenue Approach:

The loyalty program points that are earned from the customers are considered as a part of the sale by the company. Hence, for the Airline Company records this as a revenue, till the points earned by the customers are redeemed or expired. The deferred revenue approach recognizes this using the fair value concept for the estimation of cost.

On the other hand, both explained approaches on the balance sheet generates the liability as a “program liability” and unearned program revenue under the incremental cost approach and the deferred revenue approach respectively, and this would be recorded during the time period of points earned, and redeemed or expired.

This liability in terms of the amount have the impact on the net income of the company, and that amount is usually larger in the revenue recognition approach than the incremental cost method. It is because of the reason that, revenue in terms of the amount is larger than the cost incurred, and this effect exists when the incremental cost approach is used.

QUESTION 2:           Describe briefly the provisions of IFRS as applicable to FFPs. Cite relevant pronouncement/s.

ANSWER 2:

The provisions were provided by the IFRS those were applicable to FFP have two concepts and these are defined below:

Firstly, it says about the credits earned from the customers must be recorded in the balance sheet separately under the sales as one of its components and for this purpose the method that would be used is a deferred revenue method. On the other hand, that portion of sales must be recorded in the income statement and remaining portion would be recognized as loyalty point’s value. This would only be recognized when a customer would earn the points at the time of purchase of services or already earned points to reach its maturity.

Secondly, the provisions have been made in calculating the deferred revenue amount on the fair value basis at the time on which customer purchases that service. This provision provides the guidance to record the point’s value with accordance to the cost customer had paid.

QUESTION 3:           U.S. GAAP is oftentimes labeled as rules-based, whereas IFRS are considered to be principles-based.  In the context of accounting standards for FFPs, do you think such a view is valid? Why?

ANSWER 3:

The U.S. GAAP is considered as a rule based, and it is because it doesn’t provide the guideline to follow it instead just sets..................

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Airline frequent flyer programs offer participants the opportunity to earn free flights to accumulate miles. Accounting and reporting obligations of airlines and the cost for frequent-flier raises complex issues of measurement. In 1991, the U.S. Securities and Exchange Commission began requiring airlines to disclose the number of free flights program participants took. The case allows the assessment of costs and responsibilities include United Air Lines. "Hide
by William J. Bruns Jr., Susan S. Harmeling Source: Harvard Business School 7 pages. Publication Date: November 14, 1991. Prod. #: 192040-PDF-ENG

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