Ifrs And Gaap Frequent Flyer Plan Harvard Case Solution & Analysis

Question No. 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:

FREQUENT FLYER PLANS:

The Frequent Flyer Plans (FFPs) are the loyalty plans offered by Airlines to its customers who travels frequently with the airlines. Typically, a frequent - flyer program, airline customers get registered in the program to collect frequent-flyer miles or sometimes called points (kilometers, points, segments) against to the distance flown on that airline or its partners. The plan offered to the customer to earn free travels and other assistances or benefits when they accumulate all their mileage from a frequent flyer program. It is very much like the travel industry, although, these frequent flyer loyalty programs are frequently changing and it is difficult for the customer to find the most promising and gratifying. For this program, the accounting treatment under Generally Accepted Accounting Principles (called as US GAAP) are as follows with classification.

TREATMENT FOR FFPs UNDER US GAAP:

The Airlines liability to deliver free or reduced-fare travel to passengers who cash-in their accrued frequent flyer program (FFP) benefits denotes a major liability portion on every major U.S. airline’s balance sheet because most of the U.S. based airlines are offering frequent flyer benefit plans to their passengers. Major U.S. airlines employ one of the two given methods to justify for the liabilities they incur while issuing mileage credits to their travelling passengers.

The first method under GAAP is the Deferred Revenue Method, which recognizes an obligation for the F.V of the outstanding mileage credits with the F.V meanings that the value for which the benefit credits could be sold separately. The other method being the Incremental Cost Method. In this approach the airline charges for the marginal or extra cost of providing air transportation to qualified passengers (i.e. food, fuel, the cost of taxes, etc. to fly one additional passenger on a seat that else would have been vacant).

DEFERRED REVENUE APPROACH:

The Deferred Revenue approach, as acceptable as one of the two options under U.S. GAAP, is required under IFRS and is precisely addressed in IFRIC. It states that the future benefits and awards should be separately acknowledged goods or services for which passengers or customers are indirectly paying. Airlines who want to use Deferred Revenue Method must divide using the Deferred Revenue Method divide the proceeding into two components: First the amount reflecting the value of the air transportation explicitly purchased by the customer in the sale and secondly, the value described as the fair value of the mileage benefits awarded to the customer. The first part is recognized as revenue once the first sale is complete (i.e. the ticket that has been purchased is provided). The amount allotted to the second part (the F.V of mileage credits) is deferred as a liability until the fulfillment of airlines’ obligations.

INCREMENTAL COST METHOD:

The Incremental Cost approach, the other option acceptable under U.S. GAAP concept states that the airline offers PPFs as customers redeeming awards that file vacant seats that otherwise would have been remain vacant, so identifying the only marginal cost or incremental cost of transporting an additional passenger. Airlines who are using the Incremental Cost Method expect and record a liability for the incremental cost of issuing credits to entitled passengers. The incremental costs may include insurance, fuel and other handling such as foods and beverages and traveling costs. There are various practices that have been developed concerning and determining the cost such as an incremental cost estimation and full cost estimation. The cost of loyalty program should be recognized in Cost of Goods Sold (COGS) of the FPP. The full cost approach is used for the F.V of the customer loyalty program. Using these methods abolishes the liability of the airline company to the reclamation of passengers’ earned points while availing the air services.

Question No. 2: Describe briefly the provisions of IFRS as applicable to FFPs. Cite relevant pronouncement/s.

Answer:

The provisions provided by IFRS to account for Frequent Flyer Plans have two school of thoughts and are explained below:

At first it states that, under the Deferred Revenue Method, the credits or benefits received from the customers, i.e. sale of tickets, must be accounted separately under the Sales as one of its components. The sales portion must be noted in the Income Statement and outstanding value must be recognized as a liability. That portion of liability should only be recognized when a passenger earned the points at the time of purchase of services or already earned points to reach its maturity. Hence, showing that the company will have to pay back to the passengers once the maturity time arrives.....................

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