IFRIC 13 accounting for customer loyalty programmes

Description
The purpose of this paper is to present the views and challenges from a range of
accounting professionals, regulators and preparers with the introduction of a standardised approach
to accounting for customer loyalty programmes (CLPs). It aims to highlight the ambiguities of the
classification of commercial transactions, particularly the nature and timing of revenue recognition.

Accounting Research Journal
IFRIC 13: accounting for “customer loyalty programmes”
Sandra Chapple Lee Moerman Kathy Rudkin
Article information:
To cite this document:
Sandra Chapple Lee Moerman Kathy Rudkin, (2010),"IFRIC 13: accounting for “customer loyalty
programmes”", Accounting Research J ournal, Vol. 23 Iss 2 pp. 124 - 145
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Helen Irvine, Lee Moerman, Kathy Rudkin, (2010),"A green drought: the challenge of mentoring for
Australian accounting academics", Accounting Research J ournal, Vol. 23 Iss 2 pp. 146-171 http://
dx.doi.org/10.1108/10309611011073241
Mark D. Uncles, Grahame R. Dowling, Kathy Hammond, (2003),"Customer loyalty and
customer loyalty programs", J ournal of Consumer Marketing, Vol. 20 Iss 4 pp. 294-316 http://
dx.doi.org/10.1108/07363760310483676
Ahsan Habib, (2010),"Value relevance of alternative accounting performance measures:
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IFRIC 13: accounting for
“customer loyalty programmes”
Sandra Chapple, Lee Moerman and Kathy Rudkin
School 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 of
accounting professionals, regulators and preparers with the introduction of a standardised approach
to accounting for customer loyalty programmes (CLPs). It aims to highlight the ambiguities of the
classi?cation of commercial transactions, particularly the nature and timing of revenue recognition.
Design/methodology/approach – Comment letters in response to the exposure draft D20 CLPs are
analysed together with an exposition of the effect of International Financial Reporting Interpretations
Committee (IFRIC) 13 on an early adopter, Qantas airlines.
Findings – Despite limited support for the consensus view advocated in D20, the International
Accounting Standards Board (IASB) has upheld the deferred revenue approach consistent with the
anticipated outcome of the IASB and Financial Accounting Standards Board revenue recognition
project.
Research limitations/implications – The paper analyses the characteristics and views of
lobbyists using the IFRIC process. The use of other discourse methodologies may present issues of
power within this process.
Practical implications – The paper highlights how the implementation of IFRIC interpretations
has the potential to alter reported ?nancial results.
Originality/value – The paper highlights the lobbying process and interpretation process at an
international level. It also illustrates how companies can engage accounting interpretations to manage
earnings, particularly in times of economic challenges.
Keywords Customer loyalty, Accountancy, Lobbying, Australia, Airlines
Paper type Research paper
1. Introduction
Since 1 July 2008, with early adoption permitted, reporting entities in Australia have
been required to apply International Financial Reporting Interpretations Committee
(IFRIC) 13 customer loyalty programmes (CLPs)[1] (IFRIC, 2007) in an attempt to
standardise alleged widespread and divergent accounting practices for CLPs (IFRIC,
D20 BC2). IFRIC 13 is an example of the move to fair value accounting for revenue
recognition, whereby the CLP component of a sale transaction is deferred. CLPs are
generallyestablished byentities to encourage customers to buy their goods and services.
Customers may accumulate points or awards andredeemthemin the future, often froma
range of options offered by the entity or a third party. Alternatively, points or awards
may be linked to certain custom over time, or offered as a welcome customer incentive.
The implications for the timing andamount of revenue recognition following adoption of
IFRIC 13 has had a signi?cant impact on reported results, particularly in the airline
industry (Picker et al., 2009).
IFRIC 13 only applies to schemes where an entity grants awards to its customers
as part of a sales transaction and the awards are subsequently redeemed for free
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1030-9616.htm
ARJ
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124
Accounting Research Journal
Vol. 23 No. 2, 2010
pp. 124-145
qEmerald Group Publishing Limited
1030-9616
DOI 10.1108/10309611011073232
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or discounted goods or services. IFRIC 13 does not apply to other types of schemes
where incentives are offered in the absence of a sale, or where award credits are sold
separately. IFRIC 13 also includes schemes where a third party is obligated to supply
the goods or services.
An award related to a CLP must be categorised as either an asset, liability, revenue or
expense to enable representation on a ?rm’s ?nancial statements. This categorisation
assigns importance and relevance to some matters and objects, constructing a ?nancial
reality (Young, 2003). This construction, however, is controversial as items are
“prodded, probed and snipped, and made to ?t into these categories”; categories which
themselves are “ambiguous and highly adaptable” (Young, 2003, p. 621). The ambiguity
of categorising and measuring economic phenomena is highlighted in the case of CLPs.
The obligation to supplyawards caneither be treated using a provisioning approach or a
deferred revenue approach. This choice has been interpreted by the IFRIC as a revenue
recognition issue but it could equally be interpreted as a cost/provision issue within the
requirements of International Accounting Standard (IAS) 37: Provisions, Contingent
Liabilities and Assets. IFRIC 13 provides guidance on the recognition of revenue
consistent with IAS 18: Revenue, “in a way that re?ects our viewthat loyalty awards are
separate goods or services for which customers are implicitly paying” (International
Accounting Standards Board (IASB), 2007b). Thus, entities are required to use the
deferred revenue approach, whereby a proportion of sales consideration is allocated to a
liability account, and the revenue subsequently recognised when awards are later
redeemed by the customer.
This treatment is a move towards that anticipated in the revenue recognition project
of the IASB and Financial Accounting Standards Board (FASB) (2009). This project,
initiated in September 2002, represents a major change in the approach to revenue
recognition, from a risk and returns model to that of an asset/liability model. Under this
new approach revenue is recognised when an entity’s net position increases, at the time
that it transfers goods and/or services to a customer. In the case of CLPs, revenue
recognition occurs when the customer redeems the awards. The revenue recognition
project also heralds a move towards fair value measurement of revenue and has
particular rami?cations for those entities currently using the cost/provision method for
CLPs where awards are measured at the often insigni?cant cost of satisfying the
obligation.
Alternate interpretations have the potential to alter the redistribution of wealth in
society, bringing both costs and bene?ts to diverse stakeholders. Since the timing and
amount of revenue recognised in a particular period has economic consequences, the
standard-setting process is designed to consider the opinions of various stakeholders
(Rappaport, 1977). The IFRIC process of promulgating an interpretation includes
invitations to stakeholders to comment on an exposure draft of proposed changes. The
ambiguities encountered by practitioners and their advisers in the interpretation of
accounting standards, in particular with respect to the commercial practice of CLPs,
are explored by reference to the comment letters received in response to the Draft
Interpretation D20: Customer Loyalty Programmes (IFRIC, 2006a).
The next section provides an overview of the literature on lobbying of accounting
standard setters, and the emergent research questions. Section 3 provides background
information on the IFRIC with speci?c reference to IFRIC 13, followed by a discussion
of the method used to analyse the comment letters in Section 4. Section 5 provides
Customer loyalty
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an analysis of the data, with reference to organisational type and geographical area. The
discussion in Section 6, explores the impact of IFRIC 13 on an early adopter, Qantas,
Australia’s international airline.
2. Standard setting as a process
The study of IFRIC 13 is an example of accounting change in action and the process of
promulgating an interpretation of existing accounting standards. There have been
numerous calls for such studies. Young (1994) advocated the importance of studying
changes in accounting recognition practises, proposing that accounting problems are
not there waiting to be resolved, but rather, are actively constructed by multiple
occupants in a regulatory space. Young (1994) argues that standard setters must create
change to mediate the divergence between the interface of accounting principles and
elements and the practice of accounting. Bradbury (2007) extends this argument, noting
that as IFRIC interpretations have the same authority as an International Financial
Reporting Standard (IFRS), they bestowsigni?cant power on those who in?uence IFRIC
interpretations. Interpretations signal an omission or ?aw in the logic and cohesion of
existing accounting standards that cannot be mitigated by professional judgement and
have the potential to undermine a principles-based approach. Therefore, as Bradbury
(2007) argues, the interpretation process is signi?cant because it provides a windowinto
the “IASB world” (Bradbury, 2007, p. 120).
Comment letters document the interpretation process and users’ attributes
and participation in the standard setting process. Masocha and Weetman (2007) claim
attention to textual analysis of documents such as published letters of
comment, increases the explanatory power of an analysis. Companies use diverse and
non-observable lobbying methods including auditor appeals and private meetings with
standard setters. Therefore, comment letters can be regarded as a good proxy for the
direct corporate lobbying activity to which the standard setter is subjected (Georgiuo,
2004).
Grinyer and Russell (1992) found that those who write comment letters were seeking
to further their economic position, and that such lobbying pressures can negate efforts to
produce standards that are consistent with accounting concepts. Larson (1997)
examined the characteristics of corporations that lobbied the IASC between 1989 and
1994, ?nding that lobbying of the IASC was done by very large corporations and
multinationals. Responses were overwhelmingly fromdeveloped countries, questioning
the accessibility of the comment letter process to emerging countries. MacArthur (1999)
investigated the impact of cultural factors on the submission of comment letters ?nding
that cultural and economic differences between groups constrain harmonisation of
accounting standards. Therefore, categorisation of comment letters and their particular
perceptions of the issues are important to document the attributes and breadth of those
participating in this process. This study analyses the technical arguments and
the perceived impact on practice as presented in the comment letters by lobbyists of
IRFIC 13.
It is important to undertake speci?c case study research of accounting change in its
context, and apply the concept of phronesis or the analysis of what is rational and
practical in a speci?c context, to make research more relevant (Cooper and Morgan,
2008). The analysis of IFRIC13 andits associatedcomment letters contributes to the case
study 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 identi?es the
interests and attitudes of the commentators on IFRIC 13 and documents the practical
implications for revenue recognition of the proposed interpretation. In doing so, it
provides an example of users’ participation in a standard setting process, exposing
underlying assumptions that contribute to the notion of revenue recognition.
3. Background and IFRIC 13: CLPs
The trustees of the International Accounting Standards Committee Foundation (IASCF)
established the IFRIC in March 2002 to act in conjunction with the IASB to improve
?nancial reporting through timely identi?cation, discussion and resolution of ?nancial
reporting issues (IASCF, 2007). The IFRIC reviews newly identi?ed reporting issues in
existing IFRS in order to reach a consensus on appropriate treatments that are said to be
consistent with IFRS and the framework (IASCF, 2007)[2].
The French standard setter, Conseil National de la Comptabilite´ (CNC), requested
clari?cation of the accounting treatment for CLPs in 2005. Despite the joint FASB and
IASBengagement in a project on revenue recognition staff fromthe CNC were invited to
prepare an issues paper for the IFRIC to provide timely guidance on divergent
accounting practice (IFRIC, 2005). The IFRIC subsequently discussed issues relating to
CLPs (see Appendix 1 for a list of meetings) and the Draft Interpretation D20 was
released for comment in September 2006. Atotal of 59 submissions were received by the
due date of 6 November 2006 (Appendix 2). It should be noted that IFRIC interpretations
do not always proceed to the issuing of a ?nal interpretation, however, in the case of
CLPs, IFRIC 13 was approved by the IASB in June 2007. IFRIC 13 is substantively
consistent with D20 with some minor concessions in response to concerns raised by
commentators to the draft interpretation, such as the change from measurement of
awards at “relative fair value” to “fair value”, and removal of the reference to intangible
assets (Figure 1).
D20 proposed two accounting treatments for CLPs and a hybrid approach re?ecting
a choice dependent upon the commercial reality of the entities allocating and
redeeming award credits.
The IFRICs preferred treatment, the consensus view, relies upon an interpretation of
IAS 18 paragraph 13, which states that the recognition criteria for revenue, in relation to
goods and services, are usually applied separately to each transaction. However, in some
cases there is a requirement to recognise the substance of the transaction by identifying
the separate components of a single transaction. Therefore, where a sales transaction
involves the issue of an award arising from a CLP, the initial transaction is divided into
two components. Each component of the sale is allocated a proportion of the
consideration according to their relative fair value. The amount allocated to the award
component is deferred and recognised as revenue when the awards are subsequently
redeemed. 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 paragraph
19, which states that “revenue and expenses that relate to the same transaction or other
event are recognised simultaneously”. This interpretation would apply, for example, to
warranties provided on the sale of goods. The total consideration for the sale of goods or
services is recognised as revenue at the time of sale with a corresponding provision
raised for the estimated future costs of supplying the awards in accordance with IAS 37.
Customer loyalty
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Figure 1.
Timeline of IFRIC/IASB
meetings and other key
events
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This interpretation forms the basis of Option 1 (D20 BC4) and treats CLP awards as akin
to marketing expenses.
Option 3 (D20, BC6) offers a choice of treatment between the deferred revenue and
cost/provision approach. This choice is dependent on the nature of the CLP, the value of
the award credit and the entity providing the reward. The deferred revenue approach
measures the liability arising fromfuture redemption at fair value or selling price, while
the cost/provision approach measures the liability based on the expected cost of
supplying the award (IASB, 2007b). For reporting entities the “interpretation may result
in a signi?cant change in the point in time at which revenue is recognised” and for “large
and complex programmes, initial application [. . .] can be a very time-consuming
exercise” (Ernst & Young, 2007).
4. Method
This study uses the data contained in the following sources: the 56 comment letters
available in response to D20 (out of a total of 59 comment letters, three were not available
on the IASB web site); the relevant 2006 and 2007 IFRIC and IASB meeting updates and
observer notes (Appendix 1); and the text of D20 and IFRIC 13.
Figure 2.
D20 options
D20 options
Recognition and measurement of
obligations to supply goods and
services to customers if they
redeem “award” points
Option 1 (D20 BC4)
Cost/provision approach.
Award recognised as an expense and
measured 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 as
guidance for interpretation
Option 2 (D20 BC5)
Deferred revenue (liability) approach.
Awards granted as an element of market
exchange, which are separately
identifiable components of initial
transaction (sale). Measured at fair value
Uses IAS18, paragraph 13 as guidance
for interpretation
Option 3 (D20 BC6)
Mixed approach
Accounting treatment depends on the nature
of CLP – either relative value or the nature or
method of supplying rewards
Insignificant value
and/or goods or service
provided by third party
Significant value and/or
goods or service provided
by entity
Customer loyalty
programmes
129
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The 56comment letters were readbytworesearchers independently. Eachsubmission
was allocated to a prede?ned organisational type; professional accounting bodies,
professional accounting ?rms, national standard setters, stock exchange regulators,
banks, airlines, other business, actuaries and other business. These were further
categorised by geographical representation: Asia, Australia, Europe, North America,
Russia, Scandinavia and South Africa. This was done manually, and summarised on an
excel spreadsheet.
While content analysis can focus on the different units of discourse, e.g. sentence or
paragraph level, the unit of analysis in this study was the entire comment letter. The
commentators were weighted evenly and each submission counted as a single response.
However, the researchers acknowledge, as in the case of International Organization of
Securities and Exchange Commissions (IOSCO) as a peak representative body, each
comment letter may have represented the views of several constituents. Coding
identi?ed support for the key proposals of D20, namely whether award credits issued
pursuant to a CLP constituted a separate component of the initial sales transaction. If the
submission supported the consensus view, two further issues were identi?ed; ?rst, how
much of the consideration should be allocated to the award and secondly, when revenue
should 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 absent
the researchers made a decision based on the narrative, e.g. if arguments were around
materiality, then it was assumed that the commentator accepted the consensus since
immaterial CLPs are not subject to the interpretation. On the other hand, if
commentators gave approval for the consensus but further argued that this situation
only applied to certain types or the nature of the CLP, e.g. goods supplied in the normal
course of business, then this was classi?ed as support for the mixed approach. Only
three comment letters were omitted: one was contradictory in the response; another did
not give a preference; and, IOSCO was explicitly non-committal as they represented a
large diverse constituency. Table I provides an analysis of comment letters according
to preferred option.
Table II presents the number of commentators that responded to D20 by
organisational type and geographical region. Two of the professional accounting bodies
were also national standard setters (South African Institute of Chartered Accountants
and Hong Kong Certi?ed Practicing Accountants) and one, the Chartered Institute of
Management Accountants based in the UK, was classi?ed with European organisations.
The professional accounting ?rms in most instances are global ?rms but were classi?ed
according to the source of the comment letter. National standard setters include urgent
issues groups, technical advice groups and emerging issues task forces. A list of
submissions is listed in Appendix 1. Additional issues raised in the comment letters
were identi?ed and analysed, as shown in Table III. Further, the texts of the IFRIC
meeting papers, D20 and IFRIC 13 were reviewed to identify arguments developed and
used to substantiate or reject available options.
5. Data analysis
Table II categorises the comment letters by organisational type and by geographic
region.
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5.1 Organisational type
Those organisations representing the accounting profession, namely the professional
bodies and public accounting ?rms, contributed 19 comment letters or 34 per cent of the
total. The “Big 4” accounting ?rms, namely KPMG, Deloitte Touche Tomatsu, Ernst &
Young and PriceWaterhouseCoopers all submitted letters, along with the French ?rm
Mazars, consistent with previous practice noted by Larson (2007). All of these ?rms
have representatives on the IFRIC. When combined with the national standard setters,
the percentage of comment letters submitted by accounting interests increased to
63 per cent of the total. This result may be compared with that of Larson (2007) in which
47 per cent of the all comment letters to IFRIC draft interpretations 1-18 came from a
similar group of constituents. This re?ects a high concentration of responses from the
accounting profession, with the technical and ?nancial resources available for this type
of endeavour. It does, however, challenge to some extent the legitimacy of the IASB and
the IFRIC, by failing to engage a broad range of stakeholders in the standard setting
process (Larson, 2002, 2007). Surprisingly, comment letters from other constituent
groups were less forthcoming given the potential economic consequences of alternative
accounting treatments on ?nancial statements. This may be explained by the ?ndings
of Durocher et al. (2007) that suggest participation in a standard setting process is
in?uenced by the perception of one’s ability to participate adequately, and one’s
knowledge of the process and justi?cation of the proposed standard.
There were only ?ve responses from banks or banking representative groups, with
four supporting the cost/provision approach. The four supporting banks were all
European, and they provided ?ve arguments to support their preferred option (BC4):
the commercial reality of CLP is that of incentive (CL23, CL37); the option is easier to
apply in practice (CL2, CL23, CL32, CL37); the treatment is consistent with practice
Option 1
cost/
provision
Option 2
deferred
revenue
Option 3
mixed
approach
Option not speci?ed/
ambiguous Total
Accounting profession
Professional bodies 4 5 4 0 13
Public accounting ?rms 0 3 3 0 6
Regulators
National accounting standard
setters 5 4 6 1 16
Stock exchange regulators 0 0 1 1 2
Preparers
Banks 4 1 0 0 5
Airlines 3 0 0 0 3
Other business/business
representative groups 1 2 6 0 9
Actuaries 0 0 0 1 1
Users
None
Others
Academics 0 0 1 0 1
Total 17 15 21 3 56
Table I.
Analysis of comment
letters: preferred options
Customer loyalty
programmes
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Categorisation
of submissions by types
and geographical
representation
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outside D20 (CL2, CL37); the value of awards is insigni?cant in comparison with the
sales transaction as a whole (CL23); and the bene?ts of the advocated treatment would
not outweigh costs, such as costs required by signi?cant system changes (CL32). This
group provided limited support for the interpretation as proposed in D20, noting
commercial “reality” as a signi?cant barrier to implementation.
Nine responses were received from the business sector (excluding airlines and
banks), 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 business
groupings supported the mixed approach where discretion should be left to the
individual preparer.
5.2 Geographical representation
A total of 31 of the comment letters, or 55 per cent came from Europe. This is consistent
with the ?ndings of Larson (2007), where 57 per cent of the comment letters on IFRIC
interpretations 1-18 came fromEuropean constituents. These results indicate the extent
to which European countries participate in this aspect of the standard setting process.
Viewed in conjunction with European representation on IFRIC during the period of
deliberations on CLPs (?ve out of 12 members were European[3]), it is suggested that the
European contingent had signi?cant opportunity to voice their opinion on the CLPissue.
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 were
from national standard setters and professional bodies, re?ecting the move towards
increased involvement at the international level of standard setting and programmes
Assumptions of
fair value
estimates Scope
Costs
versus
bene?ts
Customer
relationships and
intangible assets
Treatment of
third-party
transactions
Accounting profession
Professional bodies 8 4 3 2 3
Public accounting
?rms 6 4 0 2 2
Regulators
National accounting
standard setters 7 3 5 4 4
Stock exchange
regulators 1 0 0 1 0
Preparers
Banks 0 1 2 0 1
Airlines 3 1 2 1 1
Other business/
business
representative
groups 3 5 1 0 2
Actuaries 1 0 0 0 0
Others
Academics 0 0 0 0 1
Total 29 18 13 10 14
Table III.
Analysis of comment
letters: additional
identi?ed issues
Customer loyalty
programmes
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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 comment
letters. This is not unexpected given earlier evidence of a poor response rate to previous
draft interpretations (Larson, 2002, 2007). While IOSCO declined to commit to one
alternative, 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 deferred
revenue approach would be offset by bene?ts, 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 the
practical dif?culties anticipated with implementation, particularly regarding timing of
revenue 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, the
IFRIC states that:
Incentives to customers can be distinguished in substance from marketing expenses.
Marketing expenses are incurred independently of a sales transaction, to secure that
transaction. Incentives to customers are part of the sales transaction itself – whether they
reduce the consideration receivable or increase the goods and services deliverable, they are
elements 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 be
redeemed are inherently completely independent of the goods and services delivered in
the 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/provision
approach. Several commentators suggested that if awards are supplied by the entity as
part of its normal activities, then the deferred revenue approach is appropriate. If awards
are 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. Some
commentators also suggested that where awards are insigni?cant in value and
incidental to the sale of goods or services, they should be treated as a marketing expense
or as a deduction from revenue (trade discount or rebate). However, this argument is
super?uous as immaterial awards are not subject to the scope of the interpretation in
accordance with the materiality guidelines in IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors.
Several commentators[4] noted that in the context of the current joint project between
the IASB and the FASB on revenue recognition, IFRIC 13 may be premature or
redundant. The European Telecommunications Companies (CL10) suggested that such
an interpretation, when made “prior to the development of a comprehensive framework
for multiple component sales”, could have “far reaching effects for other component
sales”. However, given the long-term timeframe of the revenue recognition project,
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an interimsolution 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 identi?ed in the comment letters, which are
classi?ed according to type of organisation.
The predominant concern for all groups were the assumptions associated with fair
value estimation. Numerous commentators also sought clari?cation on the scope of
D20 and raised concerns about the costs versus bene?ts of implementing the preferred
approach.
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 be
allocated between the award components, i.e. the goods and services sold and the award
credits granted (D20, paragraph 5).
Implementing the guidance, especially regarding forfeitures and the time value of
money, was problematic for many of the commentators[5]. Commentators indicated that
the IFRIC was too prescriptive in proposing the use of relative fair value as a means of
allocation. Deloitte (CL31) noted that IAS 18 Revenue, paragraph 9 states that revenue
should 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. In
response, the IFRIC modi?ed the ?nal interpretation to fair value, with the subsequent
choice of variables left to professional judgement (IASB, 2007b). In instances where the
fair value of award credits are not directly observable, IFRIC 13 BC12 indicated there
should be an application of an alternative allocation method. The appendix to IFRIC 13
provides 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 clari?cation on how to recognise revenue of
forfeited awards and changes in expected forfeiture rates. According to the ?nal IFRIC
Interpretation, “the amount of revenue recognised shall be based onthe number of award
credits that have been redeemed in exchange for awards, relative to the total number
expected to be redeemed” (IFRIC 13, paragraph 7).
5.5 Scope
Commentators sought clari?cation on the types of schemes covered by the IFRIC
Interpretation. For example, UBS (CL32) discussed schemes offered by ?nancial
institutions where customers are given awards, such as reductions in interest charges on
loans. Commentators also drewattention to schemes where awards could be redeemed to
repayoutstanding loanbalances or redeemed for cash. The scope of IFRIC13 was limited
to include only awards granted as part of a sales transaction (paragraph 3 (a)). The ?nal
interpretation speci?cally brought credit card providers within this scope (BC4).
Nine commentators requested that schemes which offered awards by way of goods or
services not supplied in the ordinary course of business (for example, an airline
supplying electrical appliances) be scoped out of the Interpretation. The IFRIC notes
that:
[. . .] it could be argued that the awards may not be the main activity of the entity, but they
are 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 the
award, if the award is granted as part of the initial sales transaction, then it will fall
within the scope of IFRIC 13.
5.6 Costs versus bene?ts
The cost of implementation versus the bene?ts of relevant and reliable information was
an issue for commentators, especially for standard setters and professional accounting
bodies, attracting 13 responses (Table III). The National Accounting Standards Board of
Russia argued that in assessing an entity’s liabilities, users are interested in the
resources available to settle future obligations (CL58). Similarly, the Danish Accounting
Standards Committee (CL46) suggested that the D20 approach would lead to signi?cant
costs for preparers, with only limited bene?ts for users. The IFRIC acknowledges that:
[. . .] there might be system costs, but [. . .] most of the variables that have to be estimated to
measure the amount of revenue to allocate to award credits. . .also have to be estimated to
measure the future cost of ful?lling the obligation (IFRIC, 2007, p. 1).
In its discussion of cost-bene?t issues, the IFRIC concedes that IFRIC 13 “proposes
relatively complex accounting treatments for transactions that are often immaterial”
(IFRIC, 2007, p. 27). Within the ?nal IFRIC 13 Interpretation, cost/bene?t issues were
relegated to the basis of conclusions (BC10; BC11).
5.7 Other issues
While the focus of D20 is on revenue recognition, the IFRIC acknowledged the potential
for asset recognition in the case of CLPs. Only one (CL19) submission concurred that an
intangible asset could arise if the speci?c bene?ts of a particular customer campaign
could be separately identi?ed. The IFRIC deleted this section in the ?nal 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 stresses
that the accounting recognition of revenue depends on whether the entity is collecting
consideration 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 and
entitled to receive the consideration. Another unresolved issue raised by
D20 commentators is the dif?culty in recognising revenue recognition when a CLP
has multiple participants, and customers have multiple options for award redemption.
5.8 Airlines
CLPs gained prominence through the airline industry. The general public perceives
frequent ?yer schemes as marketing incentives which are “multibillion dollar assets” for
airline 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 the
cost/provision approach[7]. Each airline presented different arguments for retaining
their current accounting practice of accruing costs. Finnair (CL20) noted that frequent
?yer points are primarily granted on distance travelled, not on value of the sales
transaction. In addition, where different carriers are responsible for different legs of
travel, 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 as
marketing expenses to encourage ongoing sales. As highlighted by British Airways
(CL35), the seats typically offered under these programmes are usually excess and of
minimal cost to the airline. Factors such as route, time of ?ight, time of reservation and
various promotional activities of the airlines also impact on the fair value of the award.
The Airline Accounting Guideline issued by the International Air Transport
Association (IATA) in conjunction with KPMG (IATA, 1995) acknowledges the
cost/provision and the deferred revenue approaches, but favours the former. The
guideline states that “Frequent Flyer Programmes (FFPs) have nowbeen introduced by
many international airlines, principally to induce higher levels of repeat business”
(IATA, 1995, paragraph 1.1). It adds that “the extent of marketing bene?ts [by the
airline] is partly dependent on its ability to handle extra traf?c generated by the FFP
[frequent ?yer program], whilst not displacing fare paying passengers” (IATA, 1995,
paragraph 1.4). Further, “it is recognised that airlines [. . .] are committing themselves to
future liabilities arising from servicing the FFP” (IATA, 1995, paragraph 1.5), and that
historically, airlines have used the incremental cost (cost/provision) approach (IATA,
1995, paragraph 5.4)[8].
6. Discussion
The opportunity for submission of comment letters in response to D20 is an example of
the international standard-setting forum for voicing stakeholders’ interests. The
interpretation process highlights the challenges of classi?cation faced by standard
setters in their attempts to codify commercial practices, particularly the ambiguities of
implementing IAS 18 with respect to CLPs. The process of interpretation supports
Young’s (2003, p. 621) assertion:
With each issuance of a new standard, new items are called expense and revenue or asset
or liability; new things are measured; and new things are disclosed. As these things are ?tted
into the old categories, the categories are stretched and perhaps twisted and are themselves
altered – subtly at times and not so subtly at other times.
Despite compelling arguments presented by commentators, the IFRIC maintained its
initial stance of treating CLPs as a revenue recognition issue. Since 1 July 2008, an entity
must account for its award credits as deferred revenue measured at the fair value of the
subsequent reward. At the time of redemption this revenue is recognised. This approach
required a decision by the IFRIC on whether to classify CLP awards as an expense,
revenue, asset or liability. The ensuing classi?cation has economic consequences in
terms of revenue recognition and the subsequent timing of reported income, as
demonstrated by the early adoption of the IFRIC 13 and subsequent effects of deferred
revenue 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 signi?cant barrier to implementation. Qantas as an early
adopter of IFRIC 13 experienced a material impact on its reported ?nancial results. For
the half-year ending December 2007, net assets declined by8 per cent, andpro?t after tax
declined by 14 per cent. Similarly, in the half-year period ending December 2007,
net assets were reduced by 9 per cent and pro?t 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: Change
in Accounting Policy:
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The previous accounting policy created a provision for the cost of the obligation to provide
travel rewards [. . .] The provision was calculated as the present value of the expected
incremental cost (being the cost of meals and passenger expenses) of providing the travel
rewards.
The new Qantas Group accounting policy requires [. . .] the value attributable to the ?ight is
then recognised on passenger uplift, whilst the value attributed to the awarded points is
deferred 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 ?yer programme
in anticipation of a sale to external parties. While the proposed sale has been
postponed, the airline has reported segment ?nancial information which reveals a
different story to the economic impact to the one described above.
Within the context of declining pro?ts in the airline industry, due in part to rising fuel
costs and the recent HINI In?uenza 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 “Any
Seat Awards” to increase redemptions and thus the recognition of deferred revenue.
A20.8 per cent improvement in revenue was recorded for the half-year ending December
2008 as a result of the new programme. Following changes to revenue recognition on
1 January 2009, Qantas anticipates “higher earnings for approximately 2 years” (Qantas
Airways Limited, 2009b, p. 8). By the year ending 30 June 2009, bene?ts arising from
changes in accounting estimates ($147 million) and increased redemption revenue
($237 million) contributed to the pro?t before tax of $384 million, a 64 per cent increase
(Qantas Airways Limited, 2009b) from 2008 for the Frequent Flyer programme (Qantas
Airways Limited, 2009a). The Frequent Flyer segment contributed $310 million to the
consolidated pro?t before income tax and net ?nance costs of $203 million of Qantas
(Qantas Airways Limited, 2009b). The impact of this CLPhas beensigni?cant for Qantas
in a period of economic challenges for the airline industry. Qantas was also accused of
“fattening up for sale” the Frequent Flyer programme by increasing membership
throughpartnerships withthesupermarket chainWoolworths, andeliminatingthecredit
card provider as a third party supplier of points (Knight, 2009, p. 5).
7. Conclusion
The IFRIC’s classi?cation of award credits as deferred revenue was controversial, with
38 of the 56 commentators rejecting the IFRIC’s preferred treatment. The approach
advocating an accounting treatment that depended on the commercial reality or nature
of the CLP (Option 3) was dismissed by the IFRIC although it was the most popular
choice by the commentators. The review of the D20 interpretation process highlights
the commitment of the IFRIC to adhere to the asset/liability model of revenue
recognition and fair value measurement, foreshadowing the outcome of the IASB and
FASB revenue recognition project. Commentators lobbying the IFRIC also highlighted
implementation problems of its preferred approach. The development of IFRIC 13
reveals the ambiguities associated with applying accounting standards to commercial
practices.
This analysis of IFRIC 13 demonstrates the complexities of revenue recognition and
highlights the role of interpretation in determining accounting classi?cations. D20 and
IFRIC 13 involve complex arguments for the classi?cation of economic phenomena.
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The economic consequences of changes to accepted practice as a result of the IFRIC
13 determination is illustrated from the perspective of the early adopter, Qantas and the
management of its Frequent Flyer programme to support reported earnings.
Notes
1. Released in August 2007 as Australian Accounting Standards Board (AASB) Interpretation
13 for adoption by reporting entities from 1 July 2008 under AASB 1048: Interpretation and
Application of Standards, September 2007.
2. According to IAS 1 Presentation of ?nancial statements, interpretations issued by IFRIC are
considered 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 Annual
Report 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 ?ights, but also
award credits on behalf of other airlines (CL22). The nature of the relationship is determined
by the contractual arrangement between the CLP and third-party supplier. If the entity acts
on its own behalf, then it accounts for the allocation of revenue from award credits and
recognises revenue when it ful?ls its obligation. If the entity acts as an agent for a third
party, revenue arises from providing an agency service to the third party, and is the net
amount retained by the entity; that is, the consideration allocated to the award credits less
the amount payable to the third party (IFRIC 13 BC20).
7. South African Airways acknowledged that there may be situations where the deferred
revenue method might be appropriate.
8. For an example of changes to airline ?nancial statements see Picker et al. (2009, pp. 134-9).
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(Appendices follows overleaf.)
Corresponding author
Lee Moerman can be contacted at: [email protected]
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Appendix 1. IFRIC/ IASB updates and observer notes for meetings
Updates 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/UpdatesþonþIFRICþmeetingsþgivenþtoþtheþIASB.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/Current þProjects/IFRICþProjects/
IFRIC þ13 þCustomer þLoyalty þProgrammes/Meeting þSummaries þand þObserver þ
Notes/Meeting þ Summaries þand þObserver þNotes.htm
IASB meeting summaries and observer notes: customer loyalty programmes:
June 2007 (request for Rati?cation of Interpretation: Agenda papers 7A and 7B).
Published by IASB, London, available at: www.iasb.org/Current þProjects/IFRICþProjects/
IFRIC þ13 þCustomer þLoyalty þProgrammes/Meeting þSummaries þand þObserver
þNotes/Meeting þSummaries þandþObserver þNotes.htm
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This article has been cited by:
1. Robert K. Larson, Paul J. Herz. 2013. A Multi-Issue/Multi-Period Analysis of the Geographic Diversity
of IASB Comment Letter Participation. Accounting in Europe 10, 99-151. [CrossRef]
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doc_896446436.pdf