Frequent Flyer Accounting

Topics: Airline, Qantas, Virgin Blue Pages: 5 (1292 words) Published: February 25, 2008

Frequent flyer loyalty programs are a valuable marketing tool for airlines, however accounting for frequent flyer points (FFPs) is not a straight forward process (Bowman 1995). The aim of this assignment is to examine the concept of how FFPs should be accounted for according to the Framework, compare how Qantas Airways Limited (Qantas) and Virgin Blue Holdings Limited (Virgin) account for FFP's, and determine the potential consequences of different accounting treatments.

Accounting procedure for frequent flyer points according to the principles of the Framework

The major accounting issue with FFPs is how an airline accounts for their economic value (Bowman 1995). Although FFPs have a relatively low estimated value of between US$0.01 and US$0.10 each, the large number of kilometres flown by a multitude or airline customer's means that to any one airline FFPs can represent a significant liability (WebFlyer 2006).

Because FFPs represent a present obligation for an airline to provide customers with air travel at a later date, they can be considered a liability (Bowman 1995, AASB 2004). The complexity in recording these liabilities comes from the fact that the liability has to be estimated, as FFPs can be realised any time before they expire (IATA & KPMG 1995). Once determined, these liabilities should be recorded as provisions, based on the estimation of potential liability, until the points are redeemed. To further add to the complexity of accounting for FFPs the liability has the potential to be recorded as a deferred incremental cost or deferred revenue (IATA & KPMG 1995).

The incremental cost approach to accounting for FFPs involves a provision being set up based on estimated value of points that are going to be redeemed and the timing of redemption, with the amount of the provision being based on the likely incremental costs associated with the redemption of points, ie meal, drinks, ticketing (IATA & KPMG 1995). The provision for the incremental costs are then recorded as a liability, moving to an expense once the points have been redeemed.

The deferred revenue approach involves deferring a proportion of revenue from the sale of each ticket to account for the FFPs (Virgin 2006). Similar to the incremental cost approach, the amount that is deferred is calculated using assumptions as to what proportion of points are likely to be redeemed (IATA & KPMG 1995). The deferred revenue amount is recognised as a liability until the points are used whereby it is recognised as revenue (Virgin 2006).

The important distinction between both frequent flyer point accounting procedures is that the incremental cost approach treats customers flying under FFPs as being separate from the revenue process hence only incremental costs are accounted for, while the deferred revenue approach recognises the link, fully recognising the value (IATA & KPMG 1995). Qantas and Virgin provide a good example of airlines that use these two different approaches.

Qantas and Virgin frequent flyer accounting

As Qantas sells FFPs to third parties as well as providing them to customers, it accounts for FFPs in two ways. The sale of points to third parties is recorded as deferred revenue, net of points that are classified as not going to be redeemed (Qantas 2006). Revenue is only then recognised in the Income Statement as net passenger revenue once the points are redeemed (Qantas 2006). For those points Qantas considers will not be redeemed, revenue is recognised directly at the time of sale of points (Qantas 2006).

For FFPs earned by customers Qantas uses the incremental cost accounting method (Qantas 2006). The obligation to provide travel at a later date is recognised as a liability based on the incremental costs associated with providing airtravel to the customer (Qantas 2006). A provision is created for these current and non current liabilities based on the present value of the incremental cost...
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