Most airlines in the United States have frequent flier programs that grant free flights if a customer accumulates enough flight miles on the airline. For example, United Airlines offers a free domestic flight for every 25,000 miles flown on United. United describes its program as follows in a footnote to the 2011 financial statements:
In the case of the sale of air services, the Company recognizes a portion of the ticket sales as revenue when the air transportation occurs and defers a portion of the ticket sale representing the value of the related miles. The adoption of Accounting Standards Update 2009-13, Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force (“ASU 2009-13”) resulted in the revision of this accounting, effective January 1, 2011. Under the Company’s prior accounting policy, the Company estimated the weighted average equivalent ticket value by assigning a fair value to the miles that were issued in connection with the sale of air transportation. The equivalent ticket value is a weighted average ticket value of each outstanding mile, based upon projected redemption patterns for available award choices when such miles are consumed. The fair value of the miles was deferred and the residual amount of ticket proceeds was recognized as passenger revenue at the time the air transportation was provided. The Company began applying the new guidance in 2011 and determines the estimated selling price of the air transportation and miles as if each element is sold on a separate basis. The total consideration from each ticket sale is then allocated to each of these elements individually on a pro rata basis. The estimated selling price of miles is computed using an estimated weighted average equivalent ticket value that is adjusted by a sales discount that considers a number of factors, including ultimate fulfillment expectations associated with miles sold in flight transactions to various customer groups.
In its 2011 annual report, United Continental Holdings, the parent company for the newly merged United and Continental, reported a current liability of $2.4 billion and a long-term liability of $3.3 billion for frequent flyer deferred revenue. These are very large numbers equal to approximately 15% of passenger revenue.
The notes indicated that the new accounting policy decreases the value of miles that the Company records as deferred revenue and increases the passenger revenue recorded at the time air transportation is provided. Not only does the required financial accounting under
GAAP sometimes change, but also firms think about the “real cost” of frequent flyer miles differently. Some airlines believe the cost is about $70 per flight while others think it is more like $10 per flight. It depends on what the airline considers to be the marginal cost of an extra passenger. If the flights are usually full, the marginal cost is high because a frequent flyer ticket might push out a full-fare ticket worth several hundred dollars. If flights usually have open seats, putting a frequent flyer in the seat costs only insurance and very modest jet fuel.
Suppose airlines use one estimate of the cost of these “free” flights for their internal decision making and another for computing the liability for their publicly reported balance sheet.
Comment on the ethical issues.