question 4 Actions for 'question 4' Word Document View content in new windowPrevious Next Revenue recognition including construction contracts Fly the Revenue Skies Background Many entities use a customer loyalty program (CLP) to build brand loyalty, retain their valuable customers and increase sales volumes. A CLP is generally designed to reward customers for past purchases and to provide them with incentive to make further purchases. Typically, customers purchase goods or services and earn award credits (e.g., points or air miles) that can be used to obtain free or discounted goods and services. A typical but more complex CLP is an airline frequent flyer program (FFP) that accumulates miles based on flights taken, which may be redeemed for free flights or other goods sold by the airline or a third party. The airline might also sell FFP award credits to a partner, e.g., a credit card company, for the partner to issue the credits to its customers who are also members of the FFP. These amounts can be extremely significant. They were recently valued in the hundreds of billions of dollars according to the Economist. In the absence of specific guidance in IFRS on accounting for the obligation relating to the redemption of the award credits, differing practices have developed. Either: The cost of supplying the goods or services in the future is recognized as an expense at the time of selling the goods, giving rise to a liability. This views the FFP as a marketing tool and, therefore, fulfillment of the obligation attached to the award credits is a marketing cost. Differing practices emerged as to how cost is determined full cost or incremental cost. The award credit is treated as a separate component of the sales transaction that requires delivery in the future, and an element of the consideration is recognized as deferred revenue. This deferred revenue treatment views the issue of award credits as an exchange of economic benefits that is in the nature of a sale. Under both of these approaches, there have been differing practices applied to factor expected award redemption rates into the measurement of the liability. The IFRIC considered this issue and in June 2007, the IASB issued Interpretation 13, Customer Loyalty Programmes (IFRIC 13), applicable for entities with annual periods beginning on or after July 1, 2008, with early adoption permitted. IFRIC 13 reflects the conclusion that award credits granted to customers are a separate component of the initial sales transaction; therefore, consideration should be allocated between the services and the award. This consideration is measured by reference to fair value, which is the amount for which the award credits could be sold separately. IFRIC 13 includes guidance on how to measure the award credit component of the sale, the timing and amount of the related revenue that is recognized in profit or loss and how this revenue is to be presented (gross or net of the costs incurred in fulfilling the obligation). IFRIC 13 also includes guidance on the need to recognize an additional liability should the unavoidable costs of meeting the obligation to supply the awards be expected to exceed the consideration received for them. Lastly, IFRIC 13 includes guidance on measuring fair value. If the fair value is not directly observable, it must be estimated. For entities that have previously applied a cost approach and, in particular, an incremental cost approach, and for entities that applied a deferred revenue approach but did not account for changes in expected award redemption rates in the manner prescribed by IFRIC 13, the Interpretation may result in a significant change in the point in time at which revenue is recognized. The conclusions reached by the IFRIC are not the same as those applied under US GAAP. The Emerging Issues Task Force (EITF) discussed accounting for point and loyalty programs, but did not reach a conclusion. Consequently, two different practices have emerged in the US, similar to the incremental cost and deferred revenue approaches noted above. IFRIC 13 also differs from US GAAP in how the expected redemption rate is taken into account. Requirements Obtain and review the following guidance: IAS 18, Revenue, paragraph 13, and IFRIC 13, Customer Loyalty Programmes Sacho Z. IFRIC 13: How ready are you?. Accountancy [serial on the Internet]. (2008, Feb), [cited May 25, 2009]; 141(1374): 80-81. Obtain and review the accounting policy disclosures related to the FFP for each of the following airlines in their annual reports: Delta (2008 and 2007): www.delta.com/about_delta/investor_relations/index.jsp UAL (2008 and 2007): www.united.com/investorrelations American (2008): www.aa.com/aa/i18nForward.do?p=/aboutUs/main.jsp Continental (2008): www.continental.com/web/en-US/content/company/investor/default.aspx British Airways (2008-2009): www.bashares.com/phoenix.zhtml?c=69499&p=irol-index Quantas Group (2008): www.qantas.com.au/info/about/investors/index discuss the following: Determine the revenue recognition policy used by each airline: incremental cost or deferred revenue. Do you believe it is good to have two different methods or should all airlines have to report the same way? Do you think this impacts comparability? Did any airline have a recent change in policy, and if so, why? What was the financial statement impact from this change in accounting policy? Kroger buys gasoline for 1.00 per gallon and sells it for $1.25. When a customer buys $100 of merchandise at Kroger they receive an electronic voucher allowing them to save ten cents per gallon of gas. The customer can save up to 10 of these vouchers getting up to $1.00 off of a gallon of gas. In addition, Kroger allows customers to save three cents off a gallon of gas if they dont have a voucher as long as they have a Kroger card. Should Kroger show a liability for these vouchers? If so, how much? Give the journal entries for the sale of the merchandise and the sale of 1 gallon of gas if: A) only 1 voucher (10 cents off the gas) B) 10 vouchers are used ($1.00 off the gas). C) Should Kroger show a liability for the customers who have a Kroger card but dont have a voucher? Would your answer change if Kroger charged a $2 registration fee to get a Kroger card? Johnnys Pizzeria has a promotion where when you buy at $15 dollar large pizza and give them your email you get an email coupon the next day for a free $8 small pizza. It cost Johnny $5 to make a large pizza and $3 to make a small pizza. At the end of the first month Johnny had 100 of these coupons issued but not redeemed. Because business is so good, Johnny increased the cost of a large pizza to $9 even though his cost to make the pizza remains at $3. What amount should Johnny show on his balance sheet for these e-mail coupons?....$800 (8 per pizza); $900 ($9 per pizza) or $300 ($3 per pizza) or some other amount? Defend your answer.assume everyone will redeem the coupon for a free pizza..