South Africa shifts rules on loyalty point liability
In South Africa, the latest governmental guidance on customer loyalty programmes has some very significant implications for airlines, hotels, retailers and credit card providers, along with other companies offering reward schemes.
The International Financial Reporting Interpretations Committee (IFRIC) has issued its interpretation of guidelines regarding the accounting practices relating to customer loyalty programmes. This interpretation is likely to have significant implications for the customer loyalty industry, as it provides unwelcome clarity on how loyalty-related obligations and liabilities should be featured in the programme operator's company accounts.
Points and miles targeted The IFRIC 13 - Customer Loyalty Programmes guidelines address the accounting of entities that grant loyalty award credits, such as points or travel miles, to customers who buy other goods or services.
Specifically, it explains how such entities should account for their obligations to provide free or discounted goods or services (the "award") to customers who redeem award credits.
No more breakage? This latest interpretation requires companies to allocate some of the proceeds of the initial sale to the award credits and recognise these proceeds as revenue only when they have fulfilled their obligations - in full. In other words, the guidelines do not allow any estimation or interpretation regarding 'breakage' (points that are never redeemed).
The guidelines say that programme operators must fulfil their obligations by supplying awards themselves, or by engaging and paying a third party to do so on its behalf.
Standardisation The intended effect of this interpretation is to ensure that the obligation to supply customer loyalty rewards (the overall award pool liability) is measured in the same way by all companies, whether the award credits are sold separately or granted to customers as part of a larger sale.
Bob Garnett, IFRIC's chairman and a member of the International Accounting Standards Board (IASB), commented: "Until now, international standards have lacked clear guidance for award credits granted free with other goods or services. This interpretation will standardise practice in a way that reflects our view that loyalty awards are separate goods or services for which customers are implicitly paying."
Troubled accounts ahead According to Kim Bromfield, a member of the Accounting Practices Committee of the South African Institute of Chartered Accountants (SAICA) and technical partner at KPMG, "IFRIC 13 will require many entities to change their basis of accounting. This is particularly the case for airlines, which have generally measured their customer loyalty liability on the basis of expected costs, while IFRIC 13 requires selling prices or 'fair value' to be used."
Two transactions for every one IFRIC 13 actually dictates that, at the time the initial sale takes place, there are two transactions: the initial sale and the awarding of loyalty points or miles. This means that the total spend needs to be split between the actual sale and the points or miles issued. But because the points or miles will only be redeemed at a later date, the portion of the transaction allocated to them now needs to be deferred and only recognised as revenue when redeemed. In other words, if loyalty points are issued at 1% of spending, then 1% of turnover needs to be accounted for not as revenue but as a separate future liability.
More worryingly, the amount allocated to the points or miles should now be measured on a 'fair value' basis - in other words their value to the customer, not the cost to the programme operator. The amount of money allocated to the points or miles is recognised as revenue based on the number of miles that have been redeemed, relative to the total number of miles expected to be redeemed.
In other words, it could be argued under this approach that if there were no loyalty programme the price of the air ticket would be different. It is saying that you are buying two items and that the airline is actually selling two items, which are delivered at different times. The loyalty awards are considered to be separately identifiable goods or services for which customers are implicitly paying as part of the initial sale transaction.
Wide market coverage IFRIC 13 covers all types of customer loyalty programmes in which award credits are granted to customers as part of a sales transaction, whether provided by supermarkets, book stores, airlines, telecommunication operators, hotels, or credit card providers.
As to the earnings impact of IFRIC 13, this would depend on the way businesses have been accounting for such transactions, or whether or not (like the airline industry) they have merely been raising a liability for the cost of providing the award rather than quoting the value to the customer.
Impact of liability changes If companies have already been accruing liability based on the value to the customer, the impact may be no more than a shift between the revenue and cost lines. But the impact in the airline industry in particular (where the costs of fulfilment are minimal compared to the perceived value of the reward) could be catastrophic because of the need to defer a portion of the ticket revenue to a time when the miles are actually redeemed - which may never happen (i.e. breakage).
What is required in such instances are careful estimates of if - or when - the company's customers are likely to redeem their points or miles. Fortunately for most of the airlines, there is a reasonable amount of historical data on which to base those estimates. But the game will perhaps not be so easy for new-comers to the field of loyalty rewards.
All programme operators have until 1st July 2008 to prepare for the application of this interpretation, although earlier adoption of IFRIC 13 is permitted.