Accounting for Customer Loyalty

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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 classification 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 financial 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

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Accounting Research Journal Vol. 23 No. 2, 2010 pp. 124-145 q Emerald Group Publishing Limited 1030-9616 DOI 10.1108/10309611011073232

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 generally established by entities to encourage customers to buy their goods and services. Customers may accumulate points or awards and redeem them in the future, often from a 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 and amount of revenue recognition following adoption of IFRIC 13 has had a significant 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

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 firm’s financial statements. This categorisation assigns importance and relevance to some matters and objects, constructing a financial reality (Young, 2003). This construction, however, is controversial as items are “prodded, probed and snipped, and made to fit 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 supply awards can either 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 reflects our view that 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 ramifications for those entities currently using the cost/provision method for CLPs where awards are measured at the often insignificant cost of satisfying the obligation. Alternate interpretations have the potential to alter the redistribution of wealth in society, bringing both costs and benefits 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 specific reference to IFRIC 13, followed by a discussion of the method used to analyse the comment letters in Section 4. Section 5 provides

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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 bestow significant power on those who influence IFRIC interpretations. Interpretations signal an omission or flaw 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 significant because it provides a window into 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, finding that lobbying of the IASC was done by very large corporations and multinationals. Responses were overwhelmingly from developed 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 finding 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 specific 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 specific context, to make research more relevant (Cooper and Morgan, 2008). The analysis of IFRIC 13 and its associated comment 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 identifies 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 financial reporting through timely identification, discussion and resolution of financial reporting issues (IASCF, 2007). The IFRIC reviews newly identified 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]. ´ (CNC), requested The French standard setter, Conseil National de la Comptabilite clarification of the accounting treatment for CLPs in 2005. Despite the joint FASB and IASB engagement in a project on revenue recognition staff from the 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. A total 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 final 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 reflecting 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.

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Figure 1. Timeline of IFRIC/IASB meetings and other key events
IFRIC meeting. Staff issues paper discussed. Request for staff to prepare draft interpretation Comment letters Due 6/11/06 IFRIC meeting. Consideration of third-party awards and forfeiture. Agreed that draft interpretation be released for comment IFRIC meeting. Consideration of: allocation based on relative FV, timing of revenue recognition, third-party awards IFRIC meeting. Reconsideration of allocation based on ‘relative fair value’. Consideration of revised draft. Staff to prepare final interpretation Mar 06 May 06 Jul 06 Sep 06 Nov 06 Jan 07 Mar 07 May 07 Jun 07 IFRIC meeting. Discussion of draft interpretation. Consensus on IAS18 para 13 – awards as separate component of sales transaction Draft interpretation released – D20 IFRIC meeting. Comment letters considered. Members agreed on: need for interpretation overall approach proposed scope IASB meeting. Approval of final interpretation by IASB – IFRIC 13. Effective for annual reporting periods commencing 1 July 2008 D20 Approach retained in IFRIC 13 with the following amendments: Allocation of consideration to award credits with reference to fair value (not relative FV) Treatment regarding awards supplied by third parties clarified Comment regarding customer relationship intangible assets removed Guidance to measure Fair Value of award credits Illustrative examples include

IFRIC meeting. Issues paper presented by CNC and discussed by members

Nov 05

Jan 06

IFRIC meeting. Continuation of discussion. Staff requested to prepare analysis of issues

D20 options Recognition and measurement of obligations to supply goods and services to customers if they redeem “award” points

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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

Insignificant value and/or goods or service provided by third party 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

Significant value and/or goods or service provided by entity

Figure 2. D20 options

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 from future 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 significant 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.

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The 56 comment letters were read by two researchers independently. Each submission was allocated to a predefined organisational type; professional accounting bodies, professional accounting firms, 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 identified 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 identified; first, 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 classified 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 Certified Practicing Accountants) and one, the Chartered Institute of Management Accountants based in the UK, was classified with European organisations. The professional accounting firms in most instances are global firms but were classified 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 identified 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.

Option 1 cost/ provision Accounting profession Professional bodies Public accounting firms Regulators National accounting standard setters Stock exchange regulators Preparers Banks Airlines Other business/business representative groups Actuaries Users None Others Academics Total 4 0 5 0 4 3 1 0

Option 2 deferred revenue 5 3 4 0 1 0 2 0

Option 3 mixed approach 4 3 6 1 0 0 6 0

Option not specified/ ambiguous Total 0 0 1 1 0 0 0 1 13 6 16 2 5 3 9 1

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0 17

0 15

1 21

0 3

1 56

Table I. Analysis of comment letters: preferred options

5.1 Organisational type Those organisations representing the accounting profession, namely the professional bodies and public accounting firms, contributed 19 comment letters or 34 per cent of the total. The “Big 4” accounting firms, namely KPMG, Deloitte Touche Tomatsu, Ernst & Young and PriceWaterhouseCoopers all submitted letters, along with the French firm Mazars, consistent with previous practice noted by Larson (2007). All of these firms 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 reflects a high concentration of responses from the accounting profession, with the technical and financial 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 financial statements. This may be explained by the findings of Durocher et al. (2007) that suggest participation in a standard setting process is influenced by the perception of one’s ability to participate adequately, and one’s knowledge of the process and justification of the proposed standard. There were only five responses from banks or banking representative groups, with four supporting the cost/provision approach. The four supporting banks were all European, and they provided five 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

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Category 2 0 4 6 1 0 0 0 0 0 7 2 0 1 3 0 0 0 1 0 0 4 6 5 7 18 0 4 1 7 1 0 31 1 1 1 3 1 0 0 0 0 0 4 0 0 1 1 0 0 0 0 0 0 1 1 0 2 3 0 0 1 1 0 0 5

Professional accounting bodies Professional accounting firms National standard setters Sub-total – accounting interests Stock exchange regulators Banks Airlines Other business Actuaries Academics Comment letters available Comment letters not available Total comment letters

Notes: Two professional accounting bodies were also national standard setters (i.e. CL12 South African Institute of Chartered Accountants and CL57 Hong Kong Institute of Certified Practicing Accountants); they have been classified as professional bodies in the above; IOSCO has been included with North American interest

Table II. Categorisation of submissions by types and geographical representation Asia Australia Europe North America Russia Scandinavia South Africa 1 0 0 1 0 1 1 0 0 1 4 No. of submissions 13 6 16 35 2 5 3 9 1 1 56 3 59

outside D20 (CL2, CL37); the value of awards is insignificant in comparison with the sales transaction as a whole (CL23); and the benefits of the advocated treatment would not outweigh costs, such as costs required by significant system changes (CL32). This group provided limited support for the interpretation as proposed in D20, noting commercial “reality” as a significant 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 findings of Larson (2007), where 57 per cent of the comment letters on IFRIC interpretations 1-18 came from European 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 (five out of 12 members were European[3]), it is suggested that the European contingent had significant opportunity to voice their opinion on the CLP issue. 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, reflecting the move towards increased involvement at the international level of standard setting and programmes
Assumptions of fair value estimates Scope Accounting profession Professional bodies Public accounting firms Regulators National accounting standard setters Stock exchange regulators Preparers Banks Airlines Other business/ business representative groups Actuaries Others Academics Total 8 6 7 1 0 3 4 4 3 0 1 1 Costs versus benefits 3 0 5 0 2 2 Customer relationships and intangible assets 2 2 4 1 0 1 Treatment of third-party transactions 3 2 4 0 1 1

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3 1 0 29

5 0 0 18

1 0 0 13

0 0 0 10

2 0 1 14

Table III. Analysis of comment letters: additional identified issues

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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 benefits, 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 difficulties 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).

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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 insignificant 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 superfluous 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,

an interim solution 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 identified in the comment letters, which are classified according to type of organisation. The predominant concern for all groups were the assumptions associated with fair value estimation. Numerous commentators also sought clarification on the scope of D20 and raised concerns about the costs versus benefits 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).

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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 modified the final 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 clarification on how to recognise revenue of forfeited awards and changes in expected forfeiture rates. According to the final IFRIC Interpretation, “the amount of revenue recognised shall be based on the 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 clarification on the types of schemes covered by the IFRIC Interpretation. For example, UBS (CL32) discussed schemes offered by financial institutions where customers are given awards, such as reductions in interest charges on loans. Commentators also drew attention to schemes where awards could be redeemed to repay outstanding loan balances or redeemed for cash. The scope of IFRIC 13 was limited to include only awards granted as part of a sales transaction (paragraph 3 (a)). The final interpretation specifically 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 benefits The cost of implementation versus the benefits 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 significant costs for preparers, with only limited benefits 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 fulfilling the obligation (IFRIC, 2007, p. 1).

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In its discussion of cost-benefit issues, the IFRIC concedes that IFRIC 13 “proposes relatively complex accounting treatments for transactions that are often immaterial” (IFRIC, 2007, p. 27). Within the final IFRIC 13 Interpretation, cost/benefit 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 specific benefits of a particular customer campaign could be separately identified. The IFRIC deleted this section in the final 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 difficulty 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 flyer 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 flyer 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.

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 flight, 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 now been 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 benefits [by the airline] is partly dependent on its ability to handle extra traffic generated by the FFP [frequent flyer 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 classification 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 fitted 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.

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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 classification 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 significant barrier to implementation. Qantas as an early adopter of IFRIC 13 experienced a material impact on its reported financial results. For the half-year ending December 2007, net assets declined by 8 per cent, and profit 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 profit 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 flight 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).

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In 2007, Qantas created a separate operating segment for its frequent flyer programme in anticipation of a sale to external parties. While the proposed sale has been postponed, the airline has reported segment financial information which reveals a different story to the economic impact to the one described above. Within the context of declining profits in the airline industry, due in part to rising fuel costs and the recent HINI Influenza 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. A 20.8 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, benefits arising from changes in accounting estimates ($147 million) and increased redemption revenue ($237 million) contributed to the profit 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 profit before income tax and net finance costs of $203 million of Qantas (Qantas Airways Limited, 2009b). The impact of this CLP has been significant 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 through partnerships with the supermarket chain Woolworths, and eliminating the credit card provider as a third party supplier of points (Knight, 2009, p. 5). 7. Conclusion The IFRIC’s classification 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 classifications. D20 and IFRIC 13 involve complex arguments for the classification of economic phenomena.

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 financial 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 flights, 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 fulfils 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 financial statements see Picker et al. (2009, pp. 134-9). References Bradbury, M. (2007), “An anatomy of an IFRIC interpretation”, Accounting in Europe, Vol. 4 Nos 1/2, pp. 109-22. Cooper, D. and Morgan, W. (2008), “Case study research in accounting”, Accounting Horizons, Vol. 22 No. 2, pp. 159-78. Deloitte (2009), “IAS plus: use of IFRSs by jurisdiction”, available at: www.iasplus.com/country/ useias.htm (accessed 4 December 2009). Durocher, S., Fortin, A. and Cote, L. (2007), “Users’ participation in the accounting standard-setting process: a theory-building study”, Accounting, Organizations and Society, Vol. 32 Nos 1/2, pp. 29-59. Ernst & Young (2007), “Customer loyalty programmes: implementation guidance”, available at: www.ey.com/Publication/vwLUAssets/IFRIC_13_Customer_Loyalty_Programmes/ $FILE/IFRIC%2013%20Customer%20Loyalty%20Programmes.pdf (accessed 7 January 2010). FASB (2009), “Project update: revenue recognition project – a joint project of the FASB and the IASB”, available at: www.fasb.org/project/revenue_recognition.shtml (accessed 4 December 2009). Georgiuo, G. (2004), “Corporate lobbying on accounting standards: methods, timing and perceived effectiveness”, Abacus, Vol. 40 No. 2, pp. 219-37.

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Grinyer, J. and Russell, A. (1992), “National impediments to international harmonization: evidence of lobbying in the UK”, Journal of International Accounting Auditing and Taxation, Vol. 1 No. 1, pp. 13-31. IASB (2007a), IFRIC Information for Observers, International Accounting Standards Board, London, available at: www.iasb.org/NR/rdonlyres/0EF5DD50-8E43-47AA-BED4F2403BC4CEE7/0/0803ob2K.pdf (accessed 7 January 2010).

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IASB (2007b), IFRIC Issues Guidance on Customer Loyalty Programmes, International Accounting Standards Board, London, available at: www.iasb.org/NR/rdonlyres/99F8CF89-9EE1-4B09AFB8-7CC92706C174/0/IFRICissuesguidanceoncustomerloyaltyprogrammes.pdf (accessed 7 January 2010). IASCF (2007), Due Process Handbook for the IFRIC, International Accounting Standards Board, London, available at: www.iasb.org/NR/rdonlyres/24B1613A-FBD2-43EA-87EF72E0F526D35C/0/DueProcessHandbook_January2007.pdf (accessed 7 January 2010). IATA (1995), Airline Accounting Guideline No 2. Frequent Flyer Programme, International Air Transport Association, Montreal. IFRIC (2005), IFRIC Update, International Accounting Standards Foundation Committee, London, available at: www.iasb.org/NR/rdonlyres/CF3985BF-93C9-41E7-8C0C42F52ED692BD/0/nov05.pdf (accessed 7 January 2010). IFRIC (2006a), IFRIC Draft Interpretation D20 Customer Loyalty Programmes, International Accounting Standards Board, London, available at: www.iasb.org/NR/rdonlyres/ 93B52105-5055-4868-B51D-FACAA0E8B72C/0/IFRICD20.pdf (accessed 7 January 2010). IFRIC (2006b), IFRIC Update, International Accounting Standards Foundation Committee, London, available at: www.iasb.org/NR/rdonlyres/5D43EB6D-3110-4DFC-82A2267C90FA9E61/0/mar06.pdf (accessed 7 January 2010). IFRIC (2007), IFRIC Interpretation 13 Customer Loyalty Programmes, International Accounting Standards Board, London. Knight, E. (2009), “Qantas rewards arm keeps on delivering”, The Sydney Morning Herald, 20 June, p. 5. Larson, R.K. (1997), “Corporate lobbying of the International Accounting Standards Committee”, Journal of International Financial Management and Accounting, Vol. 8 No. 3, pp. 175-203. Larson, R.K. (2002), “The IASC’s search for legitimacy: an analysis of the IASC’s Standing Interpretation Committee”, Advances in International Accounting, Vol. 15, pp. 79-120. Larson, R.K. (2007), “Constituent participation and the IASB’s International Financial Reporting Interpretations Committee”, Accounting in Europe, Vol. 4, pp. 207-54. MacArthur, J. (1999), “The impact of cultural factors on the lobbying of the International Accounting Standards Committee on E32 comparability of financial statements: an extension of MacArthur to accounting member bodies”, Journal of International Accounting, Auditing and Taxation, Vol. 8 No. 2, pp. 315-35. Masocha, W. and Weetman, P. (2007), “Rhetoric in standard setting: the case of the going-concern audit”, Accounting, Auditing & Accountability Journal, Vol. 20 No. 1, pp. 74-100. Picker, R., Leo, K., Loftus, J., Clark, K. and Wise, V. (2009), Australian Accounting Standards, 2nd ed., Wiley, Milton. Qantas Airways Limited (2007), “Consolidated interim financial report for the half year ended 31 December 2007”, available at: www.qantas.com.au/infodetail/about/investors/ 2007HYResults.pdf (accessed 7 January 2010).

Qantas Airways Limited (2009a), “Media release: Qantas announces profit result – year ended 30 June 2009”, available at: www.qantas.com.au/infodetail/about/investors/mediaReleaseResults09. pdf (accessed 7 January 2010). Qantas Airways Limited (2009b), “Qantas Frequent Flyer: supplementary information”, available at: www.qantas.com.au/infodetail/about/investors/qffSupplementaryInformation.pdf (accessed 7 January 2010). Rappaport, A. (1977), “Economic impact of accounting standards – implications for the FASB”, Journal of Accountancy, May, pp. 89-98. Sheehan, P. (2008), “Frequent flyer points are a big con”, The Sydney Morning Herald, January, pp. 11, 14. Young, J. (1994), “Outlining regulatory space: agenda issues and the FASB”, Accounting, Organizations and Society, Vol. 19 No. 1, pp. 83-109. Young, J. (2003), “Constructing, persuading and silencing: the rhetoric of accounting standards”, Accounting, Organizations and Society, Vol. 28 No. 6, pp. 621-38. (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/Currentþ Projects/ IFRICþ Projects/Updatesþ onþ IFRICþ meetingsþ givenþ toþ theþ IASB.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 þ Projects/IFRIC þ Projects/ IFRIC þ 13 þ Customer þ Loyalty þ Programmes/Meeting þ Summaries þ and þ Observer þ Notes/Meeting þ Summaries þ and þ Observer þ Notes.htm IASB meeting summaries and observer notes: customer loyalty programmes: June 2007 (request for Ratification of Interpretation: Agenda papers 7A and 7B). Published by IASB, London, available at: www.iasb.org/Current þ Projects/IFRIC þ Projects/ IFRIC þ 13 þ Customer þ Loyalty þ Programmes/Meeting þ Summaries þ and þ Observer þ Notes/Meeting þ Summaries þ and þ Observer þ Notes.htm

Appendix 2

Letter number South Africa UK The Netherlands UK Malaysia Japan Singapore Global – based in UK Global – based in USA Europe UK South Africa Professional body Auditors Telecommunications – award providers Actuaries Professional body/standard setter Standard setter Business Standard setter Professional body National standard setter Standard setter Professional body University Financial institution Standard setter Standard setter

Submitter/organisation

Country

Industry/type of organisation

CL1 CL2 CL3 CL4

CL5 CL6

CL7

CL8

CL9 CL10

CL11 CL12

CL13 CL14 CL15 CL16

CL17 Korea Belgium Finland Ireland

Elmar Venter (accounting academic) British Bankers Association Dutch Accounting Standards Accounting Standards Board Urgent Issues Task Force Malaysian Accounting Standards Board Japanese Institute of Certified Practising Accountants Council on Corporate Disclosure and Governance Chartered Institute of Management Accountants Grant Thornton International Joint letter from Belgacom, debitel AG, Deutsche Telekom, Telefonica and Vodaphone Lane, Clarke and Peacock South African Institute of Chartered Accountants (also Secretariat for Accounting Practices Board) Swiss GAAP FER ACTEO, AFEP, MEDEF AcSB CPA Australia (in consultation with APRAG) FirstRand Switzerland France Canada Australia and regional perspective South Africa Financial institution – operate CLP for customers of bank Standard setter Standard setter Airline Professional body (continued )

CL18

CL19 CL20 CL21

IFRIC Review Committee of Korean Accounting Standards Board Belgian Accounting Standards Board Finnair Institute of Chartered Accountants

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Table AI. D20 comment letters received

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Letter number South Africa Europe USA Sweden Europe Sweden Switzerland Germany UK UK Switzerland UK UK UK France UK UK Australia Switzerland Sweden France Germany Switzerland Denmark Japan Business Professional body Agribusiness Professional body Professional body Airline Banking Professional body Listed companies

CL22 CL23 CL24 CL25

CL26 CL27 CL28 CL29 CL30

CL31 CL32 CL33 CL34 CL35 CL36 C37 C38 CL39 CL40 CL41 CL42 CL43 CL44 Not available Foreningen af Statsautoriserede Revisorer Accounting Standards Board of Japan Not available

CL45 CL46 CL47 CL48

Table AI. Submitter/organisation South African Airways European Association of Cooperative Banks Florida Institute of CPA ¨ ringsliv (forum for chief Svenskt Na accountants from largest Swedish listed companies) UNICE FAR SRS Syngenta Institut Der Wirtschaftsorurer Institute of Chartered Accountants in England and Wales ICAEW Deloitte UBS PricewaterhouseCoopers The 100 Group of Finance Directors British Airways CNC HSBC Ernst & Young The Institute of Chartered Accountants Nestle Redovisingsradet Mazars Rechnungslegungs Interpretations Swiss Holdings Country Industry/type of organisation Accounting firm Financial products Accounting firm Top FTSE 100 companies Airline National standard setter Financial institution International accounting firm Professional body Food Emerging issues task force International accounting and audit group Accounting interpretations committee 40 Swiss groups, including most of country’s industrial and commercial firms Danish accounting standards committee National accounting standards board (continued )

Letter number Group of 100 Australia UK UK Europe EU International Hong Kong Russia Thailand Australia

Submitter/organisation

Country

Industry/type of organisation

CL49

CL50 CL51 CL52

Chief financial officers of Australia’s largest businesses National standard setter Accounting firm Professional body Association of professional bodies Technical support to European Commission

CL53 CL54

CL55

CL56 CL57

CL58

Representative body of regulators Professional body and national standard setter National standard setter Regulator

CL59

AASB KPMG The Association of Chartered Certified Accountants Not available ´ de ´ ration des Experts Comptables Fe ´ ens (European Federation of Europe Accountants) European Financial Reporting Advisory Group EFRAG The IOSCO Hong Kong Institute of Certified Public Accountants National Accounting Standards Board of Russia Securities and Exchange Commission Thailand

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Table AI.