Accounting for Frequent FliersTo be, or not to be… a Liability

2The Team

• Humaira Sardar Ali• Irfan Rashid• M. A. Ghani Chishty• Robina Kiran• Noman Bari• S. Najmul Hassan

3

Presentation Outline

• Introduction to Frequent Fliers (FF) Program (FFP)• Importance of FFPs, Today• Cost of Redemptions (Free-Flights)• Percentage Redemption from total FF Miles• Cost Matrix

• Cost of United FFP• Methods to Measure Cost• Method to be used• Beneficial for United to Continue the FFP?

• Financial Disclosure of United’s FFP• Financial Statements or SEC Disclosure?• What & why?

4

Cost of Redemptions

• Actual cost in terms of all consumables used to service the reward – negligible

• Opportunity Cost• Free (Reward) Flight vs. Paying Customer

• Discounting costs for Present Value

5

General NOTES!!! (Not incl. in Pres.)

• Accounting policy change vs. Change in Accounting Estimates (Retrospective vs. Prospective)?• W.r.t. Teaching Notes pp 3 – para 4

• Action plan for the CFO, action plan for SEC

6Definitions

• Revenue Passenger (PAX) Miles (RPM): A transportation industry metric that shows the number of miles travelled by passengers. Revenue passenger miles are calculated by multiplying the number of passengers by the distance travelled.• For example, an airplane with 100 passengers that flies 250

miles has generated 25,000 RPMs.

• Available Seat Miles (ASM): available seat miles (ASM) show the total number of passenger miles that could be generated• An aircraft with 130 seats that flies 250mi has 32,500 ASMs

7Definitions - II

 

8Definitions - III

• Airlines consider ALL PAX in their RPMs, meaning, Airline RPMs contain:• Revenue (Paying) PAX, and• Frequent Flyer (i.e. Free/Redeemed) PAX

9

Methods of Measuring Cost (MMC)

• Based on Averages & Industry reports• Based on Opportunity Cost• Based on Displaced Earnings due to FFP• Based on Deferred Revenue

10MMC - II

Description Units Numbers

RPM (United) Miles 76,137,000,000

Revenue PAX Numbers 57,598,000

Total PAX Numbers 59,901,920

Average PAX Journey Miles 1,322

Average Flight Length Miles 912

PAX Load Factor (PLF) % 66.2%

Breakeven PLF % 66.5%

Average Yield per RPM USD $0.126

Cost Per ASM USD $0.096

Price of Fuel/Gallon USD $0.804

Average Fare per Revenue PAX USD $167.26

11

MMC – Averages & Industry Reports

Description Units Numbers

Total Revenue USD $9,633,841,480

Industry Average RPM under FF (1990) % 4%

FF RPM (United - 1990) Miles 3,045,480,000

Revenue Generating RPMs Miles 73,091,520,000

FF PAX Numbers 2,303,920

Total PAX Numbers 59,901,920

FF as %age of Total PAX % 3.85%

Average Fare for ALL PAX USD $160.83

Fare Premium for Revenue PAX USD $6.43

Fare Premium REDEEMED USD $14,821,295

Total Fare Premium (From revenue PAX) USD $370,532,365Total Fare Premium (From ALL PAX) USD $385,353,659

12

MMC – Opportunity Cost

Description Units NumbersLost Revenue from FF @ Average Fare USD $385,353,659

Total POTENTIAL Revenue (FF+Rev PAX = 9.6B + 385M) USD $10,019,195,139

Total POTENTIAL Yield for Revenue RPMs (Rev / Rev RPM) USD $0.132

Total POTENTIAL Yield (Total Rev Pot. / RPM) USD $0.132

Average Yield USD $0.126

13

MMC – Displaced Earnings

• Since the aircrafts were never at full capacity on average (PLF 66.2%)• Probability of FF PAX Displacing a Revenue PAX = minimum• Hence this could be neglected

• Assuming that for 30 days (holiday season) flights go full that means

• 654,555 x (30 / 365) = 53,800 flights go full• Assuming 10% of all FF travel during these 30 days =

230,392 PAX• Displaced Earnings = 230,392 x 167.26 = $38,535,366

14

MMC – Deferred Revenue

Description Units Numbers

Fare value of Point Credits USD $6.69

Revenue Recognized USD $15,414,146

Deferred Revenue USD $385,353,659

15

MMC – Opportunity Cost

Description Units AIR OC DE DR

Fare Premium REDEEMED USD $14,821,295 - $0 $15,414,146

Liability / Deferred USD $370,532,365 - $0 $385,353,659

Lost Revenue $385,353,659 $38,535,366

16

Method for Cost Calculation Chosen - DR

• Deferred Revenue is the way that we should calculate costs of the FF Program

• Why?• IFRIC 13 – IAS 18

Description Units Numbers

Fare value of Point Credits USD $6.69

Revenue Recognized USD $15,414,146

Deferred Revenue USD $385,353,659

17

MCCC – Deferred Revenue - II

• The FF Program is a separately identifiable element of the transaction for which the customer implicitly paid

• Not delivered to the customer at the same time• Recognized separately to reflect the substance of the

transaction• Distinguished from Marketing Expenses• Integral part of the initial sale transaction

18Continuing the FFP

• As the CFO, I would compare the incremental cost of the program with the lost revenue

• Revenue Gained = 130,000 new members x 12months• = 1,560,000 PAX x $0.126 x 1322mi RPM• = 196,560 x 1322mi RPM• = $ 259,852,320

• Assuming that no Revenue PAX is displaced by FF PAX and that 4% of all RPM generated through the program is redeemed• = 82,492,800mi redeemed / 1322mi• = 62,400 x $167.26• Lost Revenue = $10,437,024

• NET Revenue = 259,852,320 – 10,437,024 = $249,415,296• Its highly beneficial to continue the FFP

19Disclosure of FFP

• Disclosure is required in the Financial Statements – Basis of Accounting policies

• Standards and Interpretations adopted in making the FS• All the accounting policies are consistently applied –

making information comparable for the user of FS• The users should know that FS are drawn up in

accordance with the requirements of SEC i.e. the FS presented before them are in line with the requirements and give true and fair view of the affairs.

20

What should be Accounted for / Disclosed

• Revenue recognition policy• Nature of the frequent flier program• Any contingencies / commitments• Differed Revenue amount• Amount realized / recognized during the year• Assumptions / expectations for the redemption – along

with the bases• Any change in estimates – prospective application

21

Way to Choose Accounting for the Prog.

• Recognized as a deferred revenue, or provision for future costs

22

Accounting of FFP in Published Financials

• We opt for Deferred Revenue method• Sale originates from initial transaction • Fair value of the awards are incorporated in the

transaction initially• Although insignificant as compared to the revenue, yet

they are redeemable for services in ordinary course of business

23

Accounting of FFP in Published Financials - II

Description (Expense/Future Cost) $ Dr. $ Cr.

Cash (Fare Collected) 167.26

Revenue 160.83

Provision for FF 6.43

Description (Deferred Revenue) $ Dr. $ Cr.

Cash (Fare Collected) 167.26

Revenue 160.83

Deferred Revenue 6.43

24If I were the CFO

• I would continue the FFP• Profitable• Brings repeat clients

• Would use the Deferred Revenue method (post 2007)• Principally correct any way even in pre-2007

25

THANK YOU!