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!