Accounting

for Frequent
Fliers
Case Analysis
By
Glen Savio Palmer 15BM60056
Thomas John 15BM60061
Aman Pasari 15BM60052
Sarthak Singla 15BM60085
Sai Prasanth Chilekampalli 15BM60004

Core Issue of the Case

The case deals with the problem of
estimating cost and obligations of the
United Air Lines frequent flier program. The
major accounting issue with FFPs is how an
airline accounts for their economic value.
Since FFPs represent a present obligation
for an airline to provide customers with air
travel at a later date, they are considered
as a liability.

Incremental Cost Approach

One approach can be to estimate the value of points that are going to be redeemed
and the timing of redemption, with the cost being based only on the variable costs
associated with the redemption of points, i.e. meal, drinks, ticketing. The provision for
the variable costs is then recorded as a liability, moving to an expense once the
points have been redeemed.

A provision can be created for these liabilities based on the present value of the
incremental cost estimate, net of any points that are deemed likely to expire. The
provision is reduced as members redeem points from which it is recorded to expenses.

This approach can be justified in that customers are redeeming their points for excess
capacity on flights, an activity that is incidental to the process of generating revenue
from passengers.

The incremental cost approach is designed to maximize profitability and minimize

provisioning levels, and so an airline using the incremental cost approach needs to be
able to prove that flights flown by frequent flyers represent excess capacity and are
incidental to the normal business of flying passengers.

Incremental Cost Approach

Calculations:

We are assuming that free miles constitute 4% of revenue

passenger miles.

Liability = (4% of revenue passengers) Extra Capacity

Cost per Available Seat Mile = 0.04 38,858 0.096 149
($Millions)

Extra Capacity = Available Seat Miles Revenue Passenger

Miles = 114,995 76,137 = 38,858 (Millions)

Deferred Revenue Approach

Another approach is to defer a proportion of revenue from the sale of each ticket to account
for the FFPs. The amount that is deferred is calculated using assumptions as to what
proportion of points are likely to be redeemed and includes an amount to cover expected
costs as well as an adequate amount of profit. The deferred revenue amount is recognized
as a liability until the points are used whereby it is recognized as revenue.
The points that airline does not consider will not be redeemed, so revenue is recognized
directly at the time of sale of points. These provisions are identified under liabilities as
unearned revenue until the points are redeemed where it becomes revenue and is
recognized in the Income Statement.

This approach can be justified in that it allows customers to use their points to access any
seat at any time.

Deferred Revenue Approach

Calculations:

We are assuming that free miles constitute 4% of revenue

passenger miles.

Liability = 0.04 Revenue Passenger Miles Average

Yield per Revenue Passenger Mile = 0.04 76,137
0.126 384 ($Million)

Difference of Cost Under Incremental

Cost and Deferred Revenue Method
S.No

Description

Cost

Cost Under Incremental Method

$ 149 million

Cost Under Deferred Revenue

Method

$ 384 million

Difference

$ 235 million

Deferred Revenue Method to be

Used
Under IFRS, revenues from original sales that give rise to loyalty points (or other award credits)
should be allocated.
Fair value of award credits should be deferred as unearned revenue and recognized when exchanged
for promised rewards
The recommendation to use the deferred revenue method is given by International Financial
Reporting Interpretations Committee 13(IFRIC 13).
Deferred Revenue Approach is based on deferring a portion of the revenue of sale of a ticket as
deferred revenue on the liability side of the balance sheet. Once the points are redeemed or expired
they are considered as revenue.
So we use Deferred Revenue Method Approach.

Calculations of Deferred Revenue method:

We are assuming that free miles constitute 4% of revenue passenger miles.
Liability = 0.04 Revenue Passenger Miles Average Yield per Revenue Passenger Mile = 0.04
76,137 0.126 384 ($Millions)

Whether to Continue or not Continue FFP:

CFO, I would calculate the revenue that United Airlines might loose by abandoning the program

venue Gained = 130,000 new members x12months

,560,000 PAX x $0.126 x 1322mi RPM

96,560 x 1322mi RPM

259,852,320

Whether to Continue or not

Continue FFP:
Assuming that no Revenue PAX is displaced by FF PAX and that
4% of all RPM generated through the program is redeemed

=1,560,000 PAX x 4%
= 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

Should United Airlines Account FFP

in Published Financial Statements?
Yes, we believe that ideally United Airlines
should account in itspublished financial
statements for the frequent flierprogram.

Reasons
An investor to the airline company must be able to know the costs that may be
incurred in future as a resultof frequent flier members redeeming their points.
Thesecosts are future liabilities which may affect the revenue ofthe company in
future years.
By making the provisioning of future liabilities explicit inthe financial statements,
the potential investors will not be tricked into investing into theairline company if
the liabilities arepotentially huge and the airlineis not operating with operating
efficiencies.

Possible Ways for United to Account

for the Program in Published
Financial Statements
The possible way according to IFRS
isthe Deferred Revenue Method which
calculates the costs as a percentage
of the revenue andprovisions it as a
deferredliability.

Also, for customers looking at joining

a frequent flyer program it would also
be useful to consider which
accounting procedure is used as an
airline using the deferred revenue
approach would be able to provide
frequent flyer seats on any trip at any
time while the airline using the
incremental cost approach can only
provide access to seats that represent
excess capacity.

Extract of Balance Sheet

Liabilities

$ in Millions

Frequent Flyer Deferred Revenue

384

Journal Entry To record Revenue and Deferred Liability

Dr.
($ in Millions)

Bank

Cr.
($ in Millions)

9,593

Revenue

9,209

Deferred Revenue

384

Total Revenue

76,137 Millions x $0.126= $9,593 Millions

Revenue Earned

$9,593 x 96% = $9,209 Millions

Deferred Revenue =

$9,593 x 4% = $384 Millions

What would we do as CFO?

The capacity utilization of United
Airlines on an average is less or very
near to the break even load factor.
Yet, there may be some routes
orflights in which the maximum
capacity of the aircraft can
bereached.

I would have analyzedvarious routes

where a high utilizationfactor of the
aircraft can be incurred and
subsequentlyassigned costs on those
routes based on the Deferred Revenue
method.

CONCLUSION
FFP is very valuable for United
Airlines as it increases the loyalty
of customers that ultimately posts
increase in future sales.
From accounting perspective,
guidelines are available in
International Financial Reporting
Standard (IFRS) to record FFP

The most suitable method to record

FFP program according to IFRS is
Deferred Revenue Method