AIRLINE ACCOUNTING GUIDELINES
in association with KPMG
AIRLINE ACCOUNTING
GUIDELINE No. 2
Frequent Flyer Programme Accounting
Effective 1 June 1995
International Air Transport Association
Montreal – Geneva
AIRLINE ACCOUNTING GUIDELINES
INTERNATIONAL AIR TRANSPORT ASSOCIATION
TABLE OF CONTENTS
Page
1. BACKGROUND................................................................................................... 1
2. OBJECTIVES....................................................................................................... 2
3. CURRENT ACCOUNTING STANDARDS FRAMEWORK................................ 2
4. CONTINGENT LIABILITY APPROACH ........................................................... 3
5. INCREMENTAL COST VERSUS DEFERRD REVENUE.................................. 3
6. REDEMPTION RATES ....................................................................................... 6
7. ACCOUNTING FOR NON-SPONSOR AIRLINE PARTICIPANTS ................... 7
8. COPOPERATION AND SHARED ARRANGEMENTS ...................................... 8
9. CLASSIFICATIONOF FFP COSTS ..................................................................... 9
10. RECOMMENDATIONS ...................................................................................... 9
11. DISCLOSURE...................................................................................................... 12
AIRLINE ACCOUNTING GUIDELINES
IATA ACCOUNTING POLICY TASK FORCE
AIRLINE ACCOUNTING GUIDELINE NO. 2:
FREQUENT FLYER PROGRAMME ACCOUNTING
1. BACKGROUND
1.1 Frequent Flyer Programmes (“FFP’s “) have now been introduced by many
international airlines, principally to induce higher levels of repeat business from
premium fare traffic. The basic concept of a FFP is to encourage passenger loyalty
by providing rewards geared to the frequency of travel on the sponsoring airline,
typically in the form of “frequent flyer points” of “air miles” which can be
accumulated and converted into free or discounted travel.
1.2. Certain FFP’s also involve participants other than the sponsoring airline, for
example, travel related businesses such as hotels or car rental companies. These
businesses will similarly award FFP members for the purchase of their particular
products by adding to the members points or miles accumulated under the FFP.
1.3 Various types of awards may be offered by a FFP in exchange for frequent flyer
points accumulated under the scheme:
a) the right to buy a ticket at a discount; or
b) the right to an upgrade; or
c) the right to a free companion ticket; or
d) the right to free travel on the sponsoring airline or on a participating airline; or
e) the right to other non-travel rewards
1.4 For the sponsoring airline, the extent of the marketing benefits to be obtained from
FFP is partly dependent on its ability to handle the extra traffic generated by the
FFP, whilst not displacing fare paying passengers. With this in mind, as schemes
have developed, it has become more commonplace for airlines to impose
restrictions involving, for example, the limitation of capacity on some or all flights
which are available for frequent flyer passengers, including in particular those
during peak travel periods on high density routes.
1.5 At the same time from a financial perspective it is recognised that airlines, by
granting frequent flyer benefits to customers, are committing themselves to future
liabilities arising from servicing the FFP, which for the purpose of periodic financial
reporting to shareholders and others, may be difficult to quantify with any precision
at a particular point in time.
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1.6 Whether or not the cost of setting up those liabilities is more that offset by
increased revenues ( new sales from competitive advantage, repeat business from
loyal customers, or prevention of revenue erosion to other carriers) is also clearly
very difficult to quantify since it is not possible to say what the revenue stream
would have been if the FFPs had not been in existence. This therefore raises the
question of how to measure the overall performance of such schemes especially in
the light of iming differences that can occur in the recognition of revenues and costs
associated with such schemes. It is not the intention of this paper to address the
measurement of marketing benefits to be derived from FFPs
2. OBJECTIVES
2.1 This Airline Accounting Guideline concentrates mainly on the accounting for free
or discounted travel arising under FFPs. The principle area of contention concerns
the manner in which the obligations or commitments to reward the FFP members
for frequent flyer points should be dealt with in the accounts. Three basic concepts
might be contemplated and each is addressed in this Airline Accounting Guideline;
not to make any provision, but to make disclosure by way of contingent liability
note to maintain a provision equivalent to the estimated incremental costs which the
airline expects to incur as a result of an assumed level of redemption of frequent
flyer points; or to recognise the FFP obligation by deferring a proportion of
passenger revenue on the grounds that part of the value of any ticket conferring
frequent flyer points is unearned until those points are utilised.
2.2 The purpose of this Airline Accounting Guideline is to provide guidance on the
accounting methods available for dealing with different types of FFPs and to make
recommendations on their application. In addition, recommendations are provided
regarding associated disclosures in accounts.
2.3 It is noted that certain airlines operate their FFPs through third party or possibly
associated companies rather than through a member of the airline group. The
extent to which this Accounting Guideline is applicable in such circumstances will
depend on the particular arrangements in question, but as a generality the IATA
Accounting Policy Task Force believes that the principles of the Guideline should
be applied in accounting for all FFPs as far as is practical and meaningful.
3. CURRENT ACCOUNTING STANDARS FRAMEWORK
3.1 Other than relying on general accounting principles, the Accounting Task Force has
not been able to identify any specific guidance issued by major accounting standards
setting bodies relating to the accounting treatment appropriate for a FFP.
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However, it is known that the American Institute of Certified Public Accountants
addressed the relevance of both the incremental cost and the deferred
revenuemethods during 1980 and 1990, although no pronouncment was issued in
this regard. Nevertheless, it is noted that the Securities Exchange Commission
(“SEC”) in the US views the matter to be of sufficient relevance to require US
airlines to provide detailed supplemental information on FFP’s in the annual SEC
Form 10K
4. CONTINGENT LIABILITY APPROACH
4.1 Certain airlines have, in the past, disclosed their frequent flyer liabilities as
contingent liabilities in their accounts, apparently on the basis that the probability of
the air miles being redeemed is not readily quantifiable. The Accounting Policy
Task Force believes that this approach is unlikely to be appropriate in most
circumstances. It considers that airlines should recognise that the very nature of a
FFP is such that it is designed to stimulate traffic by rewarding frequent flyers and
inevitably this produces a degree of certainty that a proportion of frequent flyer
points in issue will be redeemed. Accordingly, it is considered that it is not
reasonable to argue that the likelihood of a provision being needed is remote (which
is what might justify a contingent liability approach). The fact that, in practice,
there may be difficulties in estimating the financial consequences of a FFP (for
example, because of uncertainties regarding future rates of redemption of frequent
flyer points) is not of itself considered sufficient to sustain a contingent liability
treatment.
5. INCREMENTAL COST VERSUS DEFERRED REVENUE
5.1 The incremental cost and the deferred revenue techniques for accounting for FFPs
may be contrasted as follows:
Incremental cost: A provision is set up for the incremental costs associated
with rewarding those FFP members expected to redeem
frequent flyer points. For those expected to take up free
travel awards, incremental costs typically include the costs of
food, drink, fuel ticket delivery costs, certain passenger taxes
and insurances. The calculation of the components of the
provision depends critically on assumptions concerning the
proportion of points in issue to be redeemed and the mix of
awards to be taken up.
Deferred revenue: A proportion of passenger revenue generated from the sale
of tickets conferring frequent flyer benefits is deferred until
such time as a ticket associated with the use of the frequent
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flyer award is used. The calculation of the level of deferred
revenue depends again on assumptions concerning the
proportion of points to be redeemed and the mix of awards
to be taken up; also on the yield assigned to the mileage or
points attributed to the expected take up of free travel
awards; in most circumstances the yield allocated to the FFP
travel award would be that normally derived from a
discounted ticket with similar restrictions.
5.2 It can be recognised that incremental costs and deferred revenue approaches are
conceptually fundamentally different. The former presumes that passengers flying
as a result of awards under a FFP are incidental to the passenger revenue process
whilst the latter presumes the converse.
5.3 There appears to be no absolute test which can be determined conclusively whether
or not free travel generated by a FFP is incidental to the passenger revenue process.
However, it is considered that the following two assertions should be capable of
being sustained for the general premise to hold true:-
a) that the probability is slight of revenue paying passengers being displaced by
passengers using free travel awards; and
b) that the worth of frequent flyer points (expressed in terms of ticket value or
mileage) issued as a result of the purchase of a qualifying ticket should be
immaterial in relation to the value of that ticket (correspondingly expressed
in terms of fare or sector length).
5.4 Historically where airlines have considered it appropriate to account for frequent
flyer liabilities there has been a strong tendency to do so using the incremental cost
method rather than the deferred revenue method. The main reason for doing so are
as follows:-
• there appears to have been a belief that any displacement of revenue
generating passengers has been insignificant. The existence of less full loads
has been cited in support of this view which in the generality was used to
sustain the assertion that the users of free tickets were travelling in seats on
flights which would otherwise have been empty;
• the increasingly sophisticated reservations and yield management systems
have been utilised by many airlines to control capacity and maximise yields
in a manner so as to restrict the ability to use free tickets or even
promotional offers on high density routes at peak times. This is believed to
limit the probability of a frequent flyer passenger displacing a fare paying
passenger.
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• taken overall the proportion of free travel passengers is not material in the
context of the overall passenger traffic
5.5 Nevertheless it is doubtful that the incremental cost approach may not be
appropriate in all circumstances. With regard to assertion 5.3 a) it will ultimately
be a matter of fact whether or not fare paying passengers are being displaced and
that will depend on a number of factors which may be particular to an individual
airline. These include the extent of restrictions in the rules of the FFP, the way in
which the FFP is managed in practice and the pattern of take up of free travel
awards within the route structure of the airline. For an airline to be able to sustain
the view that fare paying passengers are not being displaced by frequent flyers it
will be necessary for the airline to maintain sufficient region by region data
concerning capacity management, load factors and redemption patterns to justify
that the assertion not only holds true historically but that it is likely to hold true for
the future.
5.6 With regard to assertion 5.3 b), it is likely that historical ratios of the level of free
travel to overall traffic (expressed in Revenue Passenger Kilometres (“RPK”s) or
Available Seat Kilometres (“ASK”s) will provide a useful benchmark to whether or
not the assertion can be met. However, this may not be the case if awards under a
FFP have been significantly stepped up (for example, through double or triple
mileage awards) such as to invalidate historical trends. It is self evident that should
frequent flyer traffic becomes a more material proportion of total traffic, the need
to consider deferring revenue (as opposed to accounting for incremental costs)
becomes more relevant. However, despite the apparent validity of this viewpoint, it
does not appear practicable to identify a particular threshold, applicable to all
airlines, over which it might be held that the incremental cost method should as a
matter of course cease to be an appropriate accounting methodology.
5.7 A further refinement to the approach of choosing between the incremental cost and
deferred revenue methods may be to implement the latter for frequent flyer
redemptions expected to occur on sectors where passenger displacement is
considered to have become a material issue, but otherwise to adopt the incremental
cost method. Such a mixed approach would appear to have relevance more
generally to deal with the situation where an airline perceives an increasing need to
adopt a deferred revenue basis of accounting, but at the same time wishes not to
suffer a significant step change in provisioning levels brought about by shifting to a
deferred revenue accounting basis across the FFP as a whole.
5.8 With regard to non air travel awards, the costs to the FFP of offering such rewards
is the cost charged to the airline for the product. It appears appropriate that
irrespective of the approach adopted for accounting for free air travel, the
incremental cost approach should be adopted for this category of reward
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This will require that airlines accumulate sufficient data regarding the proportion of
FFP points redeemed against non-air travel rewards to enable the provision for
redemption of air miles to be properly assessed.
6. REDEMPTION RATES
6.1 Whichever accounting methodology is applied, a key factor in determining the scale
of a FFP liability is the estimate of frequent flyer points which are expected to be
redeemed. In practice the redemption rate determined is influenced by a number of
factors:
a) The threshold of points required before a FFP member can secure a reward
and the mix of rewards under the FFP. the risk of redemption will clearly
be impacted by the ease with which members can accumulate sufficient
points to make a redemption and the attraction of the rewards offered by
the FFP.
b) The “sunset” period established for the scheme. A number of FFPs have a
proviso that frequent flyer points be used within a specific time period or
they are lost. The risk of redemption of the air miles population will be
affected by any systematic culling of unutilised points.
c) The redemption experience of the airline. Airlines will be able to develop
statistics including overall numbers of frequent flyer points redeemed,
proportion air travel and non-air travel rewards, flight sectors against which
rewards are taken, nature of other rewards taken, the frequency of
redemptions and the utilisation of air miles amongst particular member
categories.
6.2 Some airlines with well established schemes and comprehensive redemption data
have been able to build up experience based algorithms to estimate the likelihood of
redemption.
6.3 There does not appear to be uniform practice as to the point in time at which a
potential liability for unredeemed points is taken into account. One approach is to
provide only when those members of the FFP have accumulated sufficient points to
obtain a free travel award; another approach is to take account of the whole
population of points being accumulated. The latter approach seeks to recognise the
possibility that a proportion of those members of the FFP below the threshold will
ultimately convert their points into awards and in principle is considered more
appropriate, provided it makes due allowance for the members who are likely never
to accumulate enough miles to qualify for an award.
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7. ACCOUNTING FOR NON-SPONSOR AIRLINE PARTICIPANTS
7.1 A number of airlines have sought to extend the coverage of their FFP by involving
non-airline sponsor airline participants. Such participants grant frequent flyer
points as an inducement for the purchase of their products and pay the airline (or
effectively the FFP) for the ability to utilise the marketing benefits of the FFP.
7.2 In determining how to account for the involvement of non-sponsor airline
participants, the following factors are pertinent:-
(a): the basis upon which frequent flyer points are sold to the participant for use
to its customers. There are thre ways in which arlines issue points:
(i) Sale or return basis where clearly an airline will need to take account of
any rights held by the participant to return unsold frequent flyer points
to the airline,
(ii) Where participants only have an obligation to pay for the frequent flyer
points when they are redeemed by a member,
(iii) Where participants purchase points on issue from the airline, but at a
lower unit price than in (ii) above;
(b): in recording the sale of frequent flyer points to participants the airline should
where possible separate that element of the slae which represents the maount
associated with other goods or services acquired by the participant, such as
the acquisition of righs to use an airline’s database or customer mailing list.
Only the elements of the slae, which relate to their participation in the FFP,
should be subject to a provision for redemption risk.
7.3 In practice the following alternative approaches have evolved for accounting for the
revenue from non-sponsor airline participants:
a) To record the whole of the revenues as soon as amounts become receivable
for frequent flyer points disposed of and make a provision for redemption of
these points on a basis consistent with an incremental cost approach; or
b) To spread the revenues over the period of redemption of the frequent flyer
points disposed of, in line with the rate of usage of these points.
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7.4 Conceptually the Accounting Policy Task Force believes that the approach outlined
under 7.3 b) above is theoretically preferable. This conclusion has been reached
because the situation may be seen as analogous to the advance sale of spare
capacity or block of seats to a customer at an agreed rate, in which circumstances
generally accepted accounting would be to only recognise sales revenue when
travel takes place. However, this analysis may be argued to over simplify the
situation in that many FFPs involve awards other than air travel and consequently
there is no certainty until the point of redemption, whether an obligation to provide
services will ever arise. In practice therefore the Task Force recognises that the
above analogy is not wholly persuasive and concludes that for practical reasons,
where non-sponsor airline participants do not represent a significant part of the
overall throughput of the FFP, it may be reasonable to record the whole of the
revenue as soon as the frequent flyer points are disposed of and to make a provision
for the cost of redemption of these points.
8. CO-OPERATION AND SHARED ARRANGEMENTS
8.1 In practice certain airlines enter into arrangements whereby they co-operate with
other airlines in providing frequent flyer benefits to passengers. Typically such
arrangements might involve:
a) an ability to access each other’s FFP such that members of one airline’s FFP
can utilise their points to obtain rewards from another participating airline;
or
b) the sharing of a single FFP operated through a joint venture company.
8.2 With regard to paragraph 8.1 a) the financial statements would generally involve
each airline’s FFP remaining distinct except that periodically the airlines concerned
would settle any imbalance of points used on each others’ programme at an agreed
rate. On that basis, so far as the accounting approach is concerned, it does not
appear that any particular new factors are introduced; however, it might be
expected that the implied wider access of each of the FFPs adds to the probability
of unredeemed points being used and could therefore lead to a need for an increase
in assumed redemption rates.
8.3 With regard to paragraph 8.1 b), the situation is potentially more complicated. The
aggregated frequent flyer obligations of each of the participating airlines build up in
the joint venture company, with each of those airlines incurring a liability to the
joint venture company to service frequent flyer points granted to its own
passengers. Members of the FFP would be able to redeem points for flights on any
of the joint venture airlines.
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8.4 Charges made by the joint venture company to the airlines for points issued would
be expected to be expensed in each of the airlines’ accounts as frequent flyer points
are issued. Providing those charges are set at a level adequate to meet the future
costs of operating the FFP the accounting position has the appearance of being
more clear cut. Nevertheless, the underlying issues surrounding the appropriate
method of accounting and setting of redemption rates remain essentially unchanged
for each of the participating airlines despite the existence of the joint venture
vehicle. With regard to the method of accounting, the judgement would still have
to be made as to whether an incremental cost or referred revenue approach is
appropriate, having regard to the various factors discussed earlier. Consequently,
the situation might arise whereby the periodic payments to the joint venture
company are set at a level to cover the incremental costs of meeting the frequent
flyer points awarded but the airline has to set aside additional provisions to put
itself into a position equivalent to having accounted for his frequent flyer
obligations on a deferred revenue approach.
8.5 Another consideration under the joint venture scenario is the possibility of recourse
by beneficiaries of the FFP to the remaining airlines should one of the participating
airlines cease to operate or indeed if the joint venture entity itself ceased to operate.
The specific legal arrangements in force between the joint venture company and the
participating airlines will dictate the relevance of this issue.
9. CLASSIFICATION OF FFP COSTS
31 The classification within the profit and loss account of the economic cost of
operating the FFP is influenced partly by the choice of approach of accounting for
the FFP: under the deferred revenue approach the accounting of the FFP flows
automatically through the turnover caption; under the incremental cost method an
airline is likely to regard the cost of the FFP as part of its marketing and
promotional activities. These costs would therefore generally be charged as a cost
of sale
10. RECOMMENDATIONS
10.1 The Accounting Policy Task Force notes the existence of two conceptually
different techniques for frequent flyer accounting, namely the incremental cost
approach and the deferred revenue approach and consider that either may be an
appropriate method of accounting depending on the commercial circumstances in
which the FFP is being operated. A third approach, which is not a treatment
recommended as appropriate, is to report future obligations under a FFP only as a
contingent liability within the notes to the accounts.
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10.2 The incremental cost approach is regarded as the most appropriate technique,
provided that an airline can establish quantitatively that passengers flying as a result
of awards under the FFP are incidental to the passenger revenue process. This
presumes that (a) it can be demonstrated that there is no significant displacement of
fare paying passengers by those passengers who are utilising their frequent flyer
awards and (b) that the level of free travel passengers (expressed in terms of RPKs
or ASKs) is immaterial in the context of overall passenger traffic. If both (a) and
(b) cannot be demonstrated, the deferred revenue approach should be adopted.
10.3 The Accounting Policy Task Force considers it likely that most, if not all FFPs will
be accounted for using the incremental cost approach in their early years, but this
should not be seen as precluding the possibility of needing to change subsequently
to a deferred revenue approach. Accordingly, in order that an airline is able to
reassess on a periodic basis whether or not a deferred revenue approach has
become applicable, the Accounting Policy Task Force considers it critical that
sufficient data is maintained concerning the redemption patterns of a FFP, to
establish not only the historical extent of displacement of fare paying passengers but
also the expected future trend in that regard,.
10.4 In instances when the deferred revenue approach is viewed to be increasingly
relevant the Accounting Policy Task Force, does not rule out the possibility that
airlines should adopt a mixed incremental cost / referred revenue approach, such
that the deferred revenue approach is only used in respect of sectors where
passenger displacement is believed to be occurring.
10.5 Whichever accounting methodology is applied the Accounting Policy Task Force
considers that the whole population of points accumulated should be taken into
account to recognise the fact that some FFP members below the threshold for
claiming credit under the scheme will ultimately qualify for free travel.
10.6 The deferred revenue approach is regarded as technically preferable for accounting
for revenues from non-sponsor airline participants. This conclusion has been
reached because the situation may be seen as analogous to the advance sale of spare
capacity or a block of seats to a customer at an agreed rate. However, the
Accounting Policy Task Force recognises that this analogy is not wholly persuasive
and concludes that for practical reasons, where non-sponsor airline participants do
not represent a significant part of the overall throughput of the FFP, it may be
reasonable to record the whole of the revenue as soon as the frequent flyer points
are sold by the participating airline and at the same time to make a provision for the
cost of redemption of those points.
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10.7 The Accounting Task Force recognise that certain schemes involve the
establishment of a joint venture into which participating airlines make payment as
frequent flyer points are sold and receive payments as points are redeemed on their
flights. In principle, the practicalities of these arrangements inevitably lead to
different accounting consequences, but the Accounting Task Force believes that the
key principles affecting the choice of the method of accounting and the associated
disclosures remain essentially unchanged from the situation when an FFP is
operated directly by an airline.
10.8 More generally the establishment of a detailed database of statistical information
and experience trends concerning a FFP is seen as vital to an assessment of its
financial impact and therefore of the accounting methodology employed. Such a
database should encompass information on:
• the profile and ageing of points in issue
• redemption rates
• the mix of awards taken up
• the profile of flight sectors chosen for free flight awards and load factors on
those sectors
• source of air miles
10.9 The Accounting Policy Task Force recognises that a deferred revenue approach
will impact reported results directly through the turnover caption. However, with
regard to the incremental cost method, the costs are likely to be reflected as a cost
of sale.
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11. DISCLOSURE
11.1 Where material, it is recommended that the following disclosures are made in the
annual accounts in relation to frequent flyer accounting:-
a) With regard to the accounting policy:
• an outline of the nature scheme;
• the method of accounting for a FFP, disclosing whether the
incremental costs or the deferred revenue approach has been
adopted;
• if the incremental cost method is used, describe which principle
costs are allowed for in providing for such costs and explain which
caption in the profit and loss account is debited with the costs;
• if the deferred revenue method is used, describe the method of
calculating that portion of the revenue that is to be deferred;
• the method of accounting for other participants and non air travel
rewards;
b) With regards to disclosures in the notes to the accounts:
• For the period in question; the proportion of total passenger traffic
arising from FFP rewards (expressed as a percentage of total RPKs
or ASKs);
• value of the opening and closing provision.
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