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Revenue recognition

project – preliminary
IFRS views
Appendix A – airlines

This industry-specific appendix should be read together with the publication titled
Revenue recognition project – preliminary IFRS views. The main body of the publication
provides a summary of the revenue recognition model proposed in the Discussion Paper,
highlights some issues for companies to consider in evaluating the merits of the
Discussion Paper and discusses some of the expected changes to current IFRS.
This appendix is provided as a means to highlight some of the more significant
implications that the proposed revenue recognition model may have on the airlines
industry. We encourage companies to read the topics carefully and consider the
potential effects that the proposed model could have on their existing revenue
recognition practices.
The issues discussed in this appendix are intended to provoke thought and assist
companies in analysing the potential implications, for their businesses, of the proposals
contained in the Discussion Paper. The discussions within this publication do not
represent final or formal views, as the elements of the Discussion Paper are subject to
change on further deliberation by the Boards.

An airline’s operating revenue is derived primarily from the carriage of passengers. An

airline may also earn passenger revenue from change and other transaction fees and its
frequent flier programme (FFP). Other operating revenue may be earned from air cargo
operations—principally air freight and mail services.
The Boards’ proposed model is currently not expected to significantly affect the timing or
measurement of revenue recognition for passenger ticket sales, or air cargo operations for
most airlines. However, in the case of air cargo shipments in transit at the end of a
reporting period, the Boards’ proposed model will probably not allow revenue to be
recognised based on the percentage of service completed. The proposals may also affect
the valuation of FFP award credits, if the residual method of valuing the other components
is no longer permitted.
Preliminary considerations are that there Passenger ticket sales
are certain issues related to passenger
ticket sales, change and other transaction Under the current requirements of IAS 18
fees and FFPs that are not yet addressed in Revenue, passenger ticket sales are initially
the Boards’ proposed model, or for which recorded as unearned revenue (i.e., air
additional guidance will be needed. These traffic liability (ATL)) when a ticket is sold
include: and the scheduled service is at a later date.
• W
► hether revenue estimates may be Revenue is subsequently recognised (and
recognised before the airline has satisfied the associated ATL extinguished) either
all its obligations under a contract when transportation is provided or when
because the customer has not required the associated ticket expires unused, which
the airline to perform. and is unlikely to is generally referred to as “breakage”.
do so (i.e., may an airline record estimates Breakage is generally caused by various
of “breakage” in revenue) factors, including the airline industry’s
• W ► hether change and other transaction pricing structure and interline agreements
fees are separate performance (i.e., agreements to handle passengers
obligations independent from the travelling on itineraries that require multiple
original ticket sale airlines). Airlines frequently record revenue
• T► he manner in which revenue should be for estimates of breakage before the airline
recognised in respect of incomplete air has satisfied all its obligations under the
cargo transactions at a reporting date sales arrangement because the customer
• W ► ho is the customer for FFP miles, has not required the airline to perform and
points or segments (collectively referred is unlikely to do so. These estimates are
to as mileage credits) sold to third parties generally based on the evaluation of
(e.g., credit card issuers, hotels, car historical trends, including the use of
rental companies, etc.) and when has the regression analysis and other methods to
airline satisfied its performance model the outcome of future events based
obligation for these sales on the airline’s historical experience.

These issues are discussed in further The Boards’ proposed model for
detail below. recognising a performance obligation when
an entity enters into a contract with a
customer generally will not differ from the
current revenue recognition model in
practice for airlines — that is, recording an
ATL as a performance obligation when a
ticket is sold and subsequently recognising
revenue for each sector on a flown basis.
However, the Board’s proposed model does
not currently provide any specific guidance
relating to breakage or an entity’s ability to
recognise revenue if it determines it is
unlikely that it will be required to satisfy a
performance obligation (e.g., that an airline
customer is unlikely to use a ticket). Any
final model that precludes recognition of
revenue for estimated breakage will be a
significant change in accounting practice
for many airlines.

2 Revenue recognition project – preliminary IFRS views  Appendix A – airlines

Change and other Other transaction fees (e.g., paper ticket Frequent flier programs
fees, excess baggage and reservation fees)
transaction fees are charged by airlines for providing various Mileage credits granted to passengers
services. Each of these transaction fees that
The accounting for change and other Accounting for an airline’s FFP is highly
qualify as separate units of accounting are
transaction fees currently varies under judgmental and generally involves a number
generally recognised as revenue when the
current accounting practice. The of assumptions and estimates. Following the
related service is provided.
predominant industry practice is to account adoption of IFRIC 13 Customer Loyalty
for change fees as a separate transaction Under the Boards’ proposed model, it is Programmes, a portion of passenger
independent from the original ticket sale. uncertain which of the two views described revenue generated from the sale of tickets
Under this approach, change fees are above will be applicable to change and for current air travel is deferred until FFP
viewed as fees charged subsequent to the other transaction fees. With either awards credits are redeemed and used for
initial sales transaction. There is no approach, the primary issue is what travel or other services by the programme’s
requirement for the passenger to pay the performance obligations are identified. members (Members).
fees at the time of the original sale and Although unclear, it may be likely that
IFRIC 13 permits two models for the
passengers who pay change fees receive change fees are not considered
allocation of transaction price between the
additional utility that they are not otherwise independent of the transportation services
passenger ticket sale and the FFP award
entitled to (that of being allowed to under the Boards’ proposed model.
credit as follows:
exchange the original ticket and, therefore,
preserve its value). Under this approach, (a) Transaction price is allocated to the
revenue related to change fees is Air cargo FFP award equal to its fair value and
recognised when the fee is assessed, which the residual value allocated to the
might be when the original ticket is either For air cargo operations, revenue is typically passenger ticket sale
cancelled or exchanged. earned when the airline or carrier provides (b) Transaction price is allocated based on
An alternative approach suggests there is the transportation service. For freight in the relative fair values of the FFP
only one deliverable, passenger transit at the end of a reporting period, award credit and passenger ticket sale.
transportation, and that change fees do most carriers: 1) recognise revenue when
the shipment is completed with expenses The Boards’ proposed model is that the
not represent a separate revenue-
recognised as incurred; or 2) allocate transaction price should be allocated to each
generating event. This view is based on the
revenue between the reporting periods performance obligation in proportion to the
notion that a passenger agreeing to pay a
based on relative transit costs in each stand-alone selling price. That is, option (b)
change fee is electing to do so based on it
period with expenses recognised as under IFRIC 13. Many airlines have elected
being the lowest cost alternative available
incurred. However, under the Boards’ to apply option (a) on adoption of IFRIC 13.
to obtain the preferred travel. Therefore,
proposed model, the latter method may not Therefore, this may result in a change in the
performance cannot take place until the
be acceptable if it is determined that cargo measurement of the outstanding
airline provides transportation to the
services are represented by a single performance obligation for FFP award
passenger. As such, revenue related to
performance obligation being the delivery credits due to the difference between the
change fees would only be recognised
of cargo to its destination stand-alone fair value and the relative fair
when the ultimate transportation service
value of FFP award credits compared to the
is provided.
fair value of passenger tickets.

Revenue recognition project – preliminary IFRS views  Appendix A – airlines 3

Mileage credits sold to third parties Arrangements to sell mileage credits to
Partners also frequently include other
Airlines may also sell mileage credits to
elements. For example, an airline may sell
non-airline vendors (Partners). In such
mileage credits to a credit card company in
instances, the Partners generally distribute
connection with customer lists that the
the purchased mileage credits to their
credit card company can use to solicit FFP
customers (that are also Members of the
Members to apply for a card it issues. These
airline’s FFP) based on purchases or other
transactions are currently accounted for as
revenue-generating actions. Ultimate
multiple-element arrangements. If possible,
redemption of the mileage credits generally
an airline separates the component of the
involves delivery of transportation services
arrangement representing the value of the
by the airline. For example, an airline may
future travel awards (the mileage credits)
sell miles to a credit card company. The
from the component that represents the
credit card company in turn awards the
value associated with the other goods or
miles to its cardholders, who are also
services acquired by the Partners, such as
Members of the airline’s FFP, based on
the right to use the airline’s database or
purchases made using the credit card
customer mailing list (the marketing
company’s cards. Members meeting the
component). Under the Boards’ proposed
airline’s criteria for award redemptions can
model, if selling prices cannot be observed
redeem the resulting miles for travel
for the marketing component, the airline
services provided by the airline.
will be required to estimate such prices, in
For mileage credits sold to third parties line with the current accounting
under an airline’s FFP, additional guidance requirements, and allocate the transaction
may be needed about the Boards’ proposed price between the two components based
model to determine: 1) who is the on relative stand-alone selling prices.
customer; and 2) when has the airline
satisfied its performance obligation.
Although it seems unlikely that the airline
will satisfy its performance obligation on
transfer of the mileage credits to the credit
card company, we think further clarification
is needed on this topic.

4 Revenue recognition project – preliminary IFRS views  Appendix A – airlines

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Regional airlines and capacity Currently, the Boards’ proposed model as
unwavering commitment to quality. We
described in the Discussion Paper does not
purchase agreements exclude any particular contracts with
make a difference by helping our people,
our clients and our wider communities
customers, including contracts or achieve their potential.
Regional airlines and capacity purchase
components of contracts that may be
agreements are currently more common in For more information, please visit
deemed leasing contracts. However, the www.ey.com.
the US and therefore there is currently
Boards are considering whether the
limited application of IFRS to such Ernst & Young refers to the global
proposed model and, in particular, its
agreements. organization of member firms of
measurement approach, would provide
Ernst & Young Global Limited, each
However, under IFRS a regional airline decision-useful information for, among of which is a separate legal entity.
would be required to determine, in others, leasing contracts. If leasing Ernst & Young Global Limited, a UK
accordance with IFRIC 4 Determining contracts are excluded from the Boards’ company limited by guarantee, does
whether an arrangement contains a lease, proposed model, we do not believe the not provide services to clients.
whether its capacity purchase agreement proposed model will have a significant
with the major airline has lease revenue effect on how regional airlines should
About Ernst & Young’s International
embedded in the agreement. If a portion of recognise revenue for their capacity
Financial Reporting Standards Group
the capacity purchase agreement is purchase agreements in comparison to The move to International Financial
considered a lease, the lease components current practice. That is, regional airlines Reporting Standards (IFRS) is the single
are separated from the non-lease will be required to consider whether the most important initiative in the financial
components on a relative fair value basis. capacity purchase agreement includes an reporting world, the impact of which
The minimum lease payments associated embedded lease as discussed in IFRIC 4. stretches far beyond accounting to affect
with the lease components of the However, if leasing contracts are included in every key decision you make, not just how
you report it. We have developed the global
agreement are then accounted for in the scope of the Boards’ proposed model
resources — people and knowledge — to
accordance with IFRIC 4 and the executory and a regional airline has historically support our client teams. And we work to
costs, such as insurance, maintenance and separately accounted for the leasing give you the benefit of our broad sector
taxes are evaluated and accounted for in component, it is likely the proposed model experience, our deep subject matter
accordance with the regional airline’s will result in a different revenue recognition knowledge and the latest insights from our
revenue recognition policy. The flight- pattern. The significance of any effect on work worldwide. It’s how Ernst & Young
related non-lease components are makes a difference.
such a revenue recognition pattern will
generally recognised as revenue upon depend on the terms of the capacity
flight completion. purchase agreement.

Final remarks
Our hope is that the issues discussed in this
publication will prove thought provoking
and will assist entities in analysing the
potential implications of the proposals
contained in the Discussion Paper for their
businesses. However, the topics addressed www.ey.com/ifrs
in this appendix are not an exhaustive list of © 2009 EYGM Limited.
all the aspects of revenue recognition that All Rights Reserved.
the proposed model may affect. In addition, EYG no. AU0305
the issues discussed may change
significantly based on any final standard
This publication contains information in summary form
promulgated by the Boards. and is therefore intended for general guidance only.
It is not intended to be a substitute for detailed research
or the exercise of professional judgment. Neither EYGM
Limited nor any other member of the global Ernst & Young
organization can accept any responsibility for loss
occasioned to any person acting or refraining from action
as a result of any material in this publication. On any
specific matter, reference should be made to the
appropriate advisor.