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
are certain issues related to passenger
ticket sales, change and other transaction
fees and FFPs that are not yet addressed in
the Boards’ proposed model, or for which
additional guidance will be needed. These
include:
• W
► hether revenue estimates may be
recognised before the airline has satisfied
all its obligations under a contract
because the customer has not required
the airline to perform. and is unlikely to
do so (i.e., may an airline record estimates
of “breakage” in revenue)
• W ► hether change and other transaction
fees are separate performance
obligations independent from the
original ticket sale
• T► he manner in which revenue should be
recognised in respect of incomplete air
cargo transactions at a reporting date
• W ► ho is the customer for FFP miles,
points or segments (collectively referred
to as mileage credits) sold to third parties
(e.g., credit card issuers, hotels, car
rental companies, etc.) and when has the
airline satisfied its performance
obligation for these sales
These issues are discussed in further
detail below.
2 Revenue recognition project – preliminary IFRS views  Appendix A – airlines
Passenger ticket sales
Under the current requirements of IAS 18
Revenue, passenger ticket sales are initially
recorded as unearned revenue (i.e., air
traffic liability (ATL)) when a ticket is sold
and the scheduled service is at a later date.
Revenue is subsequently recognised (and
the associated ATL extinguished) either
when transportation is provided or when
the associated ticket expires unused, which
is generally referred to as “breakage”.
Breakage is generally caused by various
factors, including the airline industry’s
pricing structure and interline agreements
(i.e., agreements to handle passengers
travelling on itineraries that require multiple
airlines). Airlines frequently record revenue
for estimates of breakage before the airline
has satisfied all its obligations under the
sales arrangement because the customer
has not required the airline to perform and
is unlikely to do so. These estimates are
generally based on the evaluation of
historical trends, including the use of
regression analysis and other methods to
model the outcome of future events based
on the airline’s historical experience.
The Boards’ proposed model for
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.
Change and other
transaction fees
The accounting for change and other
transaction fees currently varies under
current accounting practice. The
predominant industry practice is to account
for change fees as a separate transaction
independent from the original ticket sale.
Under this approach, change fees are
viewed as fees charged subsequent to the
initial sales transaction. There is no
requirement for the passenger to pay the
fees at the time of the original sale and
passengers who pay change fees receive
additional utility that they are not otherwise
entitled to (that of being allowed to
exchange the original ticket and, therefore,
preserve its value). Under this approach,
revenue related to change fees is
recognised when the fee is assessed, which
might be when the original ticket is either
cancelled or exchanged.
An alternative approach suggests there is
only one deliverable, passenger
transportation, and that change fees do
not represent a separate revenue-
generating event. This view is based on the
notion that a passenger agreeing to pay a
change fee is electing to do so based on it
being the lowest cost alternative available
to obtain the preferred travel. Therefore,
performance cannot take place until the
airline provides transportation to the
passenger. As such, revenue related to
change fees would only be recognised
when the ultimate transportation service
is provided.
Revenue recognition project – preliminary IFRS views  Appendix A – airlines
Other transaction fees (e.g., paper ticket
fees, excess baggage and reservation fees)
are charged by airlines for providing various
services. Each of these transaction fees that
qualify as separate units of accounting are
generally recognised as revenue when the
related service is provided.
Under the Boards’ proposed model, it is
uncertain which of the two views described
above will be applicable to change and
other transaction fees. With either
approach, the primary issue is what
performance obligations are identified.
Although unclear, it may be likely that
change fees are not considered
independent of the transportation services
under the Boards’ proposed model.
Air cargo
For air cargo operations, revenue is typically
earned when the airline or carrier provides
the transportation service. For freight in
transit at the end of a reporting period,
most carriers: 1) recognise revenue when
the shipment is completed with expenses
recognised as incurred; or 2) allocate
revenue between the reporting periods
based on relative transit costs in each
period with expenses recognised as
incurred. However, under the Boards’
proposed model, the latter method may not
be acceptable if it is determined that cargo
services are represented by a single
performance obligation being the delivery
of cargo to its destination
Frequent flier programs
Mileage credits granted to passengers
Accounting for an airline’s FFP is highly
judgmental and generally involves a number
of assumptions and estimates. Following the
adoption of IFRIC 13 Customer Loyalty
Programmes, a portion of passenger
revenue generated from the sale of tickets
for current air travel is deferred until FFP
awards credits are redeemed and used for
travel or other services by the programme’s
members (Members).
IFRIC 13 permits two models for the
allocation of transaction price between the
passenger ticket sale and the FFP award
credit as follows:
(a) Transaction price is allocated to the
FFP award equal to its fair value and
the residual value allocated to the
passenger ticket sale
(b) Transaction price is allocated based on
the relative fair values of the FFP
award credit and passenger ticket sale.
The Boards’ proposed model is that the
transaction price should be allocated to each
performance obligation in proportion to the
stand-alone selling price. That is, option (b)
under IFRIC 13. Many airlines have elected
to apply option (a) on adoption of IFRIC 13.
Therefore, this may result in a change in the
measurement of the outstanding
performance obligation for FFP award
credits due to the difference between the
stand-alone fair value and the relative fair
value of FFP award credits compared to the
fair value of passenger tickets.
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


Regional airlines and capacity
purchase agreements
Regional airlines and capacity purchase
agreements are currently more common in
the US and therefore there is currently
limited application of IFRS to such
agreements.
However, under IFRS a regional airline
would be required to determine, in
accordance with IFRIC 4 Determining
whether an arrangement contains a lease,
whether its capacity purchase agreement
with the major airline has lease revenue
embedded in the agreement. If a portion of
the capacity purchase agreement is
considered a lease, the lease components
are separated from the non-lease
components on a relative fair value basis.
The minimum lease payments associated
with the lease components of the
agreement are then accounted for in
accordance with IFRIC 4 and the executory
costs, such as insurance, maintenance and
taxes are evaluated and accounted for in
accordance with the regional airline’s
revenue recognition policy. The flight-
related non-lease components are
generally recognised as revenue upon
flight completion.
Currently, the Boards’ proposed model as
described in the Discussion Paper does not
exclude any particular contracts with
customers, including contracts or
components of contracts that may be
deemed leasing contracts. However, the
Boards are considering whether the
proposed model and, in particular, its
measurement approach, would provide
decision-useful information for, among
others, leasing contracts. If leasing
contracts are excluded from the Boards’
proposed model, we do not believe the
proposed model will have a significant
effect on how regional airlines should
recognise revenue for their capacity
purchase agreements in comparison to
current practice. That is, regional airlines
will be required to consider whether the
capacity purchase agreement includes an
embedded lease as discussed in IFRIC 4.
However, if leasing contracts are included in
the scope of the Boards’ proposed model
and a regional airline has historically
separately accounted for the leasing
component, it is likely the proposed model
will result in a different revenue recognition
pattern. The significance of any effect on
such a revenue recognition pattern will
depend on the terms of the capacity
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
in this appendix are not an exhaustive list of
all the aspects of revenue recognition that
the proposed model may affect. In addition,
the issues discussed may change
significantly based on any final standard
promulgated by the Boards.
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