Accounting for Frequent Fliers

To be, or not to be a Liability

 Humaira Sardar Ali Irfan Rashid M. A. Ghani Chishty Robina Kiran Noman Bari S. Najmul Hassan

The Team

 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 Uniteds FFP
Financial Statements or SEC Disclosure? What & why?

Presentation Outline

 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

Cost of Redemptions

 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

General NOTES!!! (Not incl. in Pres.)

 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

Definitions

Definitions - II

 Airlines consider ALL PAX in their RPMs, meaning, Airline RPMs contain:
Revenue (Paying) PAX, and Frequent Flyer (i.e. Free/Redeemed) PAX

Definitions - III

 Based on Averages & Industry reports Based on Opportunity Cost Based on Displaced Earnings due to FFP Based on Deferred Revenue

Methods of Measuring Cost (MMC)

Description RPM (United) Revenue PAX Total PAX Average PAX Journey Average Flight Length PAX Load Factor (PLF) Breakeven PLF Average Yield per RPM Cost Per ASM Price of Fuel/Gallon Average Fare per Revenue PAX

Units Miles Numbers Numbers Miles Miles % % USD USD USD USD

Numbers 76,137,000,000 57,598,000 59,901,920 1,322 912 66.2% 66.5% $0.126 $0.096 $0.804 $167.26

MMC - II

Description
Total Revenue Industry Average RPM under FF (1990) FF RPM (United - 1990) Revenue Generating RPMs FF PAX Total PAX FF as %age of Total PAX Average Fare for ALL PAX Fare Premium for Revenue PAX Fare Premium REDEEMED Total Fare Premium (From revenue PAX)

Units
USD % Miles Miles Numbers Numbers % USD USD USD USD

Numbers
$9,633,841,480 4% 3,045,480,000 73,091,520,000 2,303,920 59,901,920 3.85% $160.83 $6.43 $14,821,295 $370,532,365

MMC Averages & Industry Reports

Total Fare Premium (From ALL PAX)

USD

$385,353,659

Description Lost Revenue from FF @ Average Fare Total POTENTIAL Revenue (FF+Rev PAX = 9.6B + 385M) Total POTENTIAL Yield for Revenue RPMs (Rev / Rev RPM) Total POTENTIAL Yield (Total Rev Pot. / RPM) Average Yield

Units USD USD USD USD USD

Numbers $385,353,659 $10,019,195,139 $0.132 $0.132 $0.126

MMC Opportunity Cost

 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

MMC Displaced Earnings

Description Fare value of Point Credits Revenue Recognized Deferred Revenue

Units

Numbers

USD USD USD

$6.69 $15,414,146 $385,353,659

MMC Deferred Revenue

Description Fare Premium REDEEMED Liability / Deferred Lost Revenue

Units

AIR

OC -

DE $0 $0

DR $15,414,14 6
$385,353,65 9

USD $14,821,295 USD

$370,532,36 5

$385,353,65 $38,535,366 9

MMC Opportunity Cost

 Deferred Revenue is the way that we should calculate costs of the FF Program Why?
IFRIC 13 IAS 18
Description Fare value of Point Credits Revenue Recognized Deferred Revenue Units Numbers

USD USD USD

$6.69 $15,414,146 $385,353,659

Method for Cost Calculation Chosen - DR

 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

MCCC Deferred Revenue - II

 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

Continuing the 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.

Disclosure of FFP

 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

What should be Accounted for / Disclosed

 Recognized as a deferred revenue, or provision for future costs

Way to Choose Accounting for the Prog.

 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

Accounting of FFP in Published Financials

Description (Expense/Future Cost)

$ Dr. 167.26

$ Cr. 160.83 6.43

Cash (Fare Collected) Revenue Provision for FF

Description (Deferred Revenue)

$ Dr. 167.26

$ Cr. 160.83 6.43

Cash (Fare Collected) Revenue Deferred Revenue

Accounting of FFP in Published Financials - II

 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

If I were the CFO

Thank you!