A new revenue recognition standard was released jointly by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) (collectively known as the boards) in May 2014. For over a decade, these standards have been worked on to become the single most important, industry-spanning topic ever tackled.
Within the airline industry, for example, the new standard will supersede virtually all revenue recognition guidance in US GAAP and IFRS, including industry-specific guidance used today.
The new standard provides accounting guidance for all revenue arising from contracts with customers and affects all entities that enter into contracts to provide goods or services to their customers (unless the contracts are in the scope of other US GAAP requirements, such as the leasing literature). The new revenue recognition standards are more principle-based than the existing revenue guidance, requiring all industries follow the industry specific advice. The airline industry certainly has a few important areas needing attention and necessary work to meet the new standard.
Airlines certainly have to change how they account for loyalty programs, which in turn affect their financial results.
They may also need to change the presentation of their income statement, especially for inter-airline billings, ancillary services and passenger ticket breakage. The Airlines industry can monitor the discussion of the Boards’ Joint Transition Resource Group for Revenue Recognition (TRG) and a task force formed by the American Institute of Certified Public Accountants (AICPA) to focus on airline issues. The boards created the TRG with the purpose of facilitating discussions in this wave of change and to help industries understand the implementation procedure. The group also provides a good forum for commonly asked questions to be discussed and to date has been systematically addressing these issues. Refer to our earlier post on TRG’s role – Help is on the way!
The flight path
Airlines will need to work on changing both the presentation of the income statement and the pattern of revenue recognition. Airlines are a complex industry heavily dependent on a high level of collaboration between competing companies and brands. It is essential the industry looks closely and carefully considers the circumstances for how to treat loyalty points, frequent flyer miles, inter-airline billings (known as interline billings), ancillary services revenue and passenger ticket breakage.
Account for the loyalty
Most airlines offer loyalty programs which allow customers to earn miles or points for flying on the airline. Customer can also get points or miles through partner arrangements including co-branded credit cards, flights on other airlines and activities with other travel partners such as rental car companies and hotels. Airline entities moving from an incremental cost method to treating loyalty points as a revenue element will have to allocate some portion of the transition price to the loyalty element, based on the estimated standalone selling price of each performance obligation. Airlines which have treated miles or points sold to partners, such as co-branded credit card providers, as revenue elements should be able to use that model as a starting point for the estimates necessary to value flown miles. However, the new guidance may affect the valuation of the miles.
Ancillary services
Some airlines (the selling airline) have arrangements with other airlines (the operating airline) to sell tickets for flights (fully or partially) by the operating airline. The transactions are settled when the passenger is flown by the operating airline, with the operating airline billing the selling airline, based on the terms of what is called the interline agreement.
The timing of revenue recognition may change if ancillary services are not determined to be distinct.
Passenger ticket breakage
Airline tickets are often purchased in advance which means the items may go unused on the flight date. Both refundable and non-refundable tickets have a chance they might go unused by the customer. Under current guidance, airlines have the option to recognize breakage revenue at expiration using the expiration method (when the ticket is unused at flight date or expires) or in advance using the redemption method (generally based on the pattern of associated flown revenue). Under US GAAP, the expiration method generally has been considered the preferable method.
Under the new standard, an airline must estimate unexercised rights and recognize expected breakage as revenue in proportion to the pattern of rights exercised by the customer. The result will be similar to today’s redemption method, and as a result, the new model eliminates the expiration model. This will be a significant change from current practice for airlines that apply the expiration method.
Possible route for airlines
The sooner entities conduct a preliminary assessment of how the new standards will affect them, the better it will be for a smooth implementation. All entities will need to evaluate the requirements of the new standard and make sure processes and systems are in place to collect the necessary information to implement the standard, even if accounting results won’t change significantly or at all.
Entities should already be monitoring discussions of the TRG to ensure (a) they are up to date and (b) to have a good understanding of the issues faced by other industries along with possible solutions to common transactional problems.