The Hindu Business Line : Accounting for customer loyalty schemes

Customer loyalty programmes are prevalent and offered by varied service industries such as airlines, supermarkets, hotels, credit/debit card issuers, etc. There are divergent practices followed by each organisation to record and account for customer loyalty programmes.

IFRIC 13

Many companies treat the cost of redeeming reward credits as marketing expenses. On June 28, 2007, the International Financial Reporting Interpretations Committee (IFRIC) issued IFRIC 13 —Customer Loyalty Programmes — which seeks to eliminate this diversity in accounting.Before the issue of IFRIC 13 there were as many different accounting treatments as there are loyalty schemes. IFRIC 13 was issued to bring about uniformity in the accounting treatment of reward points or customer loyalty schemes.

This interpretation applies to all entities that grant reward credits as a part of sales transaction, including rewards that can be redeemed for goods and services not supplied by the entity but it does not apply to entities that settle the rewards on behalf of the issuer.

When a customer buys goods or services and receives reward points this is treated as multiple element arrangement. The revenue earned by the seller is consequently split between the goods or services and the reward credit at fair value. The revenue allocated to reward credit is deferred and only recognised when the reward credit is redeemed.

Programme categories

Normally there can be diverse customer loyalty programmes offered by each retailer, but these typically would fall in the following categories:

Reward points that customers can use in stores within the same chain, for discounted goods or services;

Arrangements where another company provides service of redeeming reward points against a variety of goods or services;

Arrangements that entitle the customers to use goods or services by another entity (example, co-brand credit cards); and

Reward points that customers can use in the same store.

The new accounting treatment of loyalty programmes as multiple element arrangement may pose challenges for those companies that have treated reward credits as marketing costs.

The management may believe that the only reason for offering an incentive is to encourage customers to keep coming back to the store — therefore a marketing cost. However accounting is more logical if it is considered from the perspective of the seller and the customer who has bought two items — goods or services and right to future goods or services at discounted rates.

The seller determines a fair value for the reward credit which generally will be the fair value goods or services that the customer will receive and then estimates the likely number of reward points that will be redeemed.

The fair value of the revenue estimated this way is deferred. The seller must maintain detailed customer data to estimate the expected levels of redemption and keep that estimate up-to-date.

Specific Guidance lacking

There is no specific guidance in the Indian accounting standards on accounting for reward points or loyalty programmes but the Expert Advisory Committee of the Institute of Chartered Accountants of India in the Compendium of Opinions (Volume XXI) has opined that the seller should create a provision for the liability at an amount equivalent to the cost expected to be incurred on redemption of outstanding reward points any time in future.

The liability for reward points outstanding expected to be redeemed in future may be estimated, at the year-end, by applying actuarial method. This brings about the major difference with IFRIC 13 which does not mandate a specific approach for estimating fair value of reward credit, but requires that it is based on the fair value to the customer, not the cost of redemption to the issuer.

The US Financial Accounting Standards Board’s Emerging Issues Task Force (EITF) could not reach a consensus in accounting for reward points and therefore was unsuccessful in developing a model to account for these points and loyalty programmes. There is divergence in practice in US GAAP for the accounting for loyalty programmes.

For those companies having IFRS set of books, the interpretation is to be applied to all financial statements beginning on or after July 1, 2008. The interpretation states that changes in accounting policy should be accounted in accordance with IAS 8 ’Accounting Policies, Changes in Accounting Estimates and Errors’. Comparatives for the year 2007 will need to restated accordingly. Deferred revenue for the comparative period is based on information available at the end of the comparative period.

(The author is a Mumbai-based chartered accountant. Responses to blfeedback@thehindu.co.in)

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