IFRIC 13 Customer Loyalty Programmes Essay

Introduction

Customer Loyalty Programmes are used by entities to provide customers with incentives to buy their goods and services (IFRIC). Presently there is no prescribed guidance on the manner in which the companies can account for their obligations related to the customer loyalty programs. In order to fill this gap, the International Financial Reporting Interpretations Committee (IFRIC) has issued IFRIC 13, detailing the accounting guidelines in respect of customer loyalty programmes. According to IFRIC, it is mandatory for the entities providing free goods or services or any discounts to recognize the value of such incentives as a ‘separately identifiable component’ of the original sale transaction relating to which the incentives were granted (Deloitte). The entities are obligated to defer the recognition of the value of such incentives till such time the obligations under the transactions in respect of the award credits have been fulfilled by the respective entities granting the awards. For accounting purposes the fair value of the consideration received or receivable on the original sale transaction is to be allocated on the goods or services or the awards, based on the relative fair values at which the incentives would have otherwise been sold separately. The interpretations have been scheduled to be applied on or after the First day of July 2008 with permission for application at an early date if so desired by the entities (Insights).

Revenue Recognition

In the case of private sector entities ‘accrual accounting’ has been developed to match the cost of the provision of goods and services with the revenue gained from their sale. However, accrual-based accounting has been tainted with some imprecision that makes the system of accounting use some undefined notions (Page and Spira, 1999). There are instances where the Accounting Standards Board appears to have given up reporting the revenue on an accrual basis as in the case of government taxation. The Board admits that ‘the recognition criteria are likely to be met when the resources are received” (Accounting Standards Board, 2003)

The treatment of estimation of the fair value of credits applies irrespective of the fact that the award credits are redeemed by the entity itself or by any party on its behalf. For the purpose of the accounting treatment of the fair value IFRIC 13 has not adopted the approach as prescribed under clause 19 of AASB 118; i.e., the approach of providing for the estimated future cost of the awards as a liability. Instead, the interpretation has specified the approach of deferring the revenue. The cost accrual approach of providing for an estimated liability arises in cases only where there is an additional cost to be incurred by the entity related directly to the item already sold and delivered. “In contrast loyalty awards relate to goods and services to be delivered at a later date” (BDO International)

The interpretation provides for the recognition of the consideration allocated to award credits in those cases where the entity awarding the credit is responsible for supplying the awards. The recognition of the revenue is to take place at the time when the redemption of the award credit takes place which marks the fulfilment of the obligation by the entity awarding the credits. The basis for calculating the amount to be recognized as revenue depends on the number of award credits that have been redeemed with respect to the total number of awards likely to be redeemed. There may be changes in the proportion of the awards that are expected to be redeemed after the initial grant of the awards. However such changes do not affect the measurement of the original consideration allocated to the awards at the time of sale. However, the changes in expectations do affect the amount of revenue to be attributed to each award at the time of redemption.

The interpretation provides for the recognition of the revenue as the gross consideration allocated to the reward credits when the entity is acting as the principal in awarding and redeeming the credits. The entity is entitled to recognize an expense in respect of its obligation to a third party in this connection. Alternatively, if the entity acts as an agent the revenue to be recognized is taken as the difference between the amount the entity allocates to the reward credits and the amount that is payable by the entity to the third party on account of the fulfilment of the obligation for the reward credit. The obligation to recognize the revenue may occur at the time the rewards are granted. In contrastingly it may so happen that the customer may choose to claim the award from the entity instead of from the third party. In such cases, the third party would become obliged to supply the award only when the customer makes the choice. The revenue will not be recognized until the customer makes a claim of the awards.

There are situations where the retailers distribute price reduction vouchers free of charge and independent of other transactions. The interpretation does not provide for recording the liability when the price reductions are given away except under situations where the redemptions may result in the products or services being sold at a loss. Where a loss is likely to result than the entity will be deemed to have created an onerous contract and therefore is obligated to make a provision under AASB 137 – Provisions, Contingent Liabilities and Contingent Assets.

Measurement

The basic method of measuring the impact is to allocate the consideration to the different elements of the program using fair values. It is to be noted that IFRIC 13 does not insist on the adoption of any specific approach for the estimation of the fair value for the purpose of allocation. However, the interpretation requires that the award credits should be based on the fair value to the holder of such benefits but not the relative cost of such incentives to the issuer. Thus “deferred revenue might be estimated using the fair value of the award credits or the relative fair values of the award credits and the goods or services sold” (PriceWaterhouseCoopers)

The method of estimating the fair value of an individual item of credit is to use the value of the discount that the customer would be able to obtain while redeeming the incentive provided by the seller on the goods and services at the time of selling. It is quite possible that some of the customers may not redeem any or all of the credit awarded to them. In such cases, the interpretation specifies that the fair value of a population of award credits may take into account the proportion of incentives that are only expected to be redeemed.

Ambiguity arises here as to the quantum of discounts or award credits that are likely to be redeemed.

Another area where the application of IFRIC 13 would be found difficult is that some award credits have a ‘use-by date. In these cases, the credits can be deemed to have a definite life. As the interpretation goes any deferred revenue that is not released previously would be released at the time when the credits expired. However, the amount of deferred revenue may not be material if the redemptions have been made regularly or updated. Those cases with a definite life thus do not pose any problem of measurement or accounting. But in the case of award credits where there is no definite period within which the awards can be redeemed it becomes imperative for the entities to estimate the period within which they would be redeemed. It is also essential that this estimate is revised periodically to ensure that the award credits are released at the appropriate time and the deferred revenues are taken into account. This may pose a difficulty for the retailers to decide whether they should have indefinite life incentive arrangements at all.

Information Requirements

The information that may be required by the companies which issue award credits poses another issue in respect of the valuation of the credits for the purpose of IFRIC 13. It is necessary for the company to collect the information necessary for the estimation of the fair value of the award credits and expected redemptions which in most cases would be found difficult.

The following table presents an illustration of how the fair value of incentives can be arrived at:

For a simple calculation of the fair value of the award credits the historical information may be found sufficient to make an assessment of the fair values. However, for calculations involving complex assumptions, it may become necessary that the firm takes the help of an actuary.

The estimates of fair value may become more complicated in cases where there are arrangements that are informal. For instance, if the customer is given a card and is stamped every time a coffee is purchased under the card with the incentive that the cardholder can get the 10^th cup of coffee free. In such instances, there are no ways that the entities could collect the data to arrive at fair value estimates. The interpretation has not provided for the method of collecting information in such instances nor has it exempted such instances from the purview of the application of the guideline.

Interpretation

One of the main concerns with the introduction of IFRIC 13 covering the customer loyalty programmes is that the standard remains undefined and ambiguous in many respects as has been explained elsewhere in this paper. This is due to the fact that the proposed standard is principles-based which is purported to be a statement of accounting principles that guide the accounting profession as opposed to a rules-based system where accounting requirements are provided for in greater detail. One of the difficulties associated with such a principle-based standard is that it is necessary for the entities and regulators to interpret the standard as to whether the accounting practices have been properly complied with. “In the absence of authoritative interpretations, reporting entities may find that their interpretations of the standards differ from the interpretation of the regulators, exposing them to potential liability” (Senate Committee).

In this connection, Mr John O’Grady of Ernst and Young has commented that the IFIRIC might have been overwhelmed. According to Group of 100 in the absence of an authentic interpretation, there is a potential risk that the major accounting firms and regulators may develop their own interpretations. For instance, the award credits cannot be classified as ‘separately identifiable components’ in an offhand manner as the Board has not prescribed any definition for the term (Joint Comment Letter)

Economic Consequences

According to Stephen A. Zeft, the economic consequences of new accounting standards to be established must be taken into account explicitly by the standard setters, in order to avoid the possible adverse consequences. In these instances, it becomes important that the interpretation must show that it has made a thorough study of the possible consequences and that the benefits from implementing the standards more than outweigh the possible adverse consequences. In the case of Interpretation 13 relating to consumer loyalty programmes, the benefits do not seem to be material when compared to the pains the entities have to take for arriving at the fair values of the reward credits. When compared to the volume of sales the number of credits that the entities may extend may not justify the cost of gathering and presenting the information.

The economic consequences should also be viewed from the angle of corporate responsibility, governance, finance and accounting. Ambiguity in accounting and reporting standards is most likely to result in major accounting frauds as has happened in the case of Enron. New questions and problems that correspond to new materials with undefined areas are most prone to create additional problems in accounting and reporting which is clearly the case with IFRIC 13.

Conclusion

As per the IFRIC 13, a proper approach for the customer loyalty programmes would be to apply the recognition criteria for revenue arising from the sale at the time when the reward credits are redeemed by applying fair value for the considerations. However, since there is still some ambiguity left with the proper accounting treatment under certain circumstances there is a potential risk that such situations are interpreted by the regulators and accounting firms according to their own judgment and approach. For instance, there are instances where the companies offer via their loyalty programmes goods and services which do not contribute to the building of the revenue of the company. IFRIC does not provide exemption in those cases and arriving at their fair value would pose a problem to the company.

References

Accounting Standards Board (2003) ‘Statement of Principles for Financial.

Reporting – Proposed Interpretation for Public Benefit Entities’ Accounting Standards Board.

BDO International ‘IFRIC Interpretation 13: Customer Loyalty Programmes’. Web.

Deloitte “IAS 18 Revenue – Customer Loyalty Programmes”. Web.

Group of 100 ‘Submission 12’, The Group of 100, p. 2.

IFRIC International Financial Reporting Interpretations Committee ‘IFRIC Interpretation 13 – Customer Loyalty Programmes’. Web.

Insights (2007) International: IFRIC Issues Guidance on Accounting for Customer Loyalty Programs’ McGladrey & Pullen Chartered Accountants. Web.

John O’Grady ‘Transcript of Evidence, O’Grady, 7 February 2005, p. 11.

Joint Comment Letter on IFRIC Draft Interpretation D 20. Web.

Page, M. and Spira, L. (1999) ‘The Conceptual Underwear of Financial Reporting’ Accounting, Auditing and Accountability Journal 12(4) pp 489 – 501.

PriceWaterhouseCoopers ‘IFRIC 13: Accounting for Customer Loyalty Programmes’. Web.

Senate Committee ‘Chapter Three: Issues’. Web.

Stephen A. Zeft ‘The Rise of Economic Consequences’. Web.