Airline Frequent Flyer Liability to Spike From New Accounting

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By Denise Lugo

Airline balance sheets won’t look the same next year—especially liabilities—after carriers apply new revenue accounting rules that take effect in January.

Investors will notice a boost in “passenger revenue,” an important line item that reveals earnings from ticket sales that stem from carriers having to reclassify ancillary fees—items like baggage fees and ticket upgrade fees—a Bloomberg BNA analysis of a sample of airlines’ quarterly reports revealed.

Carriers won’t see a hit to earnings or change in total revenue, the 10-Q filings state. Some will, however, have to book millions more in liabilities associated with frequent flyer points because of the accounting changes under Revenue from Contracts with Customers, ASC 606. Those rules must be adopted Jan. 1.

“For a flight flown, an airline would initially recognize less revenue on that flight relative to what they currently do today; the value of the miles earned on a flight will need to be deferred,” Michael Nesta, partner, accounting advisory services at KPMG LLP, told Bloomberg BNA. “Ultimately they’ll catch up when those miles get redeemed, and they’ll recognize more revenue in the future as mile redemptions occur.”

Liabilities to Increase

Southwest Airlines Co., American Airlines Inc., Delta Airlines Inc., JetBlue Airways Corp., among other airlines, said liabilities associated with customer flight points will increase because the new revenue rules eliminate the incremental cost method for frequent flyer accounting. Instead, carriers must revalue those liabilities using a relative-fair value approach.

Airlines’ frequent flyer programs are essential marketing elements designed to drive customer loyalty. The new rules change the dynamic in terms of the things that drive revenue, accounting practitioners said. It is not only just the purchase of the ticket today, but when miles are ultimately redeemed, that will drive the timing of revenue recognition in the future.

However, Jonathan Root, VP, senior credit officer at Moody’s, told Bloomberg BNA that though very important, the financial statement changes carriers disclosed are more about geography on their financial statements, than a hit to earnings or a change to total revenue.

“Most if not all companies are going to choose the retrospective method of adoption so the prior years are going to be restated as well,” Root said. “So there’s not going to be this jump.”

Southwest’s Surge to $1.2 Billion

Southwest Airlines’ current $62 million liabilities associated with its flight points will increase by about 20 to 25 times that value after it applies the new rules, the company said in its quarterly report filed in early August with the Securities and Exchange Commission.

“That kind of goes from $62 million to $1.2 billion of a liability on their balance sheet that hadn’t been there before,” Nesta said. “That means they’re going to be recognizing that revenue later down the road when those points are redeemed.”

The question, Nesta said, is whether their 2017 revenue would have been less under this method. “That’s a question that a lot of airlines will be getting soon. Southwest Airlines noted in their disclosures that the impact would not be material on their 2016 operating revenues,” he said.

Other airlines weren’t as specific as Southwest but said they expect substantial changes.

American Airlines said the standard “will materially impact our liability for outstanding mileage credit earned by AAdvantage loyalty program members when flying on American.” AA will have to defer a portion of each passenger ticket sale attributable to mileage credits earned and recognized under passenger revenue when the customer redeems it in the future, the company’s 10-Q states.

Similarly, Delta disclosed it would increase the rate used to account for frequent flyer miles, which would increase the balance of the frequent flyer liability. And JetBlue predicts a change in the way it records the financial impact of TrueBlue(g) points earned on qualifying JetBlue purchases.

Delta Passenger Revenue Gets $2 billion Bounce

For passenger revenue, carriers predict those numbers will change because ancillary fees currently being booked as “other revenue” will now have to be recorded under that line item. In addition to baggage fees and upgrade fees, ancillary fees can include any other administrative fees that passengers are charged related to the flight.

Under the new rules, they are all viewed as one performance obligation of providing passenger transportation. “Ancillary fees will not be a separate performance obligation—they would need to be combined with the flight and revenue would be recognized at the date of the flight,” Yelena Mishkevich, American Institute of CPA’s senior manager with its accounting standards team, told Bloomberg BNA.

“They will have to combine ancillary fees—which are currently classified as other revenue—with passenger revenue into one line item,” Mishkevich said. “However, they can disclose different sources of revenue in their notes.”

For some carriers it means reclassifying millions of dollars of revenues. Delta, for example, said it would reclassify about $2 billion of revenues from ancillary fees under passenger revenue when they adopt the rules.

Overall, airline carriers in the U.S. are doing well, Root said. The performance of carriers is benefiting from consolidation within the sector. Five mergers have occurred among major airlines since 2008. “Five players have come out of the market and that’s doing well for business,” Root said.

“The common strategy is to seek to earn acceptable returns on invested capital,” Root said. “Companies are managing for profit rather than market shares as they did before the financial crisis, when there were more players.”

To contact the reporter on this story: Denise Lugo in New York at dlugo@bna.com

To contact the editor responsible for this story: S. Ali Sartipzadeh at asartipzadeh@bna.com

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