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Issue Description:

What is the appropriate accounting under IAS 18 Revenue when an entity provides rewards, normally non-cash rewards, to loyal customers. The project does not include discounts and other sales incentives.

Discussion at IFRIC Meeting November 2005

Loyalty cards/programs have long been an integral part of many companies incentives and customer relationship management programs. Loyalty programs currently operating serve businesses as diverse as supermarkets, telecommunication companies, airlines, hotels, automobile rentals companies, banks, music and books sellers.

Scope

The IFRIC discussed in general terms, the various schemes in place in trying to determine the scope of this project. IFRIC members noted that discounts and other sales incentives, regardless of how they are structured, should not be included in the scope of this project.

Multiple element sales

Paragraph 13 of IAS 18 states that "in certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction". This statement gives no guidance on:

• a. when a component of a single transaction is separately identifiable and;
• b. when applying the revenue recognition criteria in IAS 18 to a separately identifiable transaction is necessary to reflect the substance of the transaction.

The IFRIC agreed to develop indicators that could be used to establish when IAS 18.13 would be applicable.

After some debate, IFRIC agreed that IAS 18.13 is not helpful in addressing issues related to multiple element sales transactions nor is there any direction to other Standards that is useful. IAS 18.19 however leads to IAS 37.

IFRIC was asked to consider, if it considers that IAS 37 is applicable, whether the entity incurs a present obligation to its customers under a loyalty program:

• a. when purchases are made by the customer;
• b. when the customer reaches the minimum threshold at which it can redeem its accumulated points; or
• c. at a later point (for instance, when the customer asks to redeem its points)?

IFRIC did not reach a conclusion on this issue as some entities do not announce their schemes to customers and there seems to be an issue with (a) above where repeated purchases are required before the customer is entitled to a reward (at what point does the entity incur the obligation; after the first purchase or after the last required purchase, or is it somewhere in between?).

On the issue of measurement, IFRIC agreed that this should be a separate project as there are broader issues outside the scope of customer loyalty programmes that require addressing. The alternatives identified by the Staff for IFRIC to consider include measurements based on:

• a. the estimated cost to the entity to provide the promised items;
• b. the excess, if any, of the estimated cost to provide the promised items over the amount the customer will pay for the items;
• c. the excess of the value of the promised items over the amount the customer will pay for the items (opportunity cost) or;
• d. some other amount.

Regarding the applicability of IAS 32 and IAS 39, IFRIC agreed that generally, contracts within the scope of this project would be considered to be normal use contracts. In addition, schemes that reward customers in cash are very rare, therefore in most cases, no financial liability arises. In those rare cases where a customer is rewarded in cash for loyalty, then clearly a financial liability arises.

Discussion at the IFRIC Meeting March 2006

The IFRIC discussed whether customer loyalty programmes should be regarded as:

• (a) goods and services supplied as part of a sales transaction;
• (b) costs of securing sales of other goods and services; or
• (c) possibly either, depending on the nature of the programme?

Views around IFRIC were evenly divided among the three alternatives. However, several IFRIC members agreed that the analysis provided by the staff tended to support (a), but considered that in many situations (b) was the more appropriate answer. It was noted that some loyalty programmes could be analogised to lease incentives, which are treated as part of the cost of the lease to the lessor, rather than as a reduction of revenue.

The staff next addressed whether loyalty programmes represented separately identifiable components of a transaction for the purposes of IAS 18. The meeting accepted that the staff's analysis was appropriate and that if you accepted approach (a) to revenue recognition. Some members noted that the time value of money would have an effect on the amount recognised for the subsequent service component. The Chairman noted that the IASB's project to revise IAS 37, which is developing a 'cost to settle' model, which could be significant to this issue.

The staff redefined their position such that, provided that an entity could allocate revenue to the elements and could estimate the cost of the first element, the entity should recognise revenue for the first element and defer the revenue related to the subsequent element(s). Some members noted that in certain situations (for example, air fares) there could be 80-100 different prices represented on a given revenue event (for example, flight). The cost of applying the staff recommendation to the transaction would be very onerous, and, by inference, the information provided of little utility to users.

The IFRIC agreed that when the rights granted under a loyalty programme have the economic nature of sale incentives, the sale is to be considered as a whole, because IAS 18 paragraph 14(a) and (e) have been satisfied. This conclusion was appropriate when the entity had concluded that IAS 18 paragraph 19 was appropriate. However, some did not agree with the analysis that IAS 18 paragraph 19 applied in all situations.

After a protracted debate, the Chairman directed the staff to prepare a draft Interpretation on the basis of no alternative treatments, based on view (a) above (because there was little opposition to the components approach). While this did not guarantee that view (a) would be accepted by a sufficient number of IFRIC members, it provided a means to carry the debate forward.

Discussion at the May 2006 IFRIC Meeting

The IFRIC discussed the first draft of a Draft Interpretation on customer loyalty programmes. In March, the IFRIC Chairman had directed the IFRIC staff to develop the draft on the basis of recognising a separate component of the initial sales transaction in which the award credits are granted as representing the unperformed performance obligation. Under this approach, some of the consideration received for each initial sale would be allocated to the award credits.

The IFRIC spent a considerable amount of time discussing the tension between IAS 18 paragraphs 13 and 19, and several IFRIC members were not satisfied that the Draft Interpretation explained adequately the approach inferred by IAS 18 paragraph 13 should be used to the exclusion of that in paragraph 19. The debate was concluded by the Chairman, who asked whether there was sufficient support for the approach in the Draft Interpretation. Two IFRIC members would oppose the document. On this basis, the Chairman directed the staff to proceed with the approach as adopted, but to work with those who were opposed to the approach to ensure that their concerns were reflected adequately in the Basis for Conclusions.

Scope

The IFRIC agreed with a staff proposal that the scope of the Draft Interpretation need not be defined rigorously and should not specify scope exclusions.

Awards supplied by third-party providers

The IFRIC held an inconclusive discussion on how to account for awards supplied by third parties. The IFRIC was concerned that the Draft Interpretation should not confuse agency relationships with sub-contracting: that is, who is providing the service. The IFRIC discussed a staff example, which demonstrated that the measurement of these awards is also problematic. The IFRIC will continue its discussions of this topic at a later meeting.

Separate component approach

The IFRIC discussed the justification for the separate component approach in the draft Basis for Conclusions (not available to Observers). However, it was apparent that part of the justification was based on SIC 15, an Interpretation of IAS 17. IFRIC members criticised the prominence awarded to an interpretation of a leasing standard in an Interpretation of IAS 18.

Next steps

At its next meeting, the IFRIC will discuss an amended version of the Draft Interpretation.

Larry Smith, Chairman of the FASB's Emerging Issues Task Force, attended the meeting. He noted that the EITF had attempted to issue an Abstract on this issue and had been unable to reach consensus.

It should also be noted that three IFRIC Members who did not object to the Draft Interpretation were attending their last meeting. How their successors vote could be critical to the future of the direction of this issue.

Discussion at the July 2006 IFRIC Meeting

Review of text of a Draft Interpretation

Rationale for applying paragraph 13 rather than paragraph 19 of IAS 18

The IFRIC concurred with proposed changes to the Draft Interpretation to stress that the basis of the Interpretation was IAS 18 paragraph 13 and its concept of applying the 'revenue recognition criteria to the separately identifiable components of a single transaction.' In addition, the guidance in IAS 18.13 is normative and IAS 18.19 is the exception and applies in those circumstances in which the entity will incur costs in the future as a result of an event outside the control of both it and the customer (e.g., a claim under a warranty).

Estimates of fair values of award credits

The IFRIC agreed that the Draft Interpretation should not provide detailed guidance on measurement and estimation techniques. Rather, it should establish a principle that an entity should determine the fair value of the consideration received and the fair value of the goods or services delivered and recognise revenue based on the relative fair values of the two. The methods used to determine this allocation should be consistent and should also result in some revenue being allocated to the reward credits. Recognising revenue on one basis and deferring revenue on another would be precluded.

Programmes that offer a choice of awards

Decision

The IFRIC agreed that the Draft Interpretation should address programmes that offer a choice of awards. There was little discussion and the proposed wording was not available to Observers.

Awards supplied by a third-party provider

Decision

The IFRIC agreed that revenue should be recognised when either the customer redeems award credits or when a third party assumes the obligation to supply the awards. IFRIC members asked that the Draft Interpretation should give an example of this type of award (for example, a hotel grants airline miles/points).

Forfeiture

The IFRIC discussed how entities that operate customer loyalty programmes should account for award credits that are forfeited by customers, that is, never redeemed for awards.

The IFRIC agreed that the Draft Interpretation should be explicit that an entity should make an estimate of the expected forfeitures of awards as part of the initial allocation of the consideration received (between revenue and the future deliverable). That estimate can be revised (as any other estimate) but that revision does not affect the initial allocation. As agreed earlier in the session, the Draft Interpretation will not provide detailed guidance on how this estimation should be done, but the method chosen should be applied consistently.

Exposure Decision

The Chairman polled IFRIC members as to who would object to the issue of a Draft Interpretation based on the Draft Interpretation as presented, amended and supplemented by the decisions reflected above. No IFRIC members intimated an intention to object to the Draft Interpretation.

Drafting comments will be taken out of session and the normal 'negative clearance' will be sought from the Board in die course. It is hoped to issue the Draft Interpretation for comment presently.

Draft Interpretation Issued

On 7 September 2006 the IFRIC issued for public comment Draft Interpretation D20 Customer Loyalty Programmes. Comment deadline is 6 November 2006.

Discussion at the January 2007 IFRIC Meeting

The IFRIC discussed comments received on the Draft Interpretation D20 Customer Loyalty Programs.

The discussion focussed on the following aspects (the discussion overlapped):

• a. The overall approach proposed (which would require award credits to be accounted for as a separate component of the sale in which they are granted)
• b. The proposed scope

Overall approach and project scope

Of the 52 comment letters expressing a view on the overall approach, 16 commentators were supportive of the proposed separate component approach, 20 commentators advocated a mixed approach – that is, the separate component approach should be required only for some types of loyalty programme, with a cost accrual approach being permitted or required for others; and 16 commentators favoured a cost accrual approach for all customer loyalty programs.

The commentators advocating a mixed approach suggested to scope out particularly:

• Marginally managed programs mainly because of the significant practical difficulties in measuring the fair values of the award credits
• Awards comprising items that are not sold by the entity in course of the ordinary activities
• Awards that are incidental

The commentators favouring a cost accrual approach for all customer loyalty programs argued that

• the substance of all, or the vast majority of, customer loyalty programmes is that of a marketing expense rather than a sale and that the customer does not see the transaction as comprising two separate sales,
• fair values cannot always be measured reliably, and
• the proposed revenue deferral approach would be complex to implement.

Of the 25 respondents specifically commentating on the scope only one respondent considered the scope to be right. The comments on scope fell into two main categories:

• The scope is dealing with a specific arrangement, not with clearly identified principles. The respondents raised concerns that the conclusions may be inconsistent with solutions for similar arrangement (for instance, service concession arrangements) or that the conclusions may be unreasonably applied to other arrangements like gift vouchers sold and prepaid phone contracts.
• The economic arrangement is not correctly covered by the scope of the interpretation. The main concerns were:
  • Some features of customer loyalty programmes (points granted to customers without being directly linked to a sale, welcome points, birthday points, etc.) would be excluded
  • Some items are included in the scope that should not be, for example, marketing expenses, awards for goods and services that are not separately sold by the company, immaterial items. Additionally, only business to customer arrangement should be in scope.
  • Some parts of the economic arrangements are not addressed, for example, accounting for the third party when the award is provided by a third party, multiple company programmes like the UK programme NECTAR and accounting treatment for points sold between companies.

The IFRIC unanimously decided to proceed with the proposed separate component approach and the scope.

It was assumed that some of the concerns raised were caused by misunderstandings and, therefore, the IFRIC decided to give more detailed guidance in particular on the following issues:

• Explicitly point out that marketing expenses are not in the scope of D20
• Give more detailed guidance on how to deal with customer loyalty programs in which the entity has engaged a third party to supply the awards
• Make clear that D20 does not relate to immaterial award credits
• Address multiple company programmes

With regard to the scope, the IFRIC noted that it is vital that it needs to be assessed for every component of customer loyalty activities whether this component is in the scope of D20. It appeared that the IFRIC is, therefore, reluctant to include illustrative examples in D20.

The staff was asked to amend the draft Interpretation accordingly.

Discussion at the March 2007 IFRIC Meeting

The IFRIC continued their redeliberations of the proposed Interpretation in light of comments received during the exposure of Draft IFRIC Interpretation D20 Customer Loyalty Programmes.

Allocation of consideration

D20 paragraph 6 proposed that the fair value of the consideration received or receivable should be allocated to the identifiable components of the sale transaction with reference to the relative fair values of the components. Several commentators objected to the proposal. Some thought that the IFRIC was being too restrictive in an area in which IAS 18 permitted different methods; others thought that other allocation methods could produce more relevant information; and others were concerned that the restriction could be applied by analogy to situations in which such an approach was inappropriate.

The IFRIC discussed this issue at length. They were sympathetic to the argument that to restrict the allocation method was perhaps not ideal, but they were almost unanimous in opposing permitting the use of a residual value method in which the residual fair value was equated with the residual (marginal) cost of providing future services, which many saw as an invitation to avoid recognising the obligation at all. The aim of the allocation was to determine the fair value of the remaining performance obligation. The IFRIC seemed receptive to an approach that would permit an entity to perform the allocation of fair value either on the basis of measuring the fair value of what has been delivered or what remains to be delivered, provided that an entity measured the fair value of the relevant goods or services, not their cost of delivery.

The staff was asked to consider the IFRIC's views and present revised proposals at a subsequent meeting.

Whether fair value will be reliable

The IFRIC agreed that the fact that there will be cases where no market price will readily be observable for the goods and services granted within loyalty programmes does not justify the use of alternative methods not based on the fair value of the rights.

Proposed guidance

Positioning

The IFRIC agreed that the guidance in D20 paragraph 7 should be retained but that it should be moved to a separate section for Implementation guidance. In addition, guidance explaining that other methods may be used should be added, for example, by utilising the arguments currently in D20 paragraph BC10. Discounting The IFRIC noted that D20 paragraph 7 was confused and confusing. 'Discount' was used to mean a reduction of the price that would otherwise apply, rather than in a financing context. When combined with the comment about the 'time value of money' in paragraph 7(c), it was understandable that commentators were confused about what the IFRIC intended. The problems were even more acute when the English was translated into other languages. The IFRIC agreed that there should be no specific reference to the time value of money and that D20 paragraph 7 should be redrafted to clarify its meaning.

The staff was asked to present revised proposals at a subsequent meeting.

Expected forfeiture rate

The IFRIC agreed to retain the guidance in D20 that the fair value of the award credits should take into account expectations regarding forfeiture rates. However, material would be added to the Basis to emphasise that the method used in IFRS 2 Share-based Payment with respect to expected forfeitures is a modified fair value method and was adopted only for practical purposes in that Standard and should not be applied by analogy to customer loyalty schemes.

The staff was asked to consider preparing an illustrative example of this issue.

Revenue recognition

The need for guidance in the Interpretation

The IFRIC agreed that guidance on revenue recognition similar to that in D20 paragraph 8 should be included in the Interpretation.

The IFRIC saw no inconsistency between the requirements proposed in the Consensus and the objectives set out in the Basis for Conclusions. The IFRIC agreed that the Basis for Conclusions should include an explanation that the change in estimate of the award credits expected to be redeemed does not affect the measurement of the initial obligation, and should be recognised on a prospective basis.

Should there be Implementation Guidance?

There was general agreement that the Interpretation should include Implementation Guidance in the form of an example similar to that included in Observer Note 2(ii) paragraph 7.

Awards supplied by third parties

Revenue: gross or net

The IFRIC agreed to re-write the requirements in D20 paragraph 8 specifically to link the revenue recognition with the gross or net presentation. In doing so, the IFRIC noted that the scope of the Interpretation might need to be clarified to make it clear that loyalty schemes such as those operated by credit cards are third party award schemes within the scope of D20.

Classification of expense in gross presentation

The IFRIC agreed that the Interpretation should not address expense classification. Implementation Guidance for third party awards The IFRIC agreed that a short example illustrating revenue recognition when a third party supplies the awards should be provided.

Other issues

Customer relationship intangible assets

The IFRIC agreed to delete D20 paragraph 11 and to include a brief explanation in the Basis for Conclusions (as part of the discussion of changes made to D20). The IFRIC agreed that awards are unlikely to qualify for recognition under IAS 38 Intangible Assets and that the issue was peripheral to the Interpretation.

Transitional Arrangements

The IFRIC agreed to change the transitional provisions such that the general requirements of IAS 8 will apply.

Effective date

The IFRIC did not conclude on the effective date, but did state that it was likely that the Interpretation would be issued in time for it to be effective for financial years beginning on or after 1 January 2008.

Other changes

The IFRIC agreed various drafting changes proposed by the staff. These drafting changes were not available to Observers.

Next steps

The staff will bring a revised draft Interpretation to the next meeting (3 and 4 May) with the intention that the IFRIC approve it at that meeting.

Discussion at the May 2007 IFRIC Meeting

The IFRIC continued redeliberating the proposed Interpretation in light of comments received on Draft IFRIC Interpretation D20 Customer Loyalty Programmes. The meeting considered a revised draft of an Interpretation, in particular changes made as a result of the March 2007 meeting.

Allocation of consideration to award credits

In March 2007, the IFRIC had requested that the Interpretation not be prescriptive about the how the fair value of the consideration received should be allocated between the goods and services delivered and the award credits received by the customer. The staff proposed that the Interpretation should retain the requirement to use the relative fair value method, but to add application guidance (mandatory material) explaining that the fair value of the award credits might provide an acceptable substitute. The IFRIC disagreed and directed the staff to draft the Interpretation on the basis that the consideration allocated to the award credits shall be measured by reference to their fair value – the amount for which they could be sold separately. There was some discussion about how this method could best be explained in the Interpretation and related Basis.

Awards supplied by third parties

In March 2007, the IFRIC decided to amend the Interpretation:

• (a) to highlight that the entity might be collecting the consideration allocated to award credits as an agent for a third party supplying awards; and
• (b) to explain the consequences for measurement and recognition of revenue if this was the case.

The IFRIC discussed revised wording together with a related Illustrative Example, neither of which was reproduced in the Observer Note.

The IFRIC seemed to agree that, when the seller is acting as agent for the supplier, revenue should be recognised on the basis of the consideration received less the amount payable to the supplier of the award. Recognition would be at the time the entity is obliged to pass the consideration to the third party.

The IFRIC agreed that the type of award should not alter the timing of revenue recognition. Thus, if a hotel awards a voucher supplied by a third party (such as a department store), revenue is recognised when the voucher is given to the customer, not when the customer uses the voucher in a transaction at the department store.

Changes in accounting policy

In March 2007, the IFRIC requested that a comment be added to the transition section to stress that entities that had previously accrued the costs of supplying awards would be changing an accounting policy, rather than an estimate, when they first applied the Interpretation. At this meeting, the IFRIC agreed with a staff analysis that this comment was unnecessary as it should be obvious that accruing a liability and deferring revenue are different accounting policies, even if the effect of the change is not significant.

Other matters

IFRIC members raised a concern that the Interpretation as drafted implied that information would have to be assessed on a transaction-by-transaction basis. The staff amended the discussion of the allocation method in the Basis for Conclusions such that this inference was avoided. The highest level of aggregation would, however, be award credits awarded in an annual period.

IFRIC members also discussed the 'credit card example', agreeing that the Interpretation should clarify that award credits can be awarded by one party (the credit card company) as a result of a transaction between the customer and a third party (the retailer accepting payment by credit card). The staff observed that the Interpretation did suggest this, but agreed to clarify this issue.

An IFRIC member expressed concern with the way in which the guidance on onerous customer loyalty programmes was expressed. There appeared to be an inference that an additional liability would be recognised. The staff agreed to work with the IFIRC member to rectify this inference, which was unintended.

The IFRIC did not think that any additional disclosure requirements were necessary. The existing requirements of IAS 1 and IAS 18 were thought sufficient.

Re-exposure

The IFRIC agreed with a staff analysis that re-exposure was not necessary.

Effective date

The IFRIC agreed that the Interpretation should be effective for financial years beginning on or after 1 January 2008. If implementing the Interpretation required a change in accounting policy, IAS 8 would apply.

Approval

The IFRIC Chairman asked whether, based on the draft Interpretation and the discussions today, whether any IFRIC members would not support the Interpretation. None of the IFRIC indicated their dissent.

Next Steps

The staff will present a revised draft Interpretation to the IFRIC as soon as possible, with the intention that it will be presented to the June 2007 meeting of the IASB for their approval, subject to written ballot. Provided that the IASB approves the Interpretation, it should be issued in July 2007.

Interpretation Approved at the June 2007 IASB Meeting

The IFRIC had reached a consensus on how entities should apply IAS 18 Revenue if they grant loyalty award credits (air miles, points etc.) to customers who buy other goods or services and had voted to confirm that consensus at its May 2007 meeting. The consensus supports a 'separate component approach', because "In the IFRIC's view, loyalty awards are not costs that directly relate to the goods or services already delivered-rather, they are separate goods or services delivered at a later date."

This point was reiterated during the discussions. A number of changes had been made to the original draft in response to concerns voiced by constituents. One Board member asked the staff to clarify if the consensus meant that IFRIC had rejected a 'mixed approach', which the staff agreed it had. That member also asked for clarification on the methodology described in paragraph 8(b) of the draft interpretation. One Board member took issue with the examples used in IE 9 and 10 of the draft interpretation on a conceptual level.

In response to a request from another Board member, the staff clarified that in the example the transaction affected the current period (for points redeemed to date) and future periods (for points not yet redeemed). The staff was also asked (and agreed) to clarify that the interpretation does not apply to extended warranties.

One Board member remarked that, given the magnitude of the accounting changes involved in the implementation of this interpretation for a number of industries with substantial customer loyalty programmes, particularly for the airline industry, the transition period should be extended from the usual 90 days after ratification by the Board to 12 months. Moreover, it was argued that the transitional provisions should talk of earlier application being 'permitted' rather than 'encouraged'. Even though it is not normal Board procedure, 9 Board members agreed send the Interpretation back to IFRIC in order to change it, so as to 'permit' earlier application and extend the transition period to 12 months in a hands-up vote. The Board then proceeded to unanimously approve IFRIC X.

IFRIC 13 Customer Loyalty Programmes Issued 28 June 2007

On 28 June 2007, the IASB issued IFRIC 13 Customer Loyalty Programmes.