Naturally, the first step is to ensure your records are accurate and correct. Good data is essential. Each accounting period should be checked to ensure that individual transactional data matches with the total outstanding point balance used in the liability calculation.
Underlying data for breakage estimates must match with data used for the books. In general, prior period trends should also be consistent. Examine the number of points earned, points redeemed, and points expired each month. Month-to-month point volumes should appear similar when compared to historical years, notwithstanding some exceptions. Accurate breakage estimates require correctly allocating redemptions to actual point earnings.
Loyalty program point allocation has similarities to inventory valuation. As customers use their points, redemption costs should be allocated to specific point earnings.
Much like when physical inventory is sold, revenue and costs of goods sold is applied for each unit sold.
Unlike inventory valuation, there is no required method for point allocation. Regardless of which method you follow, a clean system will tie redemptions to specific point earnings. Breakage lies front and center for loyalty program accounting. Your program is optimized for customer engagement and increasing revenue.
Breakage is the variable that balances these two goals. Breakage drives most of the financial strategy for a loyalty program model. Breakage is the percentage of outstanding points that will ultimately go unredeemed. This estimate is used to calculate loyalty program liability. Breakage estimates are updated with each new period, as new customer data rolls in.
Because we now expect fewer points to be redeemed higher breakage , the revenue recognized with each future point redeemed increases. In an ideal world, your breakage estimate is spot on. As members redeem their points, deferred revenue is recognized and your accounts balance out. In reality, estimates require continual adjustment. However, if you significantly over or underestimate breakage, significant revisions will be required:.
The consequences of inaccurate breakage estimates can be avoided with robust actuarial modeling. Actuaries excel at estimating program liabilities from uncertain cash flows and consumer behavior.
However, traditional actuarial science methods, such as those used in insurance, are not ideal for loyalty program applications; the loyalty program industry is far more dynamic and fluid than the insurance industry. Predictive analytics and modeling is the best solution for estimating accurate breakage rates. Under these programs, credit card holders earn points for using their credit cards to make purchases.
The holders of these points typically can redeem them for items ranging from merchandise and gift cards from a variety of vendors to airline miles and hotel stays. The main issue for credit card issuers with respect to eligibility to use the method provided in Regs. The use of the method provided in the regulation by a credit card issuer to estimate point redemptions was addressed in Capital One Financial Corp.
Cardholders who accumulated a certain number of miles could redeem them for an airline ticket purchased for them by Capital One. The Fourth Circuit also noted that Capital One did not have gross receipts with respect to sales with which the points were issued, as Regs.
Instead, it found that, while Capital One derived its gross receipts from lending services, it issued the points in connection with purchases cardholders made from merchants and other third parties. Hospitality and airlines: Taxpayers in the hospitality industry—including hotels, gaming establishments, and restaurants—and airlines offer points to their customers in a variety of ways.
Hotels generally offer points for stays at their properties, while airlines issue points or miles for flights flown. Restaurants offer points to customers for meals purchased, and casinos and other gaming operations offer points based on gambling activity. For taxpayers not already using this method, a method change is required under the advance consent procedures of Rev.
Taxpayers should be aware, however, that the IRS National Office has not favored this method in recent years; therefore, getting a method change approved could be challenging.
Of course, some taxpayers e. In that case, the appropriate treatment is to take the redemption liability into account in the tax year in which the liability is fixed and determinable and economic performance occurs under the rules provided in Sec. When conducting exit interviews, firms face the same challenges. To corroborate the Rockefeller study, according to an article in the Journal of Accountancy , accounting firms lose customers for the following reasons:.
Notice how price and quality are conspicuously absent from the lists. The fact of the matter is that most defections are the result of human failings and perceptions of indifference, rather than price or technical quality. In other words, it is how people are treated — or mistreated — that determines their willingness to remain loyal. The late marketing professor Theodore Levitt offered this analogy in a Harvard Business Review article: "The sale. How good the marriage is depends on how well the seller manages the relationship.
Similarly, suppliers may limit these programs to specific customers rather than make it for everyone. Loyalty programs help suppliers increase their sales. The more customers spend on their products, the higher revenues these suppliers can generate.
This income comes in the form of royalty income. Similarly, these programs can provide suppliers with a competitive advantage over others. Loyalty programs also offer customers a way to decrease costs or increase their income. Overall, loyalty income may come from various sources and in several forms. Usually, this income depends on the contract that suppliers and customers have. The agreement between both parties will also dictate the timing of the revenues for the customers.
Due to these reasons, the accounting for loyalty income may fall under the scope of IFRS The accounting for loyalty income depends on the contract between both parties. As mentioned, some suppliers will attach various terms and conditions to the availability of this program.
On top of that, the contract may also involve a base price along with loyalty income for future transactions. Lastly, some loyalty income may come at a particular time, while others may fall over a specific period. The process for accounting for loyalty income falls under IFRS There are five steps that this standard identifies for recognizing loyalty income.
While these points also apply to loyalty income, it also covers revenues from other sources. The steps for revenue recognition under IFRS 15 include the following. Through the above criteria, companies must signify their upfront payments and the fulfilment of loyalty program requirements. These will fall under the identification of performance obligations and determining the transaction cost. Once they do so, they must allocate the transaction costs to those obligations.
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