(FFP: Frequent Flier Program)

The case deals with the problem of estimating cost and obligations of the United Air Lines frequent flier program. The major accounting issue with FFPs is how an airline accounts for their economic value. Since FFPs represent a present obligation for an airline to provide customers with air travel at a later date, they are considered a liability.

Incremental Cost Approach:

One approach can be to estimate the value of points that are going to be redeemed and the timing of redemption, with the cost being based only on the variable costs associated with the redemption of points, i.e. meal, drinks, ticketing. The provision for the variable costs is then recorded as a liability, moving to an expense once the points have been redeemed. A provision can be created for these liabilities based on the present value of the incremental cost estimate, net of any points that are deemed likely to expire. The provision is reduced as members redeem points from which it is recorded to expenses.

This approach can be justified in that customers are redeeming their points for excess capacity on flights, an activity that is incidental to the process of generating revenue from passengers.

The incremental cost approach is designed to maximize profitability and minimize provisioning levels, and so an airline using the incremental cost approach needs to be able to prove that flights flown by frequent flyers represent excess capacity and are incidental to the normal business of flying passengers.

Calculations:

We are assuming that free miles constitute 4% of revenue passenger miles.

Liability = (4% of revenue passengers) × Extra Capacity × Cost per Available Seat Mile = 0.04 × 38,858 × 0.096 ≈ 149 ($Millions)

Extra Capacity = Available Seat Miles – Revenue Passenger Miles = 114,995 – 76,137 = 38,858 (Millions) Deferred Revenue