Alaska Airlines Case Study

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ACCOUNTING FOR AIRLINE FREQUENT FLYER PROGRAMS: MANAGEMENT INCENTIVES AND FINANCIAL REPORTING IMPACTS May 2012
Brian J. Franklin, BBA Accounting ‘12, College of Business and Public Policy, University of Alaska Anchorage, 3211 Providence Drive, Anchorage, AK 99508, 907-268-4233 Ext. 401, bfranklin@frontiertutoring.com
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airlines that disclose that information. Table 2 Impact of Changes in Breakage Estimates Airline Breakage Impact on FFP Impact of Hypothetical Estimate Liability Balance of 10% Change in 10% Change in Breakage as Percentage Breakage in $ of Current Liabilities Alaska Incremental Cost 12% $70,000,000 4.91% Delta Air Lines Deferred Revenue 29% $320,000,000 2.81% United Deferred Revenue 24% $630,000,000 4.98% Interpretation: For Alaska Airlines, a hypothetical 10% decrease in the carrier’s estimate of breakage (the number of mileage credits expected never to be redeemed) would result in a $70,000,000 increase in the carrier’s FFP liability balance, which would represent a 4.91% increase in current liabilities. Potential to Manage Earnings through Other FFP-Related Estimates FFPs offer the potential to manage earnings through estimates other than breakage. For the Incremental Cost Method, the primary management estimate is the incremental cost of carriage. For the Deferred Revenue Method, major estimates are related to the mix of redemption activity (i.e. the proportion of awards redeemed for travel in first class versus coach, the proportion of awards redeemed on the sponsoring airline versus a partner airline, and the proportion of awards redeemed for travel versus nontravel awards). Because deferred revenue liabilities are accrued at fair value, and each of the aforementioned …show more content…
its opportunity cost), thereby making comparability across periods difficult and also negating the theoretical superiority of the Deferred Revenue Method to the Incremental Cost Method (which has to do with the Deferred Revenue Method’s recognition of an accurate opportunity cost associated with displacing fare-paying passengers). Disclosures Unfortunately, the proprietary nature of FFPs makes it difficult for airline managements to provide detailed information about their financial results. Nevertheless, investors would benefit from more detailed financial statement disclosures on FFP operations and accounting. Ideally, FFP revenue should be reported separately from passenger revenue, and the cash flow impacts of FFPs and their various components should be disclosed, as well. Such disclosures would allow investors to differentiate between cash sales of tickets and cashless revenue recognized from FFP award redemptions. Management Incentives and Earnings Management Opportunities The fact that nearly every major U.S. airline to emerge from Chapter 11 reorganization since 2000 has chosen to switch to the Deferred Revenue Method suggests that the revenue recognition opportunities associated with the Deferred Revenue Method are attractive to management. Although switching to the Deferred Revenue Method involves allowing the FFP-related liability balance to dramatically increase, the accounting “big bath” theory

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