Please enter your username or the email address associated with the account so we can help you reset your password.
Part 1: New Rules in Loyalty Liability & Revenue Recognition
Accounting rarely makes any marketer’s Top 10 list for enthralling must-reads, but if you have a loyalty program, or are contemplating one, sharpen your pencils and grab your pocket protectors. In Part 1 of this 3-part Brierley+Partners’ Mind the GAAP series, we’ll summarize the accounting changes, potential impacts to your bottom line, and reporting needs. In Part 2, we’ll highlight some examples of how these changes are impacting several leading programs’ financial statements. And in Part 3, we’ll share some best-in-class strategies and tactics to maximize loyalty program results in this new era.
Until recently, there were two different ways to account for loyalty programs. As the illustration below summarizes, prior to 2018, most US companies following Generally Accepted Accounting Principles (GAAP) set by the Financial Accounting Standards Board (FASB) used the “incremental cost” method. Under this method, points were reported as a marketing expense (estimated incremental cost of loyalty currency awarded), and all revenue was recognized at the point of purchase (when points/currency was earned). Meanwhile, most companies outside of the US were following the “deferred revenue approach” under International Financial Reporting Standards (IFRS) developed by the International Accounting Standards Board (IASB). Under this approach, loyalty currency earned was treated as a separate component of the sale and revenue was deferred (liability) until the underlying reward was redeemed or the points expired (revenue recognized). The two accounting standard organizations representing the US (FASB) and international countries (IASB) reviewed the 2 approaches and agreed to adopt the “deferred revenue approach”. Starting in 2018, US companies (private and public) are required to use the “deferred revenue approach” to account for the financial impact of structured loyalty programs.
By now you are saying to yourself, “this is why I slept through all of my accounting classes.” So what does this mean? Why does it matter? Hang in there. The end result of these changes differs depending on multiple factors, but in most cases, there is a potentially short-term adverse financial statement impact as revenue must now be reduced/allocated to the loyalty currency issued with each transaction and deferred (now based on “fair value” of points issued) – reducing revenue (and hence earnings) and increasing the liability for deferred revenue.
Those who really want to understand the debits, credits and calculations involved in the old incremental cost vs. new deferred revenue approach can review the illustration Brierley+Partners has developed based on FASB Topic guidance in the Appendix.
Note that many publicly traded companies have begun accounting for this impact with their First Quarter 2018 Financial Statements and Form 10Q’s filed with the SEC. We reviewed reporting and analytics supporting existing Brierley clients as well as 10Q’s from select leading companies with significant loyalty programs to inform some key insights and observations for any marketer looking for guidance (or at least some background for inevitable questions from your Finance peers):
Forecasting and Data-Driven Estimates Are More Critical Than Ever
Managing loyalty program liabilities has always required some level of estimation and modeling for spoilage, program changes, and valuation of points; however, the new GAAP requirements require more precise and ongoing updates to assumptions, models, and estimates. In following GAAP’s 5-Step guidance in implementing the new accounting standard, estimates are critical in determining the transaction amount, allocation, and recognition of revenue (and liability) associated with loyalty:
Reports and Analytics Supporting Loyalty Forecasts
The degree and frequency of reporting and analytics typically mirrors the complexity and size of the structured loyalty program. For example, Brierley+Partners provides a suite of regular reports, dashboards, analytics and in many cases, forecasts to enable our clients’ accurate, timely financial reporting and management of points (or other currency) liabilities and revenue recognition. Although specific reporting and analytics differ by client and industry, in general, these reports should include:
Implications for Forecasting Loyalty Liabilities and Revenue Recognition
In this initial installment, we’ve provided a high level review of the changes in accounting rules that impact how structured loyalty programs’ contributions impact your company’s financials. In Part 2, you’ll see how the new rules have impacted some leading programs. And last, but not least, in our final installment of Mind the GAAP, we’ll dive deeper into some best in class examples to show how to further maximize your loyalty program’s financial contribution and impact!
APPENDIX – DEFERRED REVENUE ACCOUNTING ILLUSTRATION
For those who want to really understand how these changes play out in a “simple” illustration, Brierley has developed the following example based on FASB guidance – Topic 606 “Revenue from Contracts from Customers”. It highlights the impacts of the new accounting rules in Years 1 and 2:
TailorMade Menswear has a loyalty program, TailorMade Rewards, where members earn 1 point for every $10 spent. Each point is good for $1 off any future purchase and the company estimates a 90% redemption rate.
As the Year 1 illustration notes, the deferred revenue resulted in a 3.7% decrease in revenue vs. the old “incremental cost” method, and a 129% increase in deferred liability as the revenue on the unredeemed points remained on the books at yearend.
In year 2, Rewards members redeem 3,000 additional points. Based on this higher than anticipated redemption, TailorMade increased the assumed redemption rate to 95%. For simplicity, we’ve ignored points earned on sales in year 2.