United Airlines' accounting treatment of frequent flier program liabilities

¶ … company or industry that has experienced an accounting issue. The focus of the essay will be on United Airlines but it could have been applied to any other major airline. The main research comes from the December 1991 story by Charles W. Taylor entitled "Airline Accounting: AICPA vs. FASB," which was on the December CPA Journal Online. The paper incorporates an analysis of the company, industry and the account issue with my personal opinion of the subject matter. A large portion of the paper focuses on the impact on investors and other stakeholders and also presents insights into the opinions of the article's author.

Industry

There have been some distressing financial reports coming out of the airline industry. Investors and corporate managers are well aware that there is an economic crisis in the airline industry. Larger carriers like United, American Airlines, Delta and Continental are all having major issues that are related to the price of fuel, terrorism and the overall weak world economies.

These major United States-based carriers have all had to or already have filed for bankruptcy protection. "Beleaguered United Airlines teetered closer to bankruptcy Wednesday after a federal board rejected its application for a $1.8 billion loan guarantee on the eve of a crucial union vote on wage concessions." (Armstrong, 2002) Most people think that the events on September 11, 2001, where terrorists hijacked planes and used them as suicide missiles was the only reason for the airline industry's current financial situation. but, over the past three decades the true dilemma the airline industry has faced can be found in other economic indicators such as inflation, the United States and world economies, globalization and stiff competition.

One solution that has made investors and stakeholders very happy was for the airlines to offer frequent flier miles and other reduced fairs. "Mileage Plus®. United's frequent-flier program, Mileage Plus, grew significantly, due to the continued success of partnerships such as First USA Mileage Plus Visa and Master Card, MCI WorldCom and E*TRADE. Revenue from third-party mileage sales reached $107 million during the first quarter, representing an 18% increase over the same period last year. Recently, United and Safeway launched Grocery Miles -- the largest partnership between a national grocer and an airline -- which allows customers at nearly 1,300 U.S. stores to earn frequent-flier miles in United's Mileage Plus program for their grocery purchases." (PR News Wire, 2000) as bankruptcy looms, frequent flier miles have become a major topic of discussion. But these frequent flier miles were an accounting problem as far back as 1990 and 1991.

Affect

The problem with frequent flier programs from an accounting perspective is that they may cause revenue displacement in the books of an airline; in this case, United Airlines. "Revenue displacement occurs when a passenger using a free travel award occupies a seat on a flight which would otherwise have been occupied by a paying passenger. This results in lost revenue for the airlines." (Taylor, 1991)

When the airline industry, the American Institute of Certified Public Accountants and the Financial Accounting Standards Board studied the displacement problem, the two accounting organizations came to a disagreement point. However, due to a technical issue the concern of the two organizations was averted and they came to an agreement that was satisfactory to all. This article was a summary of the issue, disagreement, and outcome of the frequent flier accounting problem.

The disagreement between the AICPA and the FASB was based on the methodologies of each group. "The FASB adamantly believes that all free travel award programs should be accounted for using the deferred revenue method." (Taylor, 1991) This opinion basically stated that there should be no exceptions to the deferred revenue method and that meant that the incremental cost method was not acceptable. "The AICPA, as stated in the proposed SOP, believes that the incremental cost method should be used to account for free travel award programs which are incidental in nature. If a program fails the incidental-in-nature test, then the AICPA recommends use of the deferred revenue method." (Taylor, 1991) the matter was dropped not because it was resolved by choosing one method over the other. Instead, a technicality prevented both sides from pursuing the matter further.

Comment feel that in this case, the two accounting overseeing organizations let the airline industry off a little easy. I bet the airlines, investors and the stakeholders were all very relieved when the American Institute of Certified Public Accountants backed off and decided not to pursue the problem in the future. United and the other airlines were basically given the okay to continue to use the incremental cost method to account for their frequent flier programs which actually should have been seen as free travel awards. By backing off, the American Institute of Certified Public Accountants kept the airlines from having to defer a small amount of the price of every ticket purchased by a participant of their frequent flier programs to account for the cost of the future free ticket.

The other side affect of the accounting problem would have been that the airlines would have been working on assumptions of future free ticket use as opposed to actual ticket sales. This would have been an accounting problem in regard to actual accounting accuracy which is needed to meet accounting and investor standards. In other words, looking at one airline's books would not necessarily have been an equivalent of looking at another airline's books. Other industry concerns and costs that would have affected both stakeholders and investors is the overall cost of updating computer accounting systems and process to account for the new methodologies. The airline industry most likely would have had to drop the frequent flier campaigns even though they were very successful marketing campaigns due to the fact that the new deferred revenue method would have implied too many costs to make the programs worthwhile.

Conclusion

In conclusion, this essay involved collecting and summarizing research in regard to a specific company or industry that experienced accounting issues or an accounting issue. The focus of the essay was on United Airlines but it could have been applied to any other major airline. The main research came from a December 1991 story by Charles W. Taylor entitled "Airline Accounting: AICPA vs. FASB," which was on the December CPA Journal Online. The paper incorporated an analysis of the company, industry and the accounting issue with my personal opinion on the subject. A large portion of the paper focused on the impact on investors and other stakeholders and also presented insights into the opinions of the article's author.