How are customer loyalty programs accounted for under IFRS 15, and how does the deferred revenue calculation work?
I'm studying CFA Level II revenue recognition and I came across loyalty programs where customers earn points that can be redeemed for future purchases. Under IFRS 15, these points are treated as a separate performance obligation. How do you allocate the transaction price and recognize revenue?
Customer loyalty programs are a classic application of the multiple performance obligation framework under IFRS 15 / ASC 606. The loyalty points earned by customers represent a material right — essentially a discount on future purchases that the customer would not receive without making the current purchase.
The Key Concept:
When a customer earns loyalty points with a purchase, the transaction has TWO performance obligations:
- The product/service delivered today
- The future discount (loyalty points)
The transaction price must be allocated between these obligations based on their relative standalone selling prices.
Step-by-Step — Falcon Airlines Loyalty Program:
Falcon Airlines sells a flight ticket for $800. The customer earns 2,000 loyalty miles. Based on historical redemption data:
- 1 mile has a standalone selling price of $0.012
- Expected redemption rate: 80% of miles earned
Step 1: Determine standalone selling prices
- Flight: $800 (but this is the total amount paid, so we need to consider the miles as part of the transaction)
- Miles: 2,000 × $0.012 = $24 (gross value) × 80% expected redemption = $19.20 (adjusted for breakage)
Step 2: Allocate transaction price
Total standalone selling prices = $800 + $19.20 = $819.20
Wait — the transaction price IS $800. The standalone selling prices are used for allocation only:
Allocated to flight = $800 × ($800 / $819.20) = $781.25
Allocated to miles = $800 × ($19.20 / $819.20) = $18.75
Step 3: Revenue recognition
| Performance Obligation | Revenue Timing | Amount |
|---|---|---|
| Flight | At departure (point in time) | $781.25 |
| Loyalty miles | When miles redeemed or expire | $18.75 (deferred) |
Journal Entry at Ticket Sale:
| Account | Debit | Credit |
|---|---|---|
| Cash | $800.00 | |
| Revenue — Flight | $781.25 | |
| Contract Liability (Deferred Revenue) | $18.75 |
As Miles Are Redeemed:
If the customer redeems 1,500 of 2,000 miles (75% of expected 80% = 93.75% of expected redemptions):
Revenue recognized = $18.75 × (1,500 / 1,600) = $17.58
Breakage (Unredeemed Points):
Under IFRS 15, if the entity expects breakage (non-redemption), it can recognize the expected breakage amount proportionally as the other points are redeemed — rather than waiting until expiration.
Key Exam Points:
- Loyalty points = separate performance obligation (material right)
- Transaction price is allocated based on relative standalone selling prices
- Deferred revenue is recognized as points are redeemed or as breakage is recognized proportionally
- The standalone selling price of points reflects the expected redemption rate (probability-weighted)
- The total revenue over the life of the program = $800 (same cash received)
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