Clarity needed on accounting for customer loyalty programmes

ICAI should specify the principles to be followed while recognising such rebate or refund along with revenue

Retailers work on a common objective — grab maximum share of a customer’s disposable income.

Novel ways of drawing customers are fast emerging. Over and above the availability of merchandise or price point, retailers are trying hard to develop customer loyalty, a concept still in a nascent stage in India. While price point is surely one way to attract customers, it is not easily distinguishable from one retailer to another.

Therefore, retailers are introducing loyalty programmes to lure customers and create loyalty.

Such is the power and success of loyalty programmes that in a fairly short span, the concept has spread across retailers selling medicines, fruits and vegetables, groceries, apparel, etc.

Loyalty programmes are structured marketing efforts that reward, and therefore encourage, loyal buying behaviour in the form of a loyalty card, rewards card, points card, advantage card, or club card that identifies the card holder as a member in a loyalty programme.

By presenting the card, the cardholder is typically entitled to either a discount on the current purchase, or an allotment of points that can be used for future purchases.

Accounting Standard 9 (AS-9) on Revenue Recognition issued by the Institute of Chartered Accountants of India (ICAI) does not specifically deal with accounting of discounts offered on sales. It only states that these should be deducted from the total sales. The generally accepted fundamental accounting assumption on the accrual concept of accounting holds that all costs should be recognised as incurred.

The principle of prudence as per Accounting Standard 1 (AS-1) Disclosure of Accounting Policies requires that provision should be made for all known liabilities and losses on an estimated basis. Going by the concepts provided in AS-1, retailers would need to provide for the liability based upon estimates.

Accordingly, a retailer needs to estimate the cash obligation and recognise the same as a reduction from revenue. This shall be based on a systematic and rational allocation of the cost to honour rebates/ refunds earned and claimed to each of the relatable underlying revenue transaction.

Measurement of the total cash rebate/ refund obligation can be estimated based on the number of customers and volume of transactions that will ultimately earn and claim rebates or refunds under the offer.

However, there are some factors that may impair a retailer’s ability to make a reasonable estimate. These include:
Relatively long periods in which a particular rebate or refund may be claimed
The absence of historical experience with similar types of sales incentive programmes or the inability to apply such experience because of changing circumstances
The absence of a large volume of relatively homogeneous transactions

There is no specific guidance in the Indian Accounting Standards on accounting for reward points or loyalty programmes. However, in the opinion of the expert advisory committee of the ICAI, in such a case, the seller should create a provision for the liability at an amount equivalent to the cost expected to be incurred on redemption of the outstanding reward points at any time in future by applying actuarial method.

There is guidance available in IFRIC-13, issued by the International Financial Reporting Interpretations Committee, on ‘Customer Loyalty Programmes’. An entity shall account for award credits as a separately identifiable component of the sales transaction(s) in which they are granted (the ‘initial sale’).

The fair value of the consideration received or receivable in respect of the initial sale shall be allocated between the award credits and the other components of the sale. The consideration allocated to award credits to be measured by reference to their fair value, i.e. the amount for which the award credits could be sold separately. If the fair value is not directly observable, it must be estimated.

It shall recognise the consideration allocated to award credits as revenue when award credits are redeemed and it fulfils its obligations to supply awards. The amount of revenue recognised shall be based on the number of award credits that have been redeemed in exchange for awards, relative to the total number expected to be redeemed.

An alternative view is that the obligation should be recognised as an expense at the time of the initial sale and be measured by reference to the amount required to settle it, in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. However, the consensus is to follow the first view.

There are divergent practices followed by each entity to account for customer loyalty programmes in India such as treating the cost of redeeming reward credits as marketing expenses, creating provision against sales at the time of transaction or recognising the required adjustment as and when it arises.

The absence of set measurement criteria on loyalty rewards in AS-9 has led to varied accounting practices and polices being followed, resulting in different financial results. It is imperative for the ICAI to come up with some guidance on principles that need to be followed while recognising such rebate or refund along with revenue. Such clarification is much needed and will bring uniformity and comparability in financial results of companies and will substantiate the meaning of general purpose financial statements.

The writer is director, Ernst & Young India Pvt Ltd. Views are personal.