EITF ABSTRACTS
`
`Issue No. 00-22
`
`Title: Accounting for “Points” and Certain Other Time-Based or Volume-Based Sales
`Incentive Offers, and Offers for Free Products or Services to Be Delivered in the
`Future
`
`Dates Discussed: September 20–21, 2000; November 15–16, 2000; January 17–18,
`2001; November 14–15, 2001
`
`References:
`
`FASB Statement No. 5, Accounting for Contingencies
`FASB Statement No. 48, Revenue Recognition When Right of Return
`Exists
`FASB Interpretation No. 14, Reasonable Estimation of the Amount of a
`Loss
`FASB Technical Bulletin No. 88-1, Issues Relating to Accounting for
`Leases—Lease Incentives in an Operating Lease
`FASB Technical Bulletin No. 90-1, Accounting for Separately Priced
`Extended Warranty and Product Maintenance Contracts
`FASB Concepts Statement No. 5, Recognition and Measurement in
`Financial Statements of Business Enterprises
`FASB Concepts Statement No. 6, Elements of Financial Statements
`AICPA Statement of Position No. 81-1, Accounting for Performance of
`Construction-Type and Certain Production-Type Contracts
`AICPA Statement of Position No. 93-7, Reporting on Advertising Costs
`AICPA Statement of Position No. 97-2, Software Revenue Recognition
`AICPA Statement of Position No. 98-9, Modification of SOP 97-2,
`Software Revenue Recognition, With Respect to Certain Transactions
`Proposed AICPA Statement of Position, Accounting for Frequent Travel
`Awards Programs, Development and Preoperating Costs, Purchases and
`Exchanges of Take-Off and Landing Slots, and Airframe Modifications,
`dated June 30, 1987
`Proposed AICPA Statement of Position, Accounting for Frequent Travel
`Awards Programs (Proposed Amendment to AICPA Industry Audit
`Guide, Audits of Airlines), dated August 31, 1988
`SEC Staff Accounting Bulletin No. 101, Revenue Recognition in
`Financial Statements
`
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`Page 1
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`ASKELADDEN 1027
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`

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`ISSUE
`
`1. Membership-based loyalty programs have long been an integral part of many
`
`companies'
`
`incentive and customer
`
`relationship management programs.
`
`Loyalty
`
`programs currently operating in the United States serve businesses as diverse as
`
`supermarkets,
`
`telecommunications companies, airlines, hotels, automobile rental
`
`companies, credit cards, and music and book sellers.
`
`In addition, as the number of
`
`Internet users and websites increases, Internet merchants and content providers are
`
`increasingly launching and testing loyalty programs in an effort to retain their most
`
`valuable customers.
`
`2.
`
`The general purpose of loyalty programs is to build brand loyalty and increase sales
`
`volume. Loyalty programs are structured so that a specified volume of transactions, or
`
`membership over a specified period of time, is required in order for a customer or
`
`program member to earn sufficient award credits to redeem an award. Each time a
`
`customer or program member purchases a product or service, or performs an action
`
`specified as a requirement of the loyalty program, he or she earns award credits that,
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`subject to specified minimum thresholds, may be redeemed in the future for awards such
`
`as free, or deeply discounted, products or services.
`
`3.
`
`Loyalty programs addressed by this Issue include (a) vendor-sponsored programs
`
`that offer awards consisting of the vendor's products or services, (b) broad-based
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`programs operated by program operators whose business consists solely of administering
`
`the loyalty program, and (c) combination programs operated by vendors for their own
`
`customers as well as other participating vendors and their customers. Vendors that do
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`not sponsor their own loyalty programs may participate in a loyalty program operated by
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`either another vendor or a broad-based program operator. In such instances, the vendor
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`generally purchases award credits, either directly or indirectly, from the other vendor
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`(program operator) for distribution to its customers.
`
`4.
`
`The scope of this Issue includes vendor offers to a customer for (a) free or
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`discounted products or services that will be delivered (either by the vendor or by another
`
`unrelated entity) at a future date (1) as a result of a single revenue transaction with the
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`customer or (2) only if the customer completes a specified cumulative level of revenue
`
`transactions with the vendor or remains a customer of the vendor for a specified time
`
`period and (b) a rebate or refund of a determinable cash amount only if the customer
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`completes a specified cumulative level of revenue transactions with the vendor or
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`remains a customer of the vendor for a specified time period. The scope of this Issue also
`includes the accounting by broad-based program operators1 for revenues from sales of
`award credits to other vendors or customers and the cost of redeeming awards.
`
`5.
`
`The issues are:
`
`Issue 1—How a vendor should account for an offer to a customer, in connection with a
`
`current
`
`revenue transaction,
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`for
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`free or discounted products or services
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`delivered by the vendor that
`
`is redeemable (becomes earned) only if the
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`customer completes a specified cumulative level of revenue transactions or
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`remains a customer for a specified time period
`
`Issue 2—How a vendor should account for an offer to a customer, in connection with a
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`current revenue transaction, for free or discounted products or services from the
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`vendor that is redeemable by the customer at a future date without a further
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`exchange transaction with the vendor
`
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`9A8 .?=>970<= ,= A066 ,= 9>30< ;,<>4.4;,>482 @08/9<= ,8/ >304< .?=>970<=%
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`Issue 3—How a vendor should account for an offer to a customer to rebate or refund a
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`specified amount of cash that is redeemable only if the customer completes a
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`specified cumulative level of revenue transactions or remains a customer for a
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`specified time period
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`Issue 4—How a vendor should account for an offer to a customer, in connection with a
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`current
`
`revenue transaction,
`
`for
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`free or discounted products or services
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`delivered by an unrelated entity (program operator) under an arrangement
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`between the program operator and the vendor that is redeemable only if the
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`customer completes a specified cumulative level of revenue transactions or
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`remains a customer for a specified time period
`
`Issue 5—How a program operator should account for award credits sold (directly or
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`indirectly) to other vendors and consumers.
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`EITF DISCUSSION
`
`6.
`
`At the September 20–21, 2000 meeting, the Task Force discussed Issues 1, 2, and 3
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`but was not asked to reach any consensuses. For Issues 1 and 2, some Task Force
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`members expressed a preference for an accounting approach that would allocate a portion
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`of the revenue on the transaction to the product or service that may be delivered in the
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`future, while other Task Force members expressed a preference for an accounting
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`approach that would be based on the significance of the value of the award product(s) or
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`service(s) as compared to the value of the transactions necessary to earn the award(s). If
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`the value of the award product(s) or service(s) is insignificant in relation to the value of
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`the transactions necessary to earn the award, a liability would be recorded for the
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`estimated cost of the award product(s) or service(s). On Issue 3, a majority of the Task
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`Force members expressed the view that offers for cash rebates or refunds should be
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`classified as a reduction of revenue in the income statement. The Task Force requested
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`that the FASB staff, together with the Working Group established to address Issue No.
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`00-21, "Accounting for Revenue Arrangements with Multiple Deliverables," obtain
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`certain additional information about loyalty program arrangements and further develop
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`an approach to Issues 1, 2, and 3 based on the significance of the value of the award in
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`relation to the value of the transactions necessary to earn the award.
`
`7.
`
`At
`
`the November 15–16, 2000 meeting,
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`the Task Force reached a tentative
`
`conclusion on Issue 3 that the vendor should recognize the rebate or refund obligation as
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`a reduction of revenue based on a systematic and rational allocation of the cost of
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`honoring rebates or refunds earned and claimed to each of the underlying revenue
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`transactions that results in progress by the customer toward earning the rebate or refund.
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`Measurement of the total rebate or refund obligation should be based on the estimated
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`number of customers that will ultimately earn and claim rebates or refunds under the
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`offer.
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`8.
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`The Task Force also discussed the related issue of how to account for a vendor's
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`change in estimate with respect to the number of customers that will ultimately earn and
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`claim rebates or refunds under the offer but was not asked to reach a consensus. The
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`Task Force asked the FASB staff to discuss this issue with the Working Group.
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`9. While the Task Force did not discuss Issues 1, 2, 4, and 5, the Task Force observed
`
`that any consensuses on Issue 00-21 likely would influence any proposed answers on
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`those Issues.
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`10. At the January 17–18, 2001 meeting, the Task Force reached a consensus on Issue 3
`
`that the vendor should recognize the cash rebate or refund obligation as a reduction of
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`revenue based on a systematic and rational allocation of the cost of honoring rebates or
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`refunds earned and claimed to each of the underlying revenue transactions that result in
`
`progress by the customer toward earning the rebate or refund. Measurement of the total
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`cash rebate or refund obligation should be based on the estimated number of customers
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`that will ultimately earn and claim rebates or refunds under the offer (that is, "breakage"
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`should be considered if it can be reasonably estimated). However, if the amount of future
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`cash rebates or refunds cannot be reasonably estimated, a liability should be recognized
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`for the maximum potential amount of the refund or rebate (that is, no reduction for
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`"breakage" should be made). The ability to make a reasonable estimate of the amount of
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`future cash rebates or refunds depends on many factors and circumstances that will vary
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`from case to case. However, the following factors may impair a vendor's ability to make
`
`a reasonable estimate:
`
`a.
`b.
`
`c.
`
`Relatively long periods in which a particular rebate or refund may be claimed
`The absence of historical experience with similar types of sales incentive programs
`with similar products or the inability to apply such experience because of changing
`circumstances
`The absence of a large volume of relatively homogeneous transactions.
`
`11.
`
`In some cases, the relative size of the cash rebate or refund changes based on the
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`volume of purchases. For example, the rebate may be 10 percent of total consideration if
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`more than 100 units are purchased but may increase to 20 percent if more than 200 units
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`are purchased.
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`If the volume of a customer's future purchases cannot be reasonably
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`estimated, the maximum potential cash rebate or refund factor should be used to record a
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`liability (20 percent in the example).
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`In contrast, if the volume of a customer's future
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`purchases can be reasonably estimated, the estimated amount of cash to be rebated or
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`refunded should be recognized as a liability.
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`12. The Task Force reached a consensus that changes in the estimated amount of cash
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`rebates or refunds and retroactive changes by a vendor to a previous offer (an increase or
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`a decrease in the rebate amount that is applied retroactively) should be recognized using a
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`cumulative catch-up adjustment. That is, the vendor would adjust the balance of its
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`rebate obligation to the revised estimate immediately. The vendor would then reduce
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`revenue on future sales based on the revised refund obligation rate as computed. Exhibit
`
`00-22A illustrates this methodology.
`
`13. The Task Force reached a consensus that the guidance on Issue 3 should be applied
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`no later than quarters ending after February 15, 2001. The effect of application should be
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`reported on a cumulative basis as a reduction of revenue. Upon application of this
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`consensus, rebate or refund amounts reported as an expense in prior-period financial
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`statements presented for comparative purposes should be reclassified to comply with the
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`income statement display requirements under Issue 3 (that is, presented as a reduction of
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`revenue). If it is impracticable to reclassify prior-period financial statements, disclosure
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`should be made of the reasons why reclassification was not made and the effect on the
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`current period of classifying rebates and refunds as a reduction of revenue.
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`14. At the January 17–18, 2001 meeting, the Task Force also discussed the Working
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`Group's observations and general direction with regard to Issue 5 but was not asked to
`
`reach a consensus. The Working Group preliminarily believes that the sale of award
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`credits by a program operator to other vendors is a multiple-deliverable revenue
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`arrangement in which the deliverables consist of the award product(s) or service(s) and
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`certain other services provided by the program operator to the sponsor.
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`If the
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`deliverables under the arrangement cannot be identified or the fair value of the
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`deliverables other than the award product(s) or service(s) is not determinable, Working
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`Group members expressed a preference for developing a revenue recognition approach
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`with respect to these loyalty program arrangements that is either similar to the residual
`approach2 found in SOP 98-9 or based on the program operator's proportionate
`performance under the arrangement.
`
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`15. The Task Force observed that it would be preferable for the Working Group to
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`make additional progress on the Issue 00-21 model before further developing a revenue
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`recognition approach for Issue 5, since the resolution of Issue 5 should be consistent with
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`the general model under Issue 00-21. [Note: See STATUS section.] In addition, some
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`Task Force members raised questions about whether the deliverables in the arrangements
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`under Issue 5 are separable for accounting purposes (on the basis that the services in the
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`arrangement may be necessary to maintain the value and usefulness of the awards and the
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`awards may be necessary to maintain the value and usefulness of the services). Some
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`Task Force members also expressed concerns over the timing of revenue recognition
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`associated with the estimates of program credits that will not be redeemed for awards
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`(that is, breakage) under the revenue recognition approaches being developed by the
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`Working Group. The Task Force requested that the FASB staff and the Working Group
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`consider those concerns further.
`
`STATUS
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`16. At the November 14–15, 2001 meeting, the Task Force discussed whether to
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`continue work on Issues 00-21 and 00-22. The SEC Observer stated that the SEC staff
`
`would support a decision by the Task Force to continue work on those Issues. The SEC
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`Observer also stated that the SEC staff continues to be supportive of the FASB pursuing
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`a broad project on revenue recognition. The Task Force discussed the advantages and
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`disadvantages of providing guidance in Issues 00-21 and 00-22 prior to the development
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`of a comprehensive revenue recognition framework by the FASB and agreed that
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`providing guidance on those Issues prior to completion of such a project would improve
`
`financial reporting. The Task Force agreed to first continue work on Issue 00-21 and that
`
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`,A,</= !-02488482 1<97 >30 /,>0 >30 ,A,</ .<0/4>= ,<0 =96/"%
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`a decision on whether to continue further work on Issue 00-22 would be made after a
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`consensus is reached on Issue 00-21.
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`17. At the November 14–15, 2001 meeting, the Task Force reached a consensus
`
`supporting the codification of
`
`Issues No. 00-14, “Accounting for Certain Sales
`
`Incentives,”
`
`and No. 00-25,
`
`“Vendor
`
`Income Statement Characterization of
`
`Consideration Paid to a Reseller of the Vendor’s Products,” and Issue 3 in Issue 00-22 as
`
`presented in Issue No. 01-9, “Accounting for Consideration Given by a Vendor to a
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`Customer (Including a Reseller of the Vendor’s Products).”
`
`18. At the November 21, 2002 meeting, the Task Force agreed to discontinue further
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`discussion of this Issue, which relates to revenue recognition. This Issue was placed on
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`the EITF agenda prior to the Board agreeing to add to its agenda a major project on the
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`recognition of revenues and liabilities in financial statements. That project is intended to
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`result
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`in a comprehensive revenue recognition standard with the objectives of (a)
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`eliminating the inconsistencies in the existing authoritative literature and accepted
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`practices, (b) filling the voids that have emerged in revenue recognition guidance, and (c)
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`providing guidance for addressing issues that arise in the future.
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`19. No further EITF discussion is planned.
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`Exhibit 00-22A
`
`EXAMPLE OF THE APPLICATION OF THE CONSENSUS ON ISSUE 3
`OF ISSUE 00-22
`
`The following example illustrates the calculation of the effect of a change in estimate of
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`future rebates that will be earned. The example is not necessarily intended to illustrate
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`the only approach to formulating the estimate of the cash rebate obligation, nor does the
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`example consider whether the company in the example can reasonably estimate the
`
`amount of rebates given the large change in estimate described in the example.
`
`Company A, a calendar-year company, offers a 10 percent rebate to all customers who
`
`purchase at least 500 units during any calendar year (this 10 percent rebate is retroactive
`
`in that it applies to the sale of units 1 through 499 after the 500-unit level has been
`
`reached and to all units sold thereafter). Each unit's list price is $100. Company A
`
`estimates that 650 of its 2,000 customers will purchase the number of units necessary to
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`earn the volume rebate ("high volume" customers).
`
`Based on that estimate, Company A records $90 of each unit sale to a customer in the
`
`group of 650 high volume customers as revenue and $10 as a rebate obligation. For sales
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`to its customers that are not expected to earn the rebate, Company A records $100 of each
`
`unit sale as revenue and does not recognize any amount as a liability under the rebate
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`offer.
`
`On September 30, Company A's data indicate that a higher proportion of customers are
`
`now expected to earn the rebate than previously estimated. Company A now estimates
`
`that 850 customers will earn the rebate. Assume that as of September 30, 400,000 units
`
`have been sold to the group of customers that Company A originally estimated would
`
`earn the rebate and 80,000 units have been sold to the group of customers that Company
`
`A originally estimated would not earn the rebate but now are expected to purchase the
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`required 500 units necessary to earn the rebate. To account for this change in estimate, as
`
`of September 30, Company A increases its refund obligation and reduces revenue by
`
`$800,000 (80,000 units × $10).
`
`As of September 30, Company A records the following journal entry:
`
`Revenues
`Rebate Obligation
`
`800,000
`
`800,000
`
`After the adjustment, Company A continues to record $90 of each unit sale to customers
`
`in the group of 850 high volume customers as revenue and $10 as a rebate obligation.
`
`For sales to its customers not expected to earn the rebate, Company A records $100 of
`
`each unit sale as revenue and does not recognize any amount as a liability under the
`
`rebate offer.
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