Wednesday, November 26, 2008

Loyalty Accounting

I am not an accountant, but I read an article that raised a red flag at me. The article was addressing what are the accounting principles that can be applied to loyalty programs. I found the article in "Customer World" and it references an article by Rajiv Goyal in the DNA Money magazine in India.

I have chosen to address this topic for the following reasons:
1. I have seen very little written about this topic
2. Understanding the way accountants deal with loyalty programs may be a real issue in measuring their performance (success or failure).
3. I would like to be able to factor in the accounting impact into the loyalty math models.
4. It is about time that accountants start thinking about customers and become a part of the customer-centric company

The problem as I understand it concerns how the value of loyalty points can be accounted for before they are redeemed. When a company (such as an airline, credit card company, or even a clothing store) offers customers loyalty points, there is no easy way of knowing when the points will be redeemed. At the time when the points are awarded, the company takes on a liability for the value of those points. However, the time at which the points will be redeemed is not known so that there is no way of allocating the funds to a specific accounting period. Thus, the accountant can become frustrated because there is no way that the books can be reconciled without doing something with those "ugly" loyalty points.

As the number of loyalty points increases, the value of the accumulated loyalty points increases (as the airlines are seeing) and the financial impact can become staggering.

Of course, all this time the company, and especially the marketing department that created the loyalty points program, is basking in the increased business that has accrued from the program. The sales and marketing people are looking forward to a big bonus check for the great job they have done in recapturing some old customers and increasing the sales from existing customers. And well they should - they did just what management wanted them to do.

There are two points to consider; namely,
1. not all the points will be redeemed, and
2. the value given for each point was computed before the program was initiated so that the profit margin on the products will still be sufficient to meet company profit goals even if all points are redeemed.

The issues that still remain for the accountant are:
1. Since the loyalty points act like a discount on sales, there is no way to predict how much of a discount to use since not all points will be redeemed.
2. There is no way to determine what provision should be made for the liabilities.
3. There is also no way to determine the time period in which the discounts will occur.
4. There are no specific guidelines in the accounting standards in India (and probably anywhere else) on how to handle these discounts.

In general, the accountants do not see customers in the same way that sales and marketing see them. The article points out the need for customer-centric by accountants. I agree.

The bottom line is we need to get all areas of the firm to be customer-centric and that includes accounting if we are to be able to truly focus on the customer.

15 comments:

accounting services said...

Good post about loyalty account...
Regards,
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Anonymous said...

The topic of developing accounting standards for customer loyalty awards has been discussed since the airlines devised freq flyer mile programs back in 1981. It is a complex accounting issue. Some websites to visit: IASplus.com, NYSSCPA.org or simply google accounting treatment for customer loyalty programs. Your comments that there is "no way to value rewards", etc. is not true.

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