FINANCIAL INFORMATION ANALYSIS
Accounting Analysis

Application Exercises

Question 2
Most airlines have frequent flyer programs that promise customers free flights once they have accumulated 25,000 miles of travel with the same airline. Using the simple definition of assets, liabilities, revenues, and expenses presented in the lecture, how should these programs be reflected in the airlines’ financial statements?

Promises that require future expenditures are liabilities even if they cannot be measured precisely. According to the definition, liabilities are economic obligations of a firm arising from benefits received in the past that are:
(a) required to be met with a reasonable degree of certainty;
(b) at a reasonably well-defined time in the future;

Airline companies have economic obligations to serve frequent flyer program passengers due to ticket sales (benefits) in the past to the frequent flyer program passengers. These obligations are:
(a) likely to be met[1];
(b) fulfilled within a well-defined time in the future[2];

A frequent flyer program has an impact not only on the balance sheet but also on the income statement. In principle, the costs associated with benefits that are consumed in this time period are estimated and recognized as expenses (matching concept)[3];

However, it is not easy to measure the costs associated with frequent flyer program accurately. At least the following three cost categories should be considered in the estimation:

1. The administrative costs, such as maintaining the accounting system for the program, mailings to program members, and providing service to those who request free flights;

2. The costs related to the flight itself, including meal expenses, luggage handling costs, and additional fuel expenditure;

3. The opportunity costs that airline companies may incur because the seats used by flight award