Understand new revenue recognition standards for loyalty programs. 

As a consumer, we gravitate to the idea of purchasing now and receiving rewards or discounts later. The idea that our purchases today are somehow saving us money in the future, whether it be a $10 reward certificate or bonus miles to apply to the next vacation, brings excitement to the everyday shopper. Throw in a VIP, Gold, and Silver status, and now consumers are feeling extra special.

For retailers, this is invaluable. These simple reward programs encourage consumers to spend more, help retain current consumers, welcome newbies, and at the end of the day, consumers feel like they are getting a deal. Everyone is happy. What more could you ask for?

Hate to rain on the parade, but the Financial Accounting Standards Board (FASB) has shaken things up with the new revenue recognition standards for loyalty programs.

What does this mean for both parties?

Consumers get to continue to rack up the rewards, but retailers want consumers to redeem those rewards as soon as possible. Why? Retailers must defer the allocated portion of revenue related to the future reward until that obligation and service has been redeemed or the reward has expired.

Stay with me here.

Let’s take, for example, that for every $500 spent at a store, you receive a $10 rewards certificate to be used on a future purchase. That means for each dollar spent, .20 cents are earned to get to the $10 reward ($10/$500).

If I spent $500 today and earned my $10 rewards, the retailer could not recognize the full $500 in revenue today. Instead, a portion of the $500 payment received from the consumer would need to be deferred until the $10 reward certificate is redeemed or has expired. To calculate the deferred portion, the retailer would need to consider the selling price of the product ($500) plus the dollars earned and rewarded ($10) and determine the percentage of the product sold today ($500) over the total selling price ($510).

This equates to 98% of revenue to be recognized today and the remaining 2% when the reward is redeemed or has expired. The retailer would record the 2% as a deferred liability based on the following:

 

Standalone Selling Price

Allocation %

Allocation of Transaction Price

Product

$500

98%

$490

Rewards

$10

2%

$10

 

$510

100%

$500

 

What are material rights and how do they relate?

The semi-new ASC 606 Revenue Recognition standard introduced a new concept of material rights. A material right is a separate performance obligation in a contract and represents a right granted to a consumer to purchase future goods or services at a discount.

For restaurants and retailers, loyalty program rewards earned with each purchase is an example of a material right since it is a performance obligation to deliver future goods or services in order for the reward to be earned and redeemed.

What if the consumer never redeems the reward? 

ASC 606 is redeeming itself by allowing operators to recognize breakage, i.e., unexercised customer rights. These unexercised rights can cause significant obligations on the restaurant or retailer’s financial statements.

In order to manage this, the FASB has implemented a standard that will allow the recognition of breakage into revenue prior to actual redemption. Basically, operators would have to utilize historical data to assess the probability of reward redemptions. Based on these statistics, operators can recognize revenue based on the probability of consumers redeeming or not redeeming over a period of time.

While this approach allows operators to better understand how their loyalty and rewards programs likely will pan out, it doesn’t completely replace the ease of consumers simply using their rewards, points, gift cards, etc.

The next time you remember to redeem points, know that you are doing a good deed in the ASC 606 world.  

 

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