See how the upcoming changes may affect your retail marketing and loyalty program accounting practices.
By Lane Ware, former CCG SVP Consulting and Account Services
How ready is your retail organization for the upcoming changes to revenue recognition standards? It’s critical to understand how they could impact accounting for loyalty programs, customer incentive liability and gift card indebtedness. Our overview of these core areas will help ensure your customer relationship marketing initiatives — and accounting operations — don’t miss a beat.
Background: Revenue Recognition Standards from the FASB and IASB
The upcoming changes are based on revenue recognition standards from the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). With only minor differences, the joint standard represents a single, global, principles-based revenue recognition model. While the new standard is expected to impact the retail industry, that impact will vary for each company. That’s because the standards for revenue recognition between FASB and IASB have differed in the past, which has caused different accounting practices to be used across the retail industry.
The updated joint standards were initially published in May 2014 as “Revenue from Contracts with Customers.” The FASB then issued clarifications and examples in subsequent accounting standards update (ASU) documents in 2016. But implementation has been deferred until at least December 2017. (Depending on the end of your fiscal year, they could go into effect for your company as late as the end of next year.)
The following four sections of the standard are likely to have the greatest impact on traditional retailers:
- Customer options for additional goods or services (loyalty/point programs, sales incentives, contract renewal options and other customer incentives or discounts)
- Unexercised rights of customers (such as gift cards)
- Sales tax
- Right of return (timing of returns)
We’ll focus on the first two areas in more detail, since they can directly affect your customer relationship marketing initiatives. But we encourage you to talk with your financial and tax advisors for insights on the potential impact of the standard on your particular organization.
How Loyalty Programs Are Impacted
Imagine a loyalty program member makes a purchase and earns a qualifying point, or credit, toward a free or discounted good or service. For accounting purposes, this creates a separate “performance obligation” — essentially a contract. This simple fact becomes complex when you consider the way that revenue from this “contract” is recognized.
Currently, the timing of revenue recognition varies based on the type of accounting practice followed by the retailer. Loyalty program accounting practices based on generally accepted accounting principles (GAAP) either follow an incremental cost accrual model (most prevalent in retail) or a multiple-element revenue model.
- Incremental cost models typically recognize revenue at the time of the initial sale. An accrual is then made for the expected costs incurred when the points or credits are redeemed in a future transaction.
- Multiple-element revenue models result in the transaction price being allocated to the products or services sold and to the point credits, with revenue recognized as each element is delivered. (See more details below.)
For retailers following current IASB standards, loyalty programs are accounted for as multiple-element entities:
- Some revenue, based on the fair value of the point credits, is deferred and recognized when they are redeemed or expire.
- Revenue is allocated between the good or service sold and the point credits, based on the fair value of the credits to the member.
- The assessment of fair value includes consideration of the discounts available to other customers who aren’t eligible for the points and breakage.
This method is similar to the new standard, which requires part of the revenue to be recognized at the time of the initial transaction, but another portion to be deferred until the “obligation” or discount/freebie is redeemed or expired.
“For the contract to give rise to an additional performance obligation, the option must provide a material right to the customer that would not be available without entering into the contract and that right must be incremental to any other promotional campaign that is being offered to all customers. This material right requires companies to allocate a portion of the transaction price to the incentive and defer revenue until the related performance obligations are satisfied or expire.” – Crowe Horwath LLP
The transaction price used typically includes a variable or contingent based on the outcome of future events, including (but not limited to) discounts, rebates, price concessions, refunds, returns, credits, incentives, performance bonuses and royalties. The variable is either estimated using an expected value or based on the most likely outcome — whichever provides the best estimate. In retail, breakage is typically used as the variable. This is important because it plays into the timing of what revenue is recognized by an organization.
Below is an example of the impact of the new standard for allocating loyalty program points or credits from PwC’s CFOdirect.
Potential impact: In the new standard, the transaction price is allocated between the product and the loyalty reward obligation based on relative standalone selling price. In other words: The amount allocated to the loyalty rewards is recognized as a contract liability, and revenue is recognized when the rewards are redeemed or expire.
This will generally result in later revenue recognition for a portion of the transaction price for retailers currently using an incremental cost model under the GAAP standards. On the other hand, it’s consistent with the multiple-element model currently required under IFRS.
How Customer Incentives Are Impacted
This section of the new standard covers a grab-bag of promotions, allowances and rebates, including:
- Rebates issued at the point of sale
- Free products (BOGO)
- Price protection and price-matching programs
- Vendor allowances (including volume rebates and cooperative advertising allowances)
- Market development allowances
- Mark-down allowances (compensation for poor sales levels of vendor merchandise)
- Some vendors also pay product placement or slotting fees to retailers
Today, guidance on the amount of revenue to recognize and the timing of that revenue from these incentives vary. The new revenue standard, however, includes specific guidance addressing these areas. In particular, the guidance for calculating the variability of the transaction price will apply to a wide range of customer incentives and is different from the existing guidance under IFRS and GAAP.
This quickly becomes complex because different types of discounts should be treated differently. It’s best to check with your accounting and finance advisors for details. However, below is an example from Crowe Horwath of the impact of the new revenue recognition standard on a common type of discount.
Potential impact: “The requirement to allocate a portion of the transaction price to the incentive and defer the revenue could have a substantial impact on retailers that are currently using generally accepted accounting principles (GAAP) incremental cost accrual methods in accounting for promotions (incentives).” – Crowe Horwath
How Gift Cards Are Impacted
When a customer purchases a gift card, he or she is pre-paying for goods or services to be delivered in the future. Breakage will typically result in the recognition of income for a retailer. However, the timing of recognition depends on expected customer behavior and the legal restrictions in the relevant jurisdiction.
Under current GAAP standards, when the gift card is sold to the customer, a liability is recognized for the future obligation of the retailer to honor the gift card. The liability is relieved (and revenue recognized) when the gift card is redeemed.
- Proportional model – recognize as redemptions occur
- Liability model – recognize when the right expires
- Remote model – recognize when it becomes remote that the holder of the rights will demand performance
Under the current IFRS methodology for payment received in advance of future use, the methodology is to recognize the revenue only when the card is used for payment. This means that the revenue from the sale of a gift card is accounted for upon redemption of the gift card.
No specific models are provided for recognizing breakage. The models used under GAAP are acceptable under IFRS.
Under the new model, breakage is figured into the obligation, or liability. Plus, the retailer must be able to “derecognize” the liability when it fulfills the performance obligation.
Expected breakage should be estimated based on historical trends and recognized as revenue in proportion to the pattern of customer behavior. If the retailer is unable to estimate the breakage amount, revenue for the unused portion of the gift card is recognized when the likelihood of the customer exercising his or her remaining rights becomes remote.
Below is an example from CFOdirect regarding the impact of the new joint model for determining liability for gift card and certificates.
Potential impact: Similar to today’s accounting model, retailers will continue to recognize a contract liability for the obligation to deliver goods and services. Expected breakage should be estimated and recognized as revenue in proportion to the existing pattern. If the retailer does not expect to be entitled to a breakage amount, it will recognize breakage revenue when it becomes “remote,” or unlikely, that the gift card will be redeemed.
The specific guidance for breakage in the new revenue standard should eliminate the diversity in practice that exists today.
Checking with your finance division is certainly the first step to ensuring that your company is keeping up with the new regulations. Many of the large third-party auditors are providing updates and advice to their clients now that the ASU documents have been published.
Even if your finance division is aware of the revenue recognition standard changes, it’s always a good idea to spend time with them to understand how the revenue is recognized and liability determined and timed, since these areas typically fall under the marketing department’s responsibilities. Keeping the lines of communication open and working together on preparing for the changing standards is one important way you can help ensure your customer relationship and loyalty marketing efforts don’t get derailed.
When it comes to keeping up with what’s new and evolving in the retail CRM and loyalty marketing world, as well as tried-and-true best practices, you can count on the experts at CCG. Check out our retail marketing services and capabilities for all the ways we can assist you in achieving greater success. For a complimentary one-on-one discussion, call us at 800.525.0313 or email us today.
As CCG’s senior vice president, consulting and account services, Lane Ware combines strategic expertise and experience in multiple industries with implementation and project-management skills. Her involvement in projects has ranged from building loyalty programs from the ground up to implementing long-range CRM initiatives to refining existing strategies.
“Implementing the New Revenue Recognition Standard for the Restaurant and Retail Industries,” Glen Beanland, CPA, and Andrea Castle, CPA, Crowe Horwath, published March 2017, https://www.crowehorwath.com/folio-pdf/Restaurant-and-Retail-Rev-Rec-Article-FW-17014-007A.PDF, accessed Aug. 14, 2017“
Revenue Recognition: Effectively Managing Accounting Change,” PwC, http://www.pwc.com/us/en/audit-assurance-services/accounting-advisory/revenue-recognition.html, accessed Aug. 14, 2017
“Revenue from Contracts with Customers,” CFOdirect, published June 18, 2014, https://www.pwc.com/us/en/cfodirect.html, accessed Aug. 14, 2017
“FASB Issues Update Clarifying Revenue Recognition Issue,” Jeff Drew, Journalofaccountancy.com, published March 16, 2016, https://www.journalofaccountancy.com/news/2016/mar/fasb-clarifies-revenue-recognition-issue-201614072.html, accessed Aug. 14, 2017
Revenue recognition information, EY.com, https://www.ey.com/gl/en/SearchResults?SRT_F=&SRT_O=&ACT=&Page=&CF=&LF=&FILTER=&DF=&IF=&SF=&FF=&query=revenue+recognition+&search_options=country_name, accessed Aug. 14, 2017
“Revenue Recognition,” Deloitte.com, https://www2.deloitte.com/us/en/pages/risk/solutions/revenue-recognition.html, accessed Aug. 14, 2017