ASC 606’s Impact on Loyalty Programs: Redemption is Key

As consumers look for new ways to save money, many restaurants have begun offering or have expanded their gift card and loyalty programs. In a previous post, we briefly discussed the impact of Topic 606 on loyalty programs. Now, let’s take a deeper dive and discuss Topic 606’s specific impact on restaurants’ revenue recognition of loyalty programs.   
Because current U.S. GAAP guidance is not clear, restaurants have been taking diverse approaches to revenue recognition of loyalty programs. The most common approach in the industry recognized revenue immediately at the time of the purchase or when loyalty points were earned, resulting in the company recording a liability for the cost associated with the company’s future obligation. However, this approach is no longer allowed under the new standard.
Topic 606 introduces a new concept of material rights. Now, a material right is a separate performance obligation in a contract and represents a right granted to a customer to purchase future goods or services at a discount. In the restaurant world, loyalty program points earned with each purchase is an example of a material right since they represent a performance obligation to deliver future goods and services for the points earned and redeemed.
So, how is a material right recognized under Topic 606? As loyalty points represent a material right, a portion of the revenue generated in a sale must be allocated to the loyalty points earned. The amount allocated to the points earned is deferred until the loyalty points are redeemed or expire. To determine how much of the sales proceeds to allocate to the loyalty points earned, companies must determine the standalone selling price of the loyalty points.
Let’s look at the example below to see how restaurants can follow this new approach:
Within the Topic 606 standard, example 52 discusses a loyalty program in which a customer earns $1 for every $10 purchased, and each point is redeemable for a $1 discount on a future purchase. If the sponsor of the program sells $100,000 worth of goods and services during the period, the customers earn 10,000 loyalty points. To determine how much of the $100,000 of revenue received to allocate to the loyalty points earned, the company must determine the standalone selling price of the loyalty points.
In this example, the company expects 95% of the loyalty points to be redeemed, so it estimates the value of the 10,000 points earned to be $9,500.  The company then allocates the $100,000 received between the goods and services sold, which are worth $100,000 on a standalone basis, and the loyalty points earned, which results in $91,324 [$100,000 x ($100,000 standalone selling price/$109,500)] being allocated to the goods and services and $8,676 [$100,000 x ($9,500 standalone selling price/$109,500)] being allocated to the loyalty points. Thus, $91,324 is recognized as revenue during the period, while $8,676 is deferred until the points are redeemed, at which point the revenue will be recognized.
It is important to note that when determining the standalone selling price, the new standard establishes a process for recognizing breakage, which is revenue recognized on the portion of points that will not be redeemed. The standard requires companies to apply this model to breakage related to loyalty programs. In simple terms, breakage will be recognized as revenue over the same period and on the same pattern that loyalty points are redeemed.
As noted in the above example, a portion of revenue from loyalty programs will be deferred based on the standalone selling price of the loyalty points. This change, along with the requirement to recognize breakage as the points are redeemed, will result in a cumulative adjustment to beginning retained earnings upon adoption of Topic 606.
The effective date for private entities, December 15, 2018, is fast approaching. Now is the time for restaurants to understand ASC 606’s potential effects on its financials and to ensure that systems and process are in place to handle the accounting required by the new guidance, which will require collecting historical data. It is also important to note that the changes to the loyalty program accounting may affect financial metrics, including key performance indicators, liabilities, debt covenants, as well as additional, extensive disclosures. Of course, these potential changes should be communicated to appropriate parties as soon as possible.
For more information on ASC 606, visit BDO’s Revenue Recognition News & Resources hub.
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