For most companies and businesses, the only revenue source will be their primary operations. These operations will differ from one company to another based on their activities and industries.
These operations may consist of sale proceeds from selling products or rendering services. Similarly, each company has unique operations that allow it to earn income.
Some companies may also earn income from other sources. Accounting for this income under the relevant standards is crucial for these companies.
Sometimes, these incomes may fall under the company’s primary revenues. Other times, it may be a part of the companies’ other income. One of these types of income includes loyalty income.
What is Loyalty Income?
Companies buy products or get services from different suppliers. Each supplier provides companies with distinct or unique products.
Usually, companies may choose between various suppliers to obtain specific items. However, some companies may also select their existing vendors based on historical transactions. This preference may also come as a result of a company’s loyalty to its suppliers.
Some suppliers may offer loyalty programs to customers. These programs require customers to continue buying products from specific products.
In exchange, the customer receives some rewards or incentives. The compensation paid to customers to stay loyal to a supplier is an expense.
However, this expense gives rise to a future income known as loyalty income. While it is not common for suppliers to offer these programs, they may occur occasionally.
Loyalty income usually includes any sales generated through suppliers’ loyalty programs. Usually, retailers provide these rewards through gifts, discounts, or other special incentives.
The primary purpose behind such compensations is to attract or retain customers. Companies also design these programs to encourage repeat customers.
Loyalty income depends on various factors. Most commonly, however, suppliers offer this income to valuable customers. Usually, the more a customer stays loyal to the supplier, the higher rewards they can reap.
There are various types of loyalty programs that companies may offer. Therefore, accounting for loyalty income from these programs may become complicated.
How does Loyalty Income work?
Loyalty income programs differ from one company to another. Usually, suppliers decide which incentives they should offer their customers.
These incentives may fall into several categories. Some of the loyalty income programs include the following offers.
- Member-only discounts.
- Early access to products or services.
- Advance notice for new products or services.
- Free merchandise or improved services.
- Faster delivery or special services.
There are several industries where loyalty programs are common. For example, airline companies offer customers frequent flyer miles based on their trips or spending.
Similarly, some chain stores may provide customers with many packages to promote spending and loyalty. Even credit card companies offer customers various incentives to increase usage.
However, most loyalty programs come with terms and conditions attached. These terms usually involve spending more on the supplier’s products and services.
Some suppliers may also include conditions for the duration for which these rewards are available. Similarly, suppliers may limit these programs to specific customers rather than make them for everyone.
Loyalty programs help suppliers increase their sales. The more customers spend on their products, the higher revenues these suppliers can generate. This income comes in the form of royalty income.
Similarly, these programs can provide suppliers with a competitive advantage over others. However, its benefits aren’t one-sided only. Loyalty programs also offer customers a way to decrease costs or increase their income.
Overall, loyalty income may come from various sources and in several forms. Usually, this income depends on the contract that suppliers and customers have.
The agreement between both parties will also dictate the timing of the revenues for the customers. Due to these reasons, the accounting for loyalty income may fall under the scope of IFRS 15.
What is the Accounting for Loyalty Income?
The accounting for loyalty income depends on the contract between both parties. As mentioned, some suppliers will attach various terms and conditions to the availability of this program.
On top of that, the contract may also involve a base price and loyalty income for future transactions. Lastly, some loyalty income may come at a particular time, while others may fall over a specific period.
The process for accounting for loyalty income falls under IFRS 15. There are five steps that this standard identifies for recognizing loyalty income.
While these points also apply to loyalty income, it also covers revenues from other sources. The steps for revenue recognition under IFRS 15 include the following.
- Identify a contract.
- Identify performance obligations.
- Determine the transaction cost.
- Allocate the transaction cost to the identified performance obligations.
- Recognize the revenue at or over time.
Companies must signify their upfront payments through the above criteria and fulfill loyalty program requirements. These will fall under identifying performance obligations and determining the transaction cost.
Once they do so, they must allocate the transaction costs to those obligations. It will include separating the upfront payment for the goods and services from the rewards from loyalty programs.
Companies must also recognize the revenues when they occur. However, the contract may exist before those revenues realize.
Therefore, any unearned loyalty income will fall under deferred revenues for companies. Once these materialize, companies can transfer the amount to the revenues account. This amount will also expire once the offer is no longer available.
What are the journal entries for Loyalty Income?
The journal entries for loyalty income occur when a supplier enters a contract with a customer. This contract must mention the terms and conditions of the loyalty program.
Similarly, the supplier must separate earned revenues from royalty income at the time. This loyalty income will become a part of deferred revenues until earned.
The journal entries for recognizing a contract with a loyalty income element are as follows.
The above journal entries assume the supplier offered a contract that included upfront payments for goods and services. The deferred revenues account will hold the amount for the loyalty income until earned.
Once the customer avails of the option or the contract expire, the supplier must use the following journal entries to recognize the loyalty income.
A company, ABC Co., offers a loyalty program to customers, which allows them to get early access to new products. However, the terms and conditions for this program limit its availability.
Similarly, the company only allows customers to use this feature within a year. If they fail to do so, the offer expires.
During the accounting period, ABC Co. sold products worth $100,000. However, the company collected a total of $120,000 from customers.
The extra amount relates to the loyalty program that ABC Co. offers. ABC Co. recorded this amount using the following journal entries.
After a year, some customers avail of the option while others don’t use the feature within the expiry date. However, it allows ABC Co. to transfer the amount from deferred revenues to sales. ABC Co. uses the following journal entries to record the transaction.
Loyalty income is any income that companies generate from offering loyalty programs. The accounting for loyalty income falls under the scope of IFRS 15.
This accounting standard defines five steps for recognizing revenues from royalty income. This process involves the deferred revenues account and transferring the amount to the sales account later.