Impending accounting changes may mean more businesses decide to reconsider their customer loyalty programs. Initiatives that provide incentives to returning customers already require a careful balancing act between risk and reward. Though they allow companies to track client purchasing activity, customer loyalty programs can also trigger unclaimed property exposure, cybersecurity liabilities and other risks. The new revenue recognition guidelines, which begin to roll out in 2018, may tip the scale in the other direction and have more businesses deciding their customer loyalty programs are not worth the risk.
Businesses with customer loyalty programs or that are considering incentives for customers should review the current environment for loyalty programs and how that environment may change under Accounting Standards Update 2014-09 Revenue from Contracts with Customers (Topic 606) before they decide the fate of their program.
Current Environment Set to Change
Entities currently have two options to account for loyalty programs. In the cost/provision method, companies record the cost to fulfill the reward obligation as a liability with the offset to expense. Take the following example. A restaurant offers its frequent customers $20 of food after 10 visits. The reward meal costs the restaurant $7 to deliver. The restaurant would record the $7 as a liability in their expense line over the period of time that the reward is earned, allowing the company to record the expense without an impact to revenue.
Companies can also elect to defer the revenue related to their reward obligation until the customer redeems the incentive. Under the revenue deferral method of accounting, entities record the loyalty program as a liability with a direct offset to revenue The restaurant from the example above would have to defer revenue across the customer's 10 visits and wait to recognize that revenue until the customer redeems the $20 reward. In the end, it is only a timing difference but can have significant impact on quarterly performance indicators such as same store sales.
Most companies currently elect to use the cost/provision method. That option, however, will soon be going away. The new revenue recognition guidance under ASU 2014-09 makes the revenue deferral accounting method mandatory. Recognizing the revenue associated with the customer loyalty program will come much later in the business cycle, and many companies will have to determine if they want to take on that liability.
The new revenue recognition guidance is complex, and as a noted with customer loyalty programs, the effect of the changes will have a wide impact on operations. Organizations should review the new revenue recognition standard now to prepare for the implementation date. Public entities will adopt the guidance for annual periods beginning after December 15, 2017, and private entities will adopt for annual periods after December 15, 2018, and interim periods after December 15, 2019. All will be able to adopt early.
Other Risks Not Going Away
Revenue recognition is not the only liability associated with customer loyalty programs, which is one of the reasons why the new guidance may have more companies deciding not to keep or implement reward programs. The following risks, particularly the threats to cybersecurity, are becoming more common with these types of programs.
Abandoned/Unclaimed Property- Just as with gift cards, customer loyalty programs can become abandoned/unclaimed property if customers do not redeem their rewards. Unclaimed property (also known as escheat) laws vary by jurisdiction. Companies need to monitor their sources of abandoned/unclaimed property and the laws that escheat property could be subject to in order to minimize their abandoned or unclaimed property exposures.
FTC Risks- The Federal Trade Commission (FTC) keeps track of customer terms and conditions to determine whether companies uphold their end of the deal. With customer loyalty programs, this may include how customers enroll in the program, how they can opt out and how the company providing the loyalty program uses the information provided by the customers. Companies will need to verify that their opt-out abilities and use of customer information function as promised or they risk FTC enforcement actions.
Cybersecurity- Customer loyalty program information poses a high risk for data breach because security measures around these types of databases tend to be less rigid. Additionally, hackers have found customer loyalty information to be valuable. In a Hilton Hotels data breach discovered in fall 2014, hackers accessed hotel points and used them to pay for hotels and other travel expenses. Some sold the points online. The Hilton Hotels data breach indicates breached points systems could lead to monetary gain for the hacker, which could make them more of a target for future attacks. Any customer loyalty program should be protected by multiple levels of security.
Anti-trust laws- Loyalty programs that provide discounts can trigger antitrust concerns, particularly in wholesale trade scenarios. Most wholesale retail loyalty programs involve discounts or incentives for companies that purchase a substantial share of product from the wholesale retailer. The agreements become risks if they give a wholesale retailer too large of a market share and damage the competition in the marketplace. Customer loyalty programs that damage competition are most frequently found among larger companies that already occupy a sizeable presence in the marketplace. Nevertheless, wholesale retailers should keep an eye out on how the FTC rules on cases involving loyalty programs and competition because the regulations in this area can be murky.
For More Information
If you have specific comments, questions or concerns about customer loyalty programs, please share them with Andy Burczyk or Brad Hale of MHM's Professional Standards Group. Andy can be reached at firstname.lastname@example.org or 816.945.5606. Brad can be reached at email@example.com or 727.572.1400.
Published on July 20, 2015