Company accounting issues and financial reporting challenges

¶ … company or industry that has experienced an accounting issue. The focus of the essay will be on United Airlines but it could have been applied to any other major airline. The main research comes from the December 1991 story by Charles W. Taylor entitled "Airline Accounting: AICPA vs. FASB," which was on the December CPA Journal Online. The paper incorporates an analysis of the company, industry and the account issue with my personal opinion of the subject matter. A large portion of the paper focuses on the impact on investors and other stakeholders and also presents insights into the opinions of the article's author.

Industry

There have been some distressing financial reports coming out of the airline industry. Investors and corporate managers are well aware that there is an economic crisis in the airline industry. Larger carriers like United, American Airlines, Delta and Continental are all having major issues that are related to the price of fuel, terrorism and the overall weak world economies.

These major United States-based carriers have all had to or already have filed for bankruptcy protection. "Beleaguered United Airlines teetered closer to bankruptcy Wednesday after a federal board rejected its application for a $1.8 billion loan guarantee on the eve of a crucial union vote on wage concessions." (Armstrong, 2002) Most people think that the events on September 11, 2001, where terrorists hijacked planes and used them as suicide missiles was the only reason for the airline industry's current financial situation. but, over the past three decades the true dilemma the airline industry has faced can be found in other economic indicators such as inflation, the United States and world economies, globalization and stiff competition.

One solution that has made investors and stakeholders very happy was for the airlines to offer frequent flier miles and other reduced fairs. "Mileage Plus®. United's frequent-flier program, Mileage Plus, grew significantly, due to the continued success of partnerships such as First USA Mileage Plus Visa and Master Card, MCI WorldCom and E*TRADE. Revenue from third-party mileage sales reached $107 million during the first quarter, representing an 18% increase over the same period last year. Recently, United and Safeway launched Grocery Miles -- the largest partnership between a national grocer and an airline -- which allows customers at nearly 1,300 U.S. stores to earn frequent-flier miles in United's Mileage Plus program for their grocery purchases." (PR News Wire, 2000) as bankruptcy looms, frequent flier miles have become a major topic of discussion. But these frequent flier miles were an accounting problem as far back as 1990 and 1991.

Company

In the year 1991, United Airlines and Arthur Anderson were working on the dilemma of how to accurately account for frequent flier program revenue and expenses. "United Airlines utilizes a slightly different version of the incremental cost method to account for its free travel awards. United's variation involves an expense accrual and an accrued liability. Similar to the first method, when its program members achieve the necessary level to request free travel awards, the airline records the incremental cost expected to be incurred when the awards are used. However, the charge is made to the promotion expense account. Therefore, United views the transaction as an expense accrual as opposed to a revenue reduction." (Taylor, 1991)

In 2002, Anderson was dropped by United in an unrelated incidence. "The announcement by United ended a 67-year relationship between the airline and Andersen. UAL management said it dumped Andersen because of the uncertainty surrounding the auditor's future. Part of that uncertainty: on Monday, Andersen goes to court in Houston to face an obstruction of justice charge." (Taub, 2002) but the 1991 situation was luckily averted by a technical issue unrelated to the incremental cost methodology used at United. The method was almost contested which would have made investors and stakeholders very nervous at best and panicked at worst.

The airline industry's use of frequent-flier travel miles was a major marketing tool while the industry was in the midst of a terrible dry spell. "United NewVentures will allow us to expand into new e-businesses and frequent flyer partnerships that improve convenience and choice for our customers, increase opportunities for our employees and enable us to operate more efficiently." (United, 2004) the miles were seen by consumers as a win-win proposition which entailed new customer brand loyalty, boosted passenger mile's statistics and offered relief for the airlines from creditors.

Investors and stakeholders were overjoyed by the success of the frequent flier programs. But the frequent flier miles programs were also an accounting nightmare. "The American Institute of Certified Public Accountants (AICPA) and the Financial Accounting Standards Board (FASB) have been in disagreement over the method to be used in accounting for free travel awards. The AICPA was proposing the use of the increment cost method for promotional or premium travel programs, and the deferred revenue method for discount travel programs. The FASB, on the other hand, was insisting on the deferred method for all free travel programs." (Taylor, 1991)

Affect

The problem with frequent flier programs from an accounting perspective is that they may cause revenue displacement in the books of an airline; in this case, United Airlines. "Revenue displacement occurs when a passenger using a free travel award occupies a seat on a flight which would otherwise have been occupied by a paying passenger. This results in lost revenue for the airlines." (Taylor, 1991)

When the airline industry, the American Institute of Certified Public Accountants and the Financial Accounting Standards Board studied the displacement problem, the two accounting organizations came to a disagreement point. However, due to a technical issue the concern of the two organizations was averted and they came to an agreement that was satisfactory to all. This article was a summary of the issue, disagreement, and outcome of the frequent flier accounting problem.

The disagreement between the AICPA and the FASB was based on the methodologies of each group. "The FASB adamantly believes that all free travel award programs should be accounted for using the deferred revenue method." (Taylor, 1991) This opinion basically stated that there should be no exceptions to the deferred revenue method and that meant that the incremental cost method was not acceptable. "The AICPA, as stated in the proposed SOP, believes that the incremental cost method should be used to account for free travel award programs which are incidental in nature. If a program fails the incidental-in-nature test, then the AICPA recommends use of the deferred revenue method." (Taylor, 1991) the matter was dropped not because it was resolved by choosing one method over the other. Instead, a technicality prevented both sides from pursuing the matter further.

Comment feel that in this case, the two accounting overseeing organizations let the airline industry off a little easy. I bet the airlines, investors and the stakeholders were all very relieved when the American Institute of Certified Public Accountants backed off and decided not to pursue the problem in the future. United and the other airlines were basically given the okay to continue to use the incremental cost method to account for their frequent flier programs which actually should have been seen as free travel awards. By backing off, the American Institute of Certified Public Accountants kept the airlines from having to defer a small amount of the price of every ticket purchased by a participant of their frequent flier programs to account for the cost of the future free ticket.