Revenue recognition under IFRS 15 – Compensation payable to customers could give rise to the recognition of negative revenue

Thu 14 Nov 2019

The IFRS Interpretations Committee (“Committee”) recently opined on how airlines should account for compensation paid to passengers for delayed or cancelled flights.  The result of their deliberations was that such payments should be accounted for as a reduction to revenue. Here, we consider what the implications of this agenda decision are.

The Committee’s conclusion is understandable in light of the requirements on consideration payable to a customer in IFRS 15 Revenue from Contracts with Customers (“IFRS 15”) –  In brief, application of IFRS 15 results in consideration potentially payable to a customer being recognised as a reduction to revenue unless the contract also happens to require the customer to transfer a distinct good or service to the reporting entity.  An airline does not, however, receive a good or service from its passengers in return for such compensation payments.

The requirements of IFRS 15 on consideration payable to customers are sensible in that they prevent a company from deliberately wording contracts to artificially inflate the amount of revenue, which in turn would misrepresent the size of its business.  For example, if I were to construct a contract whereby I sell an apple to you from my shop for £1,000, but you simultaneously charge me a fee of £999 to collect the apple, in substance I have charged you £1 for an apple.  It would clearly be inappropriate to recognise revenue for £1,000 and an expense of £999 because the sale of the apple and the collection of the apple are not ‘distinct’.

However, the applicable legislation in (for example) the European Union dealing with how much compensation is payable by an airline can sometimes result in the compensation being greater than the original price of the flight ticket paid by the passenger.  The consequence of reducing the amount of revenue by all compensation is that an airline will recognise negative revenue on those contracts, as opposed to any part of it being presented as an expense.

In reaching its conclusion on the treatment of compensation payable in the airline industry, the Committee stated it “did not consider the question of whether the amount of compensation recognised as a reduction of revenue is limited to reducing the transaction price to nil.”  This side-stepping of how to account for compensation in excess of the original price of the flight ticket will probably be inferred by preparers and auditors alike (and also hopefully regulators) that all compensation payable may be accounted for as a reduction of revenue such that the excess compensation over the ticket price need not be accounted for as an expense.  The Committee’s agenda decision may not have been the one hoped for by those airlines that currently present all such compensation as an expense.  However, not requiring to account for any excess compensation as an expense will at least be welcome relief for those airlines that otherwise would have encountered significant systems issues in identifying the amount of any excess.

That said, theoretically at least, recognising excess compensation as negative revenue does not seem any better than recognising all compensation as an expense, but the Committee’s conclusion only seems to render the latter unacceptable.  It would be both interesting and informative to understand why the Committee chose not to specify the accounting for any such excess given that it might not achieve comparable accounting either within the airline industry (if some airlines decide to present excess compensation as an expense because their systems are sophisticated enough to do so) nor across other industries where compensation for a inadequately performed contract could be awarded at an amount in excess of the contract price, and hence typically be presented as an expense.