Yesterday I wrote about American Airlines earning its entire pre-tax profit from its frequent flyer program, and that for the last quarter and for the nine months ended September 30 they would have lost money without third party mileage sales.
The implication of course is that they are losing money on the part of their business which involves flying passengers.
It turns out that American’s passenger operation would look even worse by a couple hundred million dollars if it hadn’t been for an accounting rules change (ASC 606) that the airline had to adopt effective January 1, 2018. This increased the airline’s liability for frequent flyer miles issued for passenger travel in the past, and increased the amount of new revenue they recognize today when passengers redeem their miles.
- When the airline sells a ticket they are providing travel, and also providing miles which can be used for future travel
- That future travel has a value, and American is on the hook (not really) — even though they control how and when the miles can be used and at what cost.
- The new accounting rules require them to split the funds between those two buckets at a fair value for those future travel obligations, and that meant adjusting financials retroactively for this as well.
- American used to just book the incremental cost of carrying an additional passenger as that liability, perhaps $17 or $20 one way.
- Under the new standard the amounts involved are substantially greater than they used to be, in fact they’re about 10 times as much.
At investor day in September 2017 American announced that the new revenue recognition standards would mean a $5.5 billion increase on the balance sheet to account for those outstanding mileage credits from past travel.
Effectively American was moving money recognized from sold travel in prior years onto the balance sheet, to be recognized as revenue in future years when miles are redeemed instead.
When they sell tickets they record a liability for the miles issued that’s greater than before, and then they record the revenue when the miles are redeemed. American’s 10-Q shows this that for the first 9 months of 2018 they have recognized $263 million more in revenue for award travel redeemed than they’ve recorded in liabilities from miles issued for tickets.
The revaluation of American’s liabilities resulting from new revenue recognition standards accounts for roughly 90% of that $263 million figure. In other words, American’s passenger revenue looks $235 million higher than it would have without the new accounting rules that the airline adopted in January (which they were required to do).
I’ve already contended that American is losing money outside of its business selling miles to third parties, mostly banks. Their business of flying passengers would look nearly a quarter billion dollars worse during the first 9 months of 2018 if American hadn’t been required to make adjustments to their accounting.
The accounting rules change of course may be the best possible way to reflect the costs associated with issuing miles. It also has the effect of moving a quarter billion dollars of passenger revenue out of past years and into the present, making the present look better than it otherwise would have as a result.