Accounting for Customer Loyalty Programs under ASC 606

✦ Customer loyalty programs offer incentives—such as points or rewards—that give customers a material right to future goods or services.

✦ Under ASC 606, these rights represent separate performance obligations, requiring allocation of transaction price and deferred revenue recognition.

✦ The timing and amount of revenue recognized depend on the estimated standalone value of the loyalty reward and the likelihood of redemption.

✦ Proper accounting affects revenue recognition patterns, liability estimates, and disclosure of breakage revenue.

1. Overview of Loyalty Program Accounting

✦ Many companies offer programs that award points or credits for customer purchases.

 • Retail: store credit, discounts, or free items

 • Airlines: frequent flyer miles

 • Hospitality: free nights or upgrades

✦ Under ASC 606-10-55-42 through 55-45, loyalty rewards that give the customer a material right must be treated as separate performance obligations.

2. Identifying the Performance Obligation

✦ If the reward (e.g., points) provides a future discount or good/service, and the customer wouldn’t receive that benefit without the initial transaction, it’s a material right.

✦ This triggers a second performance obligation beyond the sale of the initial product.

Example:

• Customer earns 100 points with a $500 purchase

• Points can be redeemed for future merchandise

→ The obligation to provide discounted goods later is distinct and must be accounted for separately.

3. Allocating the Transaction Price

✦ The transaction price must be allocated between:

 • The product or service delivered today

 • The loyalty points as a future performance obligation

✦ Allocation is based on standalone selling prices, which may be estimated using:

 • Expected value method

 • Adjusted market assessment

✦ This creates deferred revenue (contract liability) for the loyalty points.

4. Initial Journal Entry — Sale with Points

Assumptions:

• Standalone value of goods sold = $475

• Fair value of loyalty points = $25

Entry:

debit Cash – $500

 credit Revenue – $475

 credit Deferred Revenue (Loyalty Obligation) – $25

5. Revenue Recognition When Points Are Redeemed

✦ When the customer redeems points for goods or services, the company fulfills its performance obligation.

✦ At that time, recognize revenue and reduce the deferred liability.

Entry:

debit Deferred Revenue – $25

 credit Revenue – $25

6. Accounting for Breakage

✦ Breakage refers to the portion of points that are expected to go unused.

✦ If breakage can be reasonably estimated, revenue may be recognized in proportion to actual redemptions.

✦ Breakage estimates must be updated periodically based on historical data and redemption behavior.

Entry (proportional breakage):

debit Deferred Revenue – $5

 credit Revenue – $5

7. Disclosure Requirements

✦ Companies must disclose:

 • Nature of loyalty program and performance obligations

 • Judgment used in estimating standalone selling price and redemption rate

 • Contract liability balance and changes in period

 • Breakage method and assumptions

8. IFRS Comparison (IFRS 15)

Topic	US GAAP (ASC 606)	IFRS 15
Performance obligation	Required if material right exists	Same
Breakage	Allowed with reliable estimate	Same
Classification	Deferred revenue (contract liability)	Same
Allocation basis	Standalone selling price	Same

9. Common Mistakes

✦ Failing to treat loyalty points as a separate performance obligation.

✦ Recognizing all revenue up front when points are issued.

✦ Using cash value instead of standalone selling price for allocation.

✦ Omitting or improperly estimating breakage.

✦ Inadequate disclosure of loyalty program assumptions or liability balances.