Accounting for customer loyalty schemes

From your favourite restaurant to the airline you fly with, loyalty schemes are a firm favourite among today’s consumers. In our recent consumer outlook survey, we explored the impact of these schemes and found that while success varies by industry and target audience, there’s no doubt they have a significant influence over consumer behaviour.

Retailers, hospitality and hotel operators have long used loyalty schemes to attract and retain customers, fostering relationships that go beyond a one-time discount. By encouraging repeat spending and enhancing the overall customer experience, these initiatives help businesses strengthen their brand, increase their visibility and even grow their market share. Plus, the valuable customer data they collect allows for more personalised and effective marketing.

But these perks come at a cost. While each individual reward might seem small, the financial obligations tied to these schemes can add up, making it essential for businesses to account for them carefully in their financial statements. 

What are the accounting requirements for loyalty schemes? 

Under FRS 102 (UK GAAP) and IFRS, the accounting treatment is not straightforward and may depend on the details of the scheme. 

A loyalty scheme will usually involve granting vouchers, coupons or loyalty points to customers to redeem at some point in the future in exchange for free or discounted goods or services. Under FRS 102, these are called multiple element arrangements, as the customer is purchasing two things – goods or services and loyalty credits. 

The loyalty credits should be accounted for as a separately identifiable component of the initial sales transaction. The fair value of the consideration received (or receivable) in the initial sale must be allocated between the loyalty credits and the goods or service supplied. The loyalty credit should be measured at its relative fair value i.e. the amount for which the loyalty credits could be sold separately, and this element of the consideration received should be deferred. The expected redemption rate of the credits can be taken into account when calculating their fair value. The consideration which has been allocated to the loyalty credits and deferred is recognised as revenue when the credits are redeemed.

From 1 January 2026, the 2024 amendments to FRS 102 introduce a new basis of revenue recognition, which is aligned to IFRS 15. This change incorporates a new five-step model with an additional focus on identifying the performance obligations in a contract with a customer.

As part of the change, businesses need to carry out an initial assessment as to whether the option for a customer to acquire additional goods or services for free or at a discount is providing the customer with a material right that they would not receive without entering into that contract. If this is the case, the option is a separate performance obligation. If the option allows the customer to acquire additional goods or services at a price that reflects the stand-alone selling price for that good or service, the option does not provide the customer with a material right and is not a separate performance obligation.

Where the option is a material right to a customer, the customer is effectively paying in advance for future goods or services. As such, the business will recognise revenue when those future goods or services are transferred or when the option expires. 

The stand-alone selling price of an option needs to be determined to allocate part of the transaction price to it. 

Some arrangements let customers earn points that can be redeemed in a variety of ways – e.g. to acquire free or discounted goods or services, or to use them to offset the amount owed to the seller. However, the accounting for these arrangements can be complex, with some specific examples of common scenarios provided by IFRS 15:

• Points earned from the purchase of goods or services which can only be redeemed for goods or services provided by the seller or issuing entity.
• Points earned from the purchase of goods or services which can be used to acquire goods or services from other businesses, but cannot be redeemed for goods or services sold by the seller.
• Points earned from the purchase of goods or services, which can be redeemed either with the seller or with other businesses. 

Management should consider the nature of its performance obligation in each of these situations to determine the right accounting approach for the loyalty programme. 

When it comes to deferred income where loyalty credits have been outstanding for a long time, UK GAAP doesn’t provide specific guidance. However, companies can consider applying the guidance in IFRS 15, which involves estimating the ‘breakage’ of the credits – the amount/value of contractual rights that will never be exercised. This estimated breakage is recognised as revenue when the likelihood of the customer exercising their remaining rights becomes remote, even though the performance obligation has not been satisfied. 

Non-refundable upfront fees should be assessed to decide if they represent a performance obligation. Typically, the upfront fee doesn’t result in the transfer of a distinct good or service to the customer and therefore isn’t treated as a separate performance obligation. Instead, it is allocated to other performance obligations identified in the contract. 

When correctly accounted, loyalty schemes will result in a reduction of revenue, EBITDA and margins in the first year, so it’s important for CFOs to proactively communicate with investors and the board to manage expectations and provide strategic context for the financial results.

Next steps for accounting on loyalty schemes

With changes to FRS 102 approaching, businesses should stay ahead by ensuring their loyalty schemes are accounted for correctly. While navigating these complexities can be challenging, our experts are here to help. Get in touch today and find out how we can help you.