FlyJet Airways instituted a frequent flyer program in which passengers accumulate points toward a free flight based on the number of miles they fly on the airline. One point was awarded for each mile flown, and a minimum of 750 miles was awarded for any one flight. Because of competition in 2011, the company began a bonus plan in which passengers receive triple the normal mileage points. In the past, about 1.5 percent of passenger miles were flown by passengers who had converted points to free flights; with the triple mileage program, FlyJet expects that the rate will increase to 2.5 percent.
During 2011, the company had passenger revenues of $966.3 million and passenger transportation operating expenses of $802.8 million before depreciation and amortization. Operating income was $86.1 million. What is the appropriate rate to use to estimate free miles? What effect would the estimated liability for free travel by frequent flyers have on 2011 net income? Describe several ways to estimate the amount of this liability. Be prepared to discuss the arguments for and against recognizing this liability.