James Ehnes has recently completed his second year of accounting studies. He has just been hired as a summer intern at the auditing firm of Hetu & Fauré. James feels fortunate to have landed an internship in such a prestigious firm. His supervisor, Venus Yang, has handed him a lengthy description of the operations of AeroTravel Inc. (ATI) and has asked James to prepare a report in which he outlines the significant accounting policies that arise in this company. She also wants James’s recommendations on how the company should account for the revenues and expenses relating to ATI’s provision of services, as well as the balance sheet ramifications of his recommendations. James knows that the purpose of this exercise is to test his understanding of the complex relationships underlying revenue and expense recognition. After reading through the description several times, he makes the following notes:

• ATI is a public company that operates loyalty reward plans for a wide range of clients involved in the travel business, including airlines, hotels, and package tour operators. ATI sells loyalty units to the clients, who, in turn, reward their customers or members with those loyalty units when they buy the clients’ services or products. Clients’ custom-ers and members can then acquire products or services through ATI either for free or at a reduced price by using their loyalty points.

• ATI derives its cash inflows by selling loyalty units in bulk to each client. Each client then issues the points to the members of the client’s loyalty plan. ATI receives payment directly from client companies for the loyalty units sold to the clients for their members.

• Loyalty plan members redeem loyalty units through ATI for rewards of travel, merchandise, or other services. ATI buys the airline seats, merchandise, or services from the vendor to provide the tangible rewards to members. For example, if a member of a client airline’s loyalty plan books reward travel, ATI must buy the seat from the airline.

• The largest client is Trans- National Airways, which accounts for over 60% of ATI’s business.

• Each year, Trans- National Airways is required by contract to buy a pre- established quantity of AeroTravel Miles from ATI.

• Conversely, each year ATI is required by the same contract to buy a minimum quantity of reward travel seats on Trans- National and its affiliates.

• The estimated redemption value of loyalty units outstanding (that is, those sold by ATI to its clients but not yet redeemed) are stated as deferred revenue on ATI’s year- end SFP. Not all loyalty units are redeemed. ATI estimated that as of the end of 20X8, 18% of the outstanding loyalty units would not be redeemed, as compared with an estimate of 21% at the end of 20X7.

• When the company revises its estimated redemption rate at the end of a fiscal year, the company restates that year- end’s balance of deferred revenue.

• In limited circumstances, ATI sells loyalty units directly to client plan members ( rather than through the client company), such as to client plan members who wish to “ top up” their point balance just enough to claim a desired reward.

• AIT also derives fees from client companies for direct marketing, for sales promotion, and for designing, developing, and administering loyalty programs for both existing and new client companies.

Required:

Ms. Yang wants the report on her desk first thing tomorrow morning. Assume that you are James Ehnes. Prepare the report for Ms. Yang.