Originally Posted by
Chuck2009x
Ah, now this gets into one reason why I thought this move might have been made. I'm not a finance guy, at all, but I know that points have to be accounted for as liabilities on the balance sheet.
In the simplest possible imagining of how that works, a dollar's worth of points on the liability side is equal to a dollar of revenue. If you redeem points and wipe out a dollar's worth of liability, it affects the BOTTOM line the same as if you paid a dollar.
But, adding a dollar to the TOP line (ie. revenue) looks better to Wall St., even if your bottom line stays the same.
By charging a loyalty penalty on points, they wipe out more liability and improve their bottom line. If they steer people away from redemptions and towards cash, they improve their top line.
Generally true, but the liability of points is discounted on the balance sheet. It is not at redemption value.
Also, liabilities are not part of the P&L. They are used in the calculation of shareholder value, the same as net worth to the individual. That does not make them unimportant. When a business takes on a liability, the money is not accounted as income. When it pays off the liability it is not a deductible expense, and any reduction of the liability even if it is not realized as cash, is a taxable event.
That exposes the thought process of devaluations and why there is never an increase in valuations of any points program. The liability is held against the value of the company. If by some magic power they can reduce the liability value by changing the discount value of the future liability, then that decreases the exposure to future taxation when the liability is reduced.
If they are carrying points on the balance sheet as a liability, the "sale" of points is not a sale at all but a loan from the balance sheet perspective. It still has to be paid. When points are used, the discounted value is removed from the liability and creates a taxable event. A devaluation that decreases the value of the liability is also a taxable event paid in the year that the liability is reduced.
Where does the money come from to pay off this liability? From us, in reduced value. It is quite simple.
Bottom line, every time we redeem points, we reduce their liability on the books and create a taxable event. Except it doesn't. Since the redemption incurs costs and expense that has no offsetting cash income, the taxable event become less taxable. In a perfect accounting world, cost of providing the redemption will equal reduction in liability and net zero tax liability. With reduced value points, the taxable event from the reduction of liability may even be less than the expense of reduction creating an on the book reduction of taxes. Yes, those diverted taxes were paid by us in the devaluation of the liability. (If you are still reading the much too long post, the light may have just gone on about certain routes costing more points.)
They could just buy our points and pay off the liability, but then we would really scream because they would only pay for them at the discounted rate. It is much easier to take a fractional part through devaluation. We all still "have" points, there are just as many on the balance sheet and in our account, but as they are now worth less they do not buy as much. And the liability is reduced increasing shareholder value since the taxes on the reduction is about 35% at top rate. Reduce liability by $1 pay $.35 in tax and be ahead by $.65 per $1 of liability. Its a good deal. Except for us.
I am not a CPA, but I do own businesses. The accounting is the same except for scale. And, you now know why businesses push gift certificates at cash value. If they want, when they sell one it is not income, it is a loan. They only pay taxes on the ones that are redeemed, carrying the others as a liability. They also put expiration dates for the same reason as it decreases the discounted book value and limits the potential liability from redemption to those sold in a specific time period. Granted, some small businesses just account for them in the regular cash flow. It is easier, and in the long run it is a wash tax wise. Either way, they make additional money on gift certificates as some are never redeemed.