Question

Many airlines have frequent flyer programs that permit travelers to accumulate credits that can be applied to the cost of tickets for future flights. Most airlines recognize the cost of their frequent flyer programs when the credits are used to purchase tickets. This practice, which seems to ignore the matching concept, results in: Answer stating liabilities and expenses at appropriate amounts. overstating liabilities and expenses. understating liabilities and expenses. understating liabilities and overstating expenses.

Answer 1

When airlines recognize the cost of their frequent flyer programs only when the credits are used to purchase tickets, it results in understating liabilities and overstating expenses.

The answer is option ⇒4

Step-by-step explanation:

The reason behind this is the matching concept in accounting. According to the matching concept, expenses should be recognized in the same period as the revenues they help generate. In the case of frequent flyer programs, the airlines incur costs to provide the program benefits to customers. These costs should be recognized as a liability as customers earn credits.

However, when the airlines delay recognizing these liabilities until the credits are used, it understates the liabilities on their financial statements. This is because the liabilities associated with the credits accumulate over time as customers earn them, but they are not reflected in the financial statements until the tickets are purchased.

Additionally, by delaying the recognition of the liabilities, the airlines overstate their expenses in the period when the tickets are purchased. This is because the expenses associated with the frequent flyer programs are not properly matched with the revenues generated from the tickets purchased using the credits.

In summary, by delaying the recognition of liabilities and overstating expenses, the airlines' accounting practice of recognizing the cost of their frequent flyer programs when the credits are used to purchase tickets goes against the matching concept in accounting.

The answer is option ⇒4

Answer 2

The correct answer is letter "B": overstating liabilities and expenses.

Step-by-step explanation:

In accounting, the matching principle states that revenues must be recognized with their corresponding expenses during the same period where both of them took place. In the case of the airlines providing frequent flyer programs, they will partly have to take charge of the basic costs of a plane ticket to continue providing such benefits to their customers. However, it is usually requested a large number of credits to swap the free flight ticket, implying the possibility that it could take more than one accounting period for that to happen.

Then, by not recognizing the revenues and their associated costs in the same period where they took place, airlines overstate liabilities and expenses in their financial statements.