United Continental Holdings Inc. is the parent company of both United Airlines a
ID: 2741813 • Letter: U
Question
United Continental Holdings Inc. is the parent company of both United Airlines and Continental Airlines. On the 12/31/2012 balance sheet the company lists as a current liability $2.4 billion of "Frequent Flyer Deferred Revenue" and as a long term liability $2.8 billion for the same account. To reward loyal customers the airlines offer free travel. The footnotes to the 2012 financial statements contain the following information: The Compay has a frequent flyer program that is designed to increase customer loyalty. Program participants earn mileage credits("miles") by flying United, Continental, and certain other participating airlines. . . . In the case of the sale of air services, the Company recognizes a portion of the ticket sales as revenue when the air transportation occurs and defers a portion of the ticket sale representing the value of the related miles. A. What is meant by "Deferred Revenue" and where does it fit into the accounting process and the financial statements? B. Discuss the csh flow implications of the $5.2 billion in deferred revenue for United Continental in 2012 and future years. C. How do you think an analyst following the company would react to a sharp change (increase or decrease) to the amount of deferred revenue on the balance sheet?
Explanation / Answer
A.
Deferred revenue is the amount of cash that has been received in advance for products or services to be delivered in future. In other words, deferred revenue is unearned revenue that has been received in cash but not yet earned. It is treated as a liability by the receiver and is classified as current liability or long-term liability on the balance sheet depending upon the time period during which it would be earned. For example, if cash has been received for services to be performed during a period of one year from the balance sheet date, it will be classified as a current liability. On the other hand, if the services have to be performed over a period of several years, it will be classified as a long-term liability.
B.
The $5.2 billion deferred revenue would increase the cash flow from operating activities in the current year. However, in the future years, when the deferred revenue is eanred and the liability recognized reduces it will decrease the cash flows from operating activities.
C.
Sharp increase in deferred revenue shows that the company would be able to generate revenue in future years. However, too much of deferred revenue can also put the company in liquidity issues in the comming years.
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