Customer incentives



Retailers in the consumer goods industry operate in a highly competitive environment and invest significantly in getting and retaining customers. Many of them offer a wide variety of sales promotions and incentive arrangements to boost sales volume and build customer loyalty. The incentives offered through sales promotions may take the following forms:

Free gifts (such as mini-umbrella or ballpoint pen) if more than one item is bought
Arrangements where customers can earn the right to a price discount
Awards (or “points”) that entitle customers to discounted goods

More complex arrangements that include points entitling the holder to discounted goods of a partner establishment.

From an accounting perspective, how should a retail company record these customer incentive arrangements in its books of accounts to comply with Philippine Financial Reporting Standards (PFRS)? We will try to answer this question by exploring a dream business of a good friend and by looking at gift vouchers.

A good friend of mine started a revolutionary skin care business on January 1 this year. The introductory product in the market is a “wonder” lotion that will make the skin look younger by 10 years. The “magic lotion,” as some may call it, is effective for seven days. During that period, the lotion cannot be removed by washing with soap and water unless intense scrubbing is applied. The lotion disappears from the skin after seven days. Ten clinical trials were performed on the product before it was finally approved for sale in the market. A wholly owned company was set up for the business.

The business is mainly divided into two functions—manufacturing (inclusive of purchasing) and retailing (inclusive of distribution and marketing). As the formula is top secret, the location of the manufacturing facility is unknown and no information on the production process is being shared. On the retail side, my good friend entered into partnership contracts with known retail shops to make sure that the product will be available in the market. The key challenge now is how they can effectively attract customers to buy the lotion, and more of it.

Discount schemes

My good friend held a workshop with his management team to discuss this challenge. The marketing chief suggested three schemes:

Buy one, get one at half the price (or simply called “50 off”)

First product is sold for free (or simply called “100 off”)

Discount vouchers are granted for free (or simply called “30 off”)

Buy one, get one half the price (or simply called “50 off”)

Under the “50 off” deal, customers who buy a 500-ml bottle of lotion is entitled to buy another bottle at the same time but for half the price. While simple as it may seem, my good friend asked: “How should we account for the transaction?” “What will be my revenue?” and “Can we take up the entire cost of the second item as marketing expense?”

The accounting chief replied that the revenue recognized is the cash consideration received for the two bottles of lotion. The additional cost from offering the second piece at a discount is recorded as a cost of goods sold, and not as a marketing expense. So this scheme will result in a lower gross margin for the company and higher operating expense.

First product is sold for free (or simply called “100 off”)

For the “100 off” scheme, the customer is allowed to have the first product for free, and is under no obligation to get more products.

Again, my good friend raised the same question—“How should we account for the transaction?” The accounting chief replied that no revenue should be recognized for the product given for free. There was no inflow of economic benefit to the company since the transaction was made for zero consideration.

The transaction is not linked to any other transaction, as the customer can just take the free product and walk away. Neither the customer nor the vendor has any right or obligation relating to future transactions due to giving (or taking) the free product. The cost of the goods given away is charged as a marketing expense. It should not be recorded as cost of goods sold, as no sale has been made.

Discount vouchers are granted for free (or simply called “30 off”)

The marketing chief envisions the “30 off” as the product’s banner campaign. The company will publish in a national newspaper a coupon that gives 30 percent discount on products bought in any of its partner retail stores.

Anticipating the same question from their boss, the accounting chief explained that they should not recognize the distribution of coupons in the financial statements at the time the coupons are distributed. Rather, they should treat the coupon as a discount against revenue when the customers redeem them. The discount that results from the customer using the coupon should not be recorded as a marketing expense, as the coupon reduces the product’s sale price. On the other hand, the cost of the newspaper advertisement should be expensed when the newspaper is published.

So what’s the verdict?

No decision has been reached as of today. In coming up with the decision, the following should be considered from a business standpoint, among others:

Effectiveness of similar schemes undertaken by others in the market

Amount of free capital (or even cash) that is available for investment

Overall business strategy—is there a strategic fit?

Production capacity in case the chosen scheme becomes a “smash hit”

The company’s future prospects—any plans to go public, or to take on investors?

Dealing with gift vouchers

Issuance of gift vouchers is prevalent nowadays among retailers in the consumer goods industry. The big challenge is how to properly account for these vouchers and what accounting literature should be our reference.

Philippine Accounting Standards No. 18, ‘Revenue’ (PAS 18), does not deal specifically with gift vouchers that require future performance. But payment received in advance of future performance should be recognized as revenue only when the future performance to which it relates occurs.

The sale of a gift voucher is a contract with a customer in its own right. It should be considered together with the contract that arises if and when the voucher is exercised. PAS 18 states that, “the recognition criteria are applied to two or more transactions together when they are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole.” The revenue from selling the voucher is generally accounted for when the seller performs under the latter contract—that is, when the seller supplies the goods or services upon exercise of the voucher.

Where gift vouchers are issued as part of a sales transaction and are redeemable against future purchases from the seller, revenue should be reported at the amount of the consideration received or receivable, less the voucher’s fair value. In substance, this is a multiple element arrangement, as the customer is buying both goods or services and a voucher.

International Financial Reporting Interpretations Committee No. 13, ‘Customer Loyalty Programmes’ (IFRIC 13), provides guidance on dealing with gift vouchers (also known as ‘award credits’ or points). Historically, certain entities were accounting for the provision of gift vouchers or loyalty award credits as marketing expenses. IFRIC 13 clarifies the distinction between certain items treated as sales allowances (or adjustments against revenue) and arrangements treated as a marketing expense. A customer incentive arrangement is included within the scope of IFRIC 13 if both of the following conditions are met:

The entity grants points to its customers as part of a sales transaction–that is, a sale of goods or a rendering of services.

Subject to meeting any further qualifying conditions, the customers can redeem the points in the future for free or discounted goods or services.

It follows then that IFRIC 13 does not apply where there is no link to a sales transaction. Free gifts are not within the scope of IFRIC 13. However, the unlikely situation could occur that a “point” (within the scope of IFRIC 13) is issued that results in a loss on the sale of the later item. The “point” arrangement then would be accounted for as an onerous contract, and provision would be made in accordance with Philippine Accounting Standards No. 37, ‘Provisions, Contingent Assets and Contingent Liabilities’ (PAS 37).

Discount vouchers issued separately from a sales transaction (and therefore, outside IFRIC 13’s scope) are deducted from revenue when a sale is made and the discount voucher is redeemed. There are no accounting entries in advance of the sales transaction, unless redeeming the vouchers will result in products (or services) being sold at a loss. In these circumstances, the seller has created an onerous contract, and provision should be made in accordance with PAS 37.

As companies slug it out in the increasingly competitive business arena, management must remember that understanding the accounting implication of marketing and promotional strategies is an integral part of coming up, not only of creative, but also financially viable, strategies. Moreover, considering the accounting and even tax implication of customer incentives at the onset enables management to ensure compliance with financial reporting and regulatory requirements.

Paul C. See is a partner from Assurance and the Assurance Transformation Leader of Isla Lipana & Co./PwC Philippines. Email your comments and questions to This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.


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