Case Paper

CASE: A-231
DATE: 07/01/17
Emily Booth, Professor Elizabeth Blankest poor, and Jaclyn For bought, CFA, prepared this case as the basis for class
discussion rather than to illustrate either effective or ineffective handling of an administrative situation.
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JETBLUE AND
THE NEW REVENUE RECOGNITION STANDARD
The core principle of Topic 606 is that an entity should recognize revenue to depict the transfer of
goods or services to customers in an amount that reflects the consideration to which the entity
expects to be entitled in exchange for those goods or services.
—Financial Accounting Standards Board (FASB) Accounting Standards Codification®
(ASC) 606-10-05-31
In May 2014, the Financial Accounting Standards Board (FASB) and the International
Accounting Standards Board (IASB) issued a converged standard on revenue recognition (ASC
Topic 606 and IFRS 15, respectively) aimed at ameliorating difficulties associated with
determining when to recognize revenue and at what amount. Prior revenue recognition standards
applied broad concepts together with a variety of requirements for specific industries or types of
transactions, sometimes resulting in divergent accounting for economically similar transactions.2
In contrast, the new standard outlined a single comprehensive model to use in accounting for
revenue from contracts with customers. Although the new standard simplified the guidelines
down to one framework, it also generally required firms to use more judgment and estimation
than prior guidance.
1 Financial Accounting Standards Board, “Revenue from Contracts with Customers (Topic 606),” Financial
Accounting Series, No. 2014-09, May 2014, p. 2.
2
The original effective date for the converged guidance was January 1, 2017, for calendar-year public business
entities while private companies were given an additional year to implement the new standard. In August 2015,
FASB deferred the effective date of the new revenue recognition standard by one year, with early adoption
permitted as of the original effective date. Due to the transitional nature of the implementation process, this case
study refers to revenue recognition standards effective prior to the issuance of the new standard as “prior revenue
recognition standards” although private companies were permitted to implement “prior” standards until the end of
2018.
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JetBlue and the New Revenue Recognition Standard A-231 p. 2
In its second quarter of 2014 financial statement filed with the Securities and Exchange
Commission (SEC) in August 2014, New York-based airliner JetBlue Airways Corporation
(JetBlue) [NASDAQ: JBLU] acknowledged the new revenue recognition standard. While it had
yet to determine the full impact of adoption, changes were imminent.
THE NEW REVENUE RECOGNITION STANDARD
At its core, the new standard stated that revenue should be recognized when there is a transfer of
promised goods or services to customers, and that the amount is what the firm expected to
receive in exchange for those goods or services. To achieve this objective, the boards developed
a five-step model:
Step 1: Identify the Contract(s) with a Customer
A contract does not have to be written; instead, it can also be oral or implied. A contract does,
however, need to create enforceable rights and obligations. In addition, the parties need to
approve the contract and be committed to perform, and rights and payment terms must be
identifiable. Finally, it must be probable that the firm will collect substantially all of the
consideration.
Step 2: Identify the Performance Obligations in the Contract
The performance obligation is the primary unit of account and is used to determine how much
revenue to recognize and when to recognize that revenue. After identifying the contract, the firm
identifies what goods and services are promised in the contract, such as the sale of goods
produced, resale of goods purchased, or performing a contractually agreed upon task for a
customer. Promised goods or services are separate performance obligations if they are distinct
(see Exhibit 1 for an illustration regarding distinct good or services). The promises can be oral,
explicit in the contract, or can even be implied by customary business practices (e.g., if a firm
sells a car and usually also provides free maintenance for the car, that could be considered a
promise). After determining the promises in the contract, a company then determines if the
promises are distinct. A promise can only be a performance obligation if it is distinct, meaning
it is both: (1) capable of being distinct and (2) distinct in the context of the contact.
Capable of being distinct
A good or service is capable of being distinct if a customer can benefit from the good or service
on its own (whether used, consumed, or sold) or with readily available resources. These could
be resources sold separately by the firm or others in the market, or resources already provided by
the firm in the contract.
The timing of delivery of goods and services can also affect whether the customer can benefit
from the good or service. For example, suppose a firm sells a television (TV) and a customized
remote control. The firm only sells the TV and remote control together, and no one else sells
either product. The customer can use the TV by manually turning it on and off without the
remote, but the remote provides no value to the customer without the TV.
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JetBlue and the New Revenue Recognition Standard A-231 p. 3
 Case 1: The firm delivers the TV first, and the remote control second. In this case, there are
two performance obligations. The customer benefits from the TV on its own and from the
remote control using a readily available resource—the TV.
 Case 2: The entity delivers the remote control first, and the TV second. In this case, there is
only one performance obligation. The remote control provides no benefit to the customer
either on its own or with readily available resources (because the TV has not been delivered
yet).
Distinct within the context of the contract
The second part of being distinct is whether the good or service can be separated from other
promises in the contract—distinct within the context of the contract. To determine this, the
firm should identify what the customer actually expects to receive as the final product. Some
contracts have promises for multiple goods, but the customer is not purchasing individual
items—just one final item. To be separable, the items must not be any of the following: (1) an
input to produce or deliver a combined final product, (2) a significant modification to another
item in the contract, or (3) highly interrelated with other items in the contract.
For example, when constructing a building, a contractor might design the building, clear the site,
construct the structure, and install electrical and plumbing fixtures. Although the contractor sells
these services individually, making them capable of being distinct, they are likely not distinct
within the context of the contract. The contractor’s main service is to integrate these components
and deliver a building, which suggests that the items are used as inputs for one final product.
This means the building is one performance obligation.
Customer options
Contracts may include options for the customer to purchase additional goods or services at some
point in the future. These options or marketing incentives are separate performance obligations
if they provide a material right that the customer would not otherwise have (such as discounted
or free services, hotel loyalty points, a year of “free” car maintenance, or contract renewal
options). The performance obligation is the option itself, rather than the underlying goods and
services for which the option represents. Revenue is recognized when future goods and services
are transferred or when the option expires.
Immaterial promises
If a promise is immaterial from the customer’s perspective, the firm does not have to consider it
as a separate performance obligation.
Step 3: Determine the Transaction Price
The transaction price is the amount an entity expects to be entitled to in exchange for transferring
promised goods or services to a customer, excluding amounts collected on behalf of third parties.
The transaction price is straightforward when the contract is for a fixed amount. For example, if
a firm contracts with a customer to construct a building for $5,000, the transaction price is
$5,000.
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JetBlue and the New Revenue Recognition Standard A-231 p. 4
The transaction price becomes more complex when the contract includes variable consideration,
i.e., when the amount to be received is contingent on a future event and must be estimated (e.g.,
bonuses, refunds, rebates, discounts, and penalties). For example, a firm contracts with a
customer to construct a building for $5,000, plus the entity will receive a $1,000 bonus if the job
is finished before the end of the year. In this case, the transaction price could be either $5,000 or
$6,000—the entity needs to estimate how much of the variable consideration to include ($0 or
$1,000). The bonus is variable because it is contingent on a future event: finishing the building
before the end of the year.
The standard describes two methods to estimate variable consideration. Companies should use
the method that better predicts the consideration based on its facts and circumstances, using all
information that is reasonably available (historical, current, and forecast).
 Expected value – the sum of the probability-weighted amounts in a range of possible
considerations. This approach may be appropriate if the entity has a large number of
contracts with similar characteristics. Using the example above, the contractor will receive
$5,000 for construction of the building plus a $1,000 bonus if completed by the end of the
year, a $500 bonus if completed by the first quarter of next year, and a $100 bonus if
completed by the second quarter of next year. The contractor believes there is a 70 percent
chance of finishing by the end of the year, a 20 percent chance of finishing by the first
quarter of next year, and a 10 percent chance of finishing by the second quarter of next year.
The expected value is as follows:
$5,000 + $1,000 = $6,000 x 70% = $4,200
$5,000 + $500 = $5,500 x 20% = $1,100
$5,000 + $100 = $5,100 x 10% = $510
Total probability-weighted consideration = $5,810
 Most likely amount – the most likely amount in a range of possible outcomes. This may be
appropriate if the variable consideration has a discrete number of outcomes. In this example,
the contractor either will or will not receive the bonus, depending on when the job is finished.
If the contractor believes it is more likely that the job will be finished by the end of the year,
the transaction price would be $6,000 ($5,000 + $1,000).
When determining the transaction price, management should assume that the contract will be
fulfilled as agreed upon and not cancelled, renewed, or modified. In addition, variable
consideration should only be included in the price to the extent that it is probable that a
significant reversal in the amount of cumulative revenue recognized will not occur when the
uncertainty associated with the variable consideration is resolved. When evaluating whether
variable consideration should be included, firms should consider both the likelihood and
magnitude of a revenue reversal.
Step 4: Allocate the Transaction Price to the Performance Obligations in the Contract
The new standard requires that the transaction price be allocated to each separate performance
obligation based on relative standalone selling prices determined at contract inception and not
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JetBlue and the New Revenue Recognition Standard A-231 p. 5
adjusted to reflect subsequent changes in the standalone selling prices. The standalone selling
price is the price at which a company would sell a promised good or service separately to a
customer. Allocation based on standalone selling prices is generally consistent with prior
practice, except the new standard no longer prescribes a hierarchy for estimating the standalone
selling price.
Step 5: Recognize Revenue When (or as) the Entity Satisfies a Performance Obligation
The new revenue recognition model is a control-based model, in which control means being able
to direct the use of an asset and obtain substantially all the remaining benefits from the asset.
Control is not the same as risks and rewards (although risks and rewards are a part of control),
nor is it the same as culmination of an earnings process like prior revenue recognition. Revenue
is recognized upon satisfaction of a performance obligation by transferring control of the
promised good or service to a customer. Performance obligations are either satisfied over time
or at a point in time. Generally, the sale of a good will be recognized at a point in time and the
sale of a service will be recognized over time, but this is not always the case.
A company transfers control of a good or service (and thus satisfies a performance obligation)
over time if any one of the following criteria was met:
 The customer simultaneously receives and consumes the benefits provided by the firm’s
performance as the firm performs. If the firm were to stop performing and another firm
resumed the contract, would the new entity have to redo the first entity’s work? (e.g.,
services—the customer receives and consumes the benefit of the service as the entity
performs)
 The firm’s performance creates or enhances an asset that the customer controls as the asset is
created or enhanced. If the firm were to stop performing, would the customer be able to
control the work that has been done to date? (e.g., a construction company contracts with a
customer to build a house on land that the customer owns)
 The firm’s performance does not create an asset with an alternative use to the firm, and the
firm has an enforceable right to payment for performance completed to date. If the customer
suddenly canceled the contract, would the firm be able to sell the asset to another customer
without incurring significant cost? (e.g., a firm creates a highly specialized asset for a
customer)
If none of the above over-time criteria are met, then the performance obligation is satisfied at the
point in time when the customer obtains control of the promised good or service.
Unexercised Rights
Firms that receive prepayments from customers should recognize a liability until the
performance obligation has been satisfied. However, if the firm expects some customers not to
exercise their right to the good or service, the firm should recognize the expected breakage
amount as revenue in proportion to the pattern of rights exercised by the customer. Because
breakage essentially causes the consideration for each performance obligation to be variable,
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JetBlue and the New Revenue Recognition Standard A-231 p. 6
revenue should only be recognized if it is probable there will not be a significant reversal of
revenue.
Contract Modifications
Unlike prior U.S. Generally Accepted Accounting Principles (GAAP), the new standard also
provides explicit guidance on accounting for contract modifications. A contract modification
includes changes in the goods and services to be provided, the price, or both. If the new goods
and services are distinct (as defined earlier) and are offered at the standalone selling price, they
should be recognized as a separate contract. If they are distinct but not provided at the
standalone selling price, the old contract has effectively been ended and a new contract created.
Any unrecognized revenue from the old contract should be allocated to the remaining goods and
services and recognized along with the new revenue over the new contract period. Finally, if the
new goods and services are not distinct, the estimate of the price and the measure of progress are
simply updated to incorporate the change in the contract.
Disclosures
Under prior U.S. GAAP, there are few requirements for revenue disclosures. This makes it
extremely difficult for users to understand a firm’s revenues, as well as the judgments and
estimates made in recognizing those revenues. The goal of the new disclosure requirements is to
help users understand the nature, amount, timing, and uncertainty of revenue and cash flows
from contracts with customers. Under the new standard, firms will provide qualitative and
quantitative information about contracts with customers, significant judgments, and assets from
capitalized costs.
AN ANALYSIS OF THE IMPACT ON JETBLUE
Overview of Revenue Sources and Revenue Recognition Policies
JetBlue was an American passenger carrier company that provided air transportation services
across the United States, the Caribbean, and Latin America. JetBlue entered into several
contracts with customers with the principal activity being traveling from one location to another.
A single passenger revenue transaction could have contained three types of goods or services: the
flight transportation, frequent flyer award miles, and ancillary services. Revenue for flight
transportation was recognized either when transportation was provided or after the ticket or
customer credit expired (where expiration of the ticket or credit without use was called
“breakage”). If passengers did not show up to their flight, the ticket expired at the time of the
flight. If passengers canceled a nonrefundable ticket prior to the flight, their flight credits were
good for one year after the date of the flight. Tickets sold but not yet recognized as revenue and
unexpired credits were included in air traffic liability on the consolidated balance sheets. JetBlue
prepared its financial statements in accordance with U.S. GAAP (see Exhibit 2 for JetBlue’s
2015 financial statements).
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JetBlue and the New Revenue Recognition Standard A-231 p. 7
Pricing Model
In June 2015, JetBlue launched its new pricing model, Fare Options. Customers could purchase
tickets at one of three branded fares: Blue, Blue Plus, and Blue Flex. Each fare included
different offerings such as free checked bags, reduced change fees, and additional TrueBlue®
points (see Customer Loyalty Program below), with all fares inclusive of free in-flight
entertainment, snacks and non-alcoholic beverages. JetBlue also provided a premium product
called “Mint,” which offered customers a business-class experience.
Customer Loyalty Program
Under JetBlue’s frequent-flyer program, points were awarded based on dollars spent on a
flight. According to JetBlue’s 2015 annual report:
TrueBlue® is JetBlue’s customer loyalty program designed to reward and
recognize loyal customers. Members earn points based upon the amount paid for
JetBlue flights and services from certain commercial partners. The points do not
expire, the program has no black-out dates or seat restrictions, and any JetBlue
destination can be booked if the TrueBlue® member has enough points to
exchange for the value of an open seat. Mosaic® is an additional level for the
most loyal customers who either (1) fly a minimum of 30 times with JetBlue and
acquire at least 12,000 base flight points within a calendar year or (2) accumulate
15,000 base flight points within a calendar year. Over 1.4 million TrueBlue®
one-way redemption awards were flown during 2015, representing approximately
4 percent of the total revenue passenger miles.3
Prior to introduction of the new standard, JetBlue accounted for loyalty programs using the
incremental cost method, whereby it did not consider the issuance of loyalty points to be a
component of revenue. JetBlue recorded a liability for the estimated incremental cost (which
was usually less than the standalone selling price) of outstanding points earned from JetBlue
purchases that were expected to be redeemed.
Ancillary Services
Passenger revenue included seat revenue and revenue from ancillary product offerings. In
addition to the flight itself, JetBlue offered several upgrades and additions for its customers to
purchase.
EvenMore™ Space
JetBlue’s largest ancillary product, the EvenMore™ Space seats, generated approximately $228
million in revenue in 2015. The EvenMore™ Space seats were available for purchase across all
fleets, giving customers the opportunity to enjoy additional legroom, as well as early boarding
access. Under prior revenue recognition guidance, fees paid to guarantee certain seat
3 JetBlue Airways Corporation 2015 Annual Report, http://blueir.investproductions.com/~/media/Files/J/Jetblue-IRV2/Annual%20Reports/2015-ar-10k.pdf (July 16, 2017), p. 9.
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JetBlue and the New Revenue Recognition Standard A-231 p. 8
assignments and fees paid for the ability to board early were recognized at the time of service
(i.e., the flight) as part of Passenger Revenue.
Other Sources of Revenue
The primary components of Other Revenue were the fees from reservation changes and excess
baggage charged to customers. JetBlue also included the marketing component of TrueBlue®
point sales, on-board product sales, charters, ground-handling fees of other airlines, and rental
income.
Fly-Fi™
Fly-Fi™ was JetBlue’s Internet product and was available on all flights. Unlike other airlines,
which typically charged customers for in-flight Internet, JetBlue offered free Wi-Fi to its
customers. Under prior guidance, companies that charged a fee for in-flight Internet access
recognized revenue at the time of service (i.e., the flight). Companies that did not charge fees for
Internet access did not recognize revenue, and simply recognized the costs of providing in-flight
Wi-Fi.
In-flight entertainment
JetBlue offered all of its customers 36 complimentary channels of DIRECTV®. In addition, had
the option to purchase JetBlue Features movies for $5 per movie on all domestic flights over 2
hours (there was no charge on all flights outside of the United States). Under prior guidance,
companies who charged a fee for in-flight entertainment recognized revenue at the time of
service (i.e., the flight). Companies that did not charge for these services did not recognize
revenue, and simply recognized the costs of providing in-flight entertainment.
Onboard purchases
JetBlue offered snacks and non-alcoholic beverages to all its customers, and customers had the
option to purchase premium beverage and food selections. JetBlue also provided its customers
with the option to purchase additional products such as blankets, headphones, or pillows.
“Mint” customers had access to complimentary premium food, premium beverages and products.
Under prior guidance, companies that offered free snacks and beverages simply recognized the
costs of the goods provided. Companies that charged for these items recognized revenue at the
time of service (i.e., the flight).
Excess baggage charges
JetBlue’s fees for checked baggage varied by ticket purchased. Customers received two free
checked bags with the Blue Flex fare, one free checked bag with the Blue Plus fare, and no free
checked bags with the Blue fare. Additional checked bags over the allowed amount, overweight
bags, and large bags all incurred additional fees. Under prior guidance, revenue was recognized
for baggage fees at the time of service (i.e., the flight).
Change fees
Similar to baggage fees, JetBlue’s various fare options included the ability to change a
reservation for free. Aside from the Blue Flex option, customers incurred a flat change fee and
had to pay any difference in fare price. Under prior guidance, these fees were non-refundable
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JetBlue and the New Revenue Recognition Standard A-231 p. 9
and did not relate to the ticket price for any future change. Therefore, revenue was recognized at
the time of service, which was the time the change was created, pre-flight.
Study Questions
1. For each of the following topics, describe the prior accounting, the likely changes (if any) the
new revenue recognition standard will require, and the potential impact of those changes on
patterns of revenue recognition. Indicate the general direction of impacts; do not try to quantify
the change amounts):
 Flight Transportation (for tickets used and for ticket/credit “breakage”) (Hint: Focus on
Unexercised Rights in the new model for breakage)
 Loyalty Program (Hint: Focus on Step 2 of the new model)
 Ancillary Services and Other Revenue (Hint: Focus on Step 2 of the new model, and
Contract Modifications as well for change fees specifically)
2. Where are the areas for discretion and judgment (and opportunities for earnings
management)?
3. Will the new revenue standard provide more decision-useful information than prior U.S.
GAAP?
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JetBlue and the New Revenue Recognition Standard A-231 p. 10
Exhibit 1
Determining Whether Goods or Services are Distinct
Source: Compiled by authors.
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JetBlue and the New Revenue Recognition Standard A-231 p. 11
Exhibit 2
JetBlue’s 2015 Financial Statements and Disclosures of Revenue Amounts
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JetBlue and the New Revenue Recognition Standard A-231 p. 12
Source: JetBlue Airways Corporation 2015 Annual Report.
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