Airline revenue adjustments for air traffic liability are baked into the accrual accounting method that nearly all airlines observe in recording passenger and freight revenues. This is because the airline industry operates on relatively thin profit margins, so revenue recognition is a vital measure to ensuring airlines remain profitable. Simply put: revenues are only recognized when the airline's service is actually provided, and revenues must be categorized accordingly.

Key Takeaways

  • Airline revenue adjustments for air traffic liability are baked into the accrual accounting method that airlines use.
  • Simply put: revenues are only recognized in accounting when the airline's service is actually provided, which is when the passenger uses his or her ticket for travel.
  • When the flight service is eventually provided, the revenue is then reclassified as earned revenue, and the air traffic liability is reduced accordingly.
  • Because airlines operate on relatively small profit margins, revenue recognition is essential to remaining profitable.

Airline tickets or freight bills are commonly sold and issued well in advance of the dates of flight. Consequently, the money received at the time of sale is technically deemed unearned revenue. For this reason, it's a common accounting practice for airlines to defer this revenue and initially designate it as a liability on their balance sheets. When the flight service is finally provided, the revenue is reclassified as earned revenue on the airline's profit and loss statement, at which time the air traffic liability figure is reduced accordingly.

In addition to representing tickets and freight bills for future flights, air traffic liability adjustment includes estimates for potential refunds on past flights, where passengers didn't ultimately fly, for one reason or another. Of course, this aspect of the revenue adjustment exercise is largely a subjective judgment by the airline because it's impossible for anyone to know for sure how many tickets will be refunded, versus those exchanged. For this reason, estimates are commonly based on an airline's historical experiences, coupled with seasonal patterns.

Depending on an individual airline's policy, unused tickets may be eligible for exchange for varying time periods. But in all cases, revenues received for these tickets must remain part of the air traffic liability calculation until a given exchange window elapses. At this time, the airline can determine how many tickets were ultimately forfeited and how many were exchanged.

Taxes and fees also factor into the traffic liability equation. Specifically, airline ticket prices carry embedded transportation taxes, airport facility fees, security charges, and foreign travel-related taxes. Because airline companies merely function as collection agents for these expenses, and don't pocket these funds themselves, they don't record them as revenue. Instead, this money is initially recognized as a liability when tickets are sold, and when the airline later renders payment to the appropriate entity, the liabilities are accordingly reduced in their accounting records.

Making revenue adjustments for air traffic liability heavily involves making estimations based on past patterns.