Auditing player reward programs: casino incentive clubs pay out big for frequent customers, but fraud and the lack of controls are turning them into a huge liability for the gaming industry

Internal Auditor, April, 2007 by John R. Mills

GAMING PROPERTIES ARE THE LATEST INDUSTRY to offer a range of incentives to their customers to reward repeat business. Player club programs provide a fantastic opportunity to increase customer play: Offer players incentives and they will come! However, these fast-growing programs are becoming a significant source of potential liability for casinos. In 2002, the largest U.S. gaming corporation, Harrah's, made an initial liability adjustment for its player reward program of US $6.9 million--less than 1 percent of revenues. By 2005, that figure was US $95.4 million, or 6 percent of total current liabilities.

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The past history of disbursement of free food, hotel rooms, entertainment, and other special privileges--commonly known as comps--has resulted in various employee fraud schemes dealing with unauthorized activities on dormant accounts or the creation of false comps for friends and relatives. The lack of appropriate internal controls provides opportunities for fraudulent transactions. At the same time, constant changes to player reward programs can lead to misunderstandings about responsibilities and correct internal controls over the transactions. The internal auditor's function is to provide assurances that these controls are in place and that personnel are actually following them (see "Internal Auditing's Role in Player Reward Programs" on this page).

Although player reward programs were considered immaterial in the past, they have become a balance sheet liability that can no longer be ignored. Analysts and external auditors now scrutinize these numbers because they show up in the financial statements. Controllers must develop procedures for regular accruals of potential player reward liabilities that incorporate costs and redemption rates. Internal auditors should remain skeptical of financial reporting of these programs because assumptions and estimates have resulted in cases of earnings management and fraudulent financial reporting.

HOW PLAYER REWARDS WORK

To comprehend accounting for player reward programs, it is essential to understand the basics of how they work. Each casino has its own unique program, but many have similar customer options, including the type of program and level of participation. The type of program represents the method of rewarding the player--cash or comps. The accrual of liabilities is dependent on the method of rewarding the player. The level of participation provides additional incentives or rewards based on the accumulation of points.

An audit plan for a player reward program should include an extensive walkthrough to assess how the program works and whether there have been major changes to it. For financial reporting purposes, there are two accounting classifications that can have an impact on disclosure of player club information: how comps are treated and whether the comp consists of an incentive or a rebate. Once these two issues are resolved, the calculation of the player point liability becomes a function of the type of reward program that is created and the methods for valuing the points.

DISCRETIONARY VS. EARNED COMPS

Casino executives have always believed that treating the customer well leads to longer stays, increased return visits, and more dollar play. The cost of a free room and dinner is minimal compared to the money the player can spend in the casino. In the early years of legalized gaming, player tracking involved evaluating individual play at table games to determine the average wager and the length of time that the person played. Because casinos had no formal data on players, casino executives offered a range of discretionary comps based on the casino manager's personal evaluation of the player's history, rather than defined criteria or a formal tracking system.

The computerization of slot machines led to the development of player tracking systems that have become central to reward programs. Today's programs offer slot players comps equivalent to those given to table game players. Information from the player tracking system is also the basis for constructing promotional activities targeting specific demographic groups.

The alternative to discretionary comps is earned comps. When players sign up for a player reward program, they receive a club card. When the card is inserted into a slot machine, the tracking program records all of the player's actions and the accumulation of reward points, which are the basis for earned comps and other rewards. Accounting authorities recognize these points as a potential contingent liability that requires an accrual for the potential liability.

Although player reward systems have brought structure to the issuance of comps, most casinos still rate high-end players and offer extra discretionary comps to level one, or top level, players. That means that casino executives may limit a player to the points accumulated from play or exercise discretion by issuing the player comps based on anticipated points.

Earned comps require financial reporting disclosure of potential liabilities that is not necessary for discretionary comps. The issue that internal auditors must address is how different properties recognize these comps. For example, although properties have level one players who have player reward cards, these players will always be considered for discretionary comps. When evaluating the player reward liability, these points are subtracted from the total outstanding points before calculating the player reward liability. Key risks related to comps include: