Investing Rulebook

Breakage

The Hidden Costs of Breakage: How Unredeemed Gift Cards and Prepaid Services Impact RevenueWhen it comes to managing finances, businesses must carefully consider all factors that affect their revenue streams. One often overlooked aspect is breakage, which refers to the revenue gained from unredeemed gift cards and prepaid services.

In this article, we will explore the definition of breakage, the accounting issues it presents, and the real-life examples and legal cases that highlight its impact. By shedding light on this hidden cost, we aim to educate readers on a topic that can significantly affect a company’s bottom line.

Definition and Explanation of Breakage

Breakage refers to the revenue gained from unredeemed gift cards and prepaid services. Often, consumers purchase these items with the intention of using them in the future.

However, life happens, and sometimes these assets go unredeemed. This leaves the company with an amount of money equal to the value of the gift cards or prepaid services that are never utilized.

Breakage is particularly prevalent in industries where prepaid services or gift cards are common, such as retail, hospitality, and telecommunications. For example, imagine a customer purchases a $100 gift card for a popular clothing store but forgets to redeem it before the expiration date.

The clothing store now has gained $100 in revenue without having to provide any goods or services in return.

Accounting Issues and Controversies Surrounding Breakage

While breakage can provide a boost in revenue for companies, it also presents certain accounting issues and controversies. One primary concern is the uncertainty in accounting for breakage.

Companies need to estimate the amount of breakage they expect to occur and then recognize it as revenue over a period of time. However, the process of estimating breakage is not without its challenges.

Companies may be tempted to inflate their revenue figures by overestimating breakage, misleading investors and stakeholders. On the other hand, underestimating breakage can result in accounting discrepancies and the need for financial restatements, leading to reputational damage.

To address these concerns, accounting standards have been developed to guide companies in estimating breakage. For example, the Financial Accounting Standards Board (FASB) provides guidelines on revenue recognition and how companies should account for breakage.

By following these standards, companies can ensure transparency and accuracy in their financial reporting.

Examples and Cases of Breakage

Historical Examples of Breakage

Breakage is not a new phenomenon; historical examples abound, highlighting the impact it can have on both consumers and businesses. One notable case was when the Federal Trade Commission (FTC) investigated Darden Restaurants for failing to adequately disclose fees associated with their gift cards.

This led to customers losing money due to unused balances and invalidated cards. It was estimated that consumers were losing around $8 billion annually due to breakage.

Legal Cases and Settlements Related to Breakage

Due to the potential harm caused to consumers, legal cases and settlements related to breakage have emerged. In 2020, Kmart settled with the FTC after being accused of failing to disclose the existence and amount of certain fees associated with their prepaid stored-value cards.

As part of the settlement, Kmart agreed to reimburse customers who faced fees they were not aware of. These examples demonstrate the real-life impact and consequences that companies face when breakage is mismanaged.

It is crucial for businesses to prioritize transparency and avoid any practices that could harm their customers or result in legal action. In conclusion,

Breakage may seem like an insignificant aspect of a company’s revenue stream, but it can have significant consequences if not managed properly.

Understanding the definition, accounting issues, and real-life examples of breakage allows businesses to make informed decisions and maintain trust with their stakeholders. By addressing breakage transparently, companies can ensure a healthier financial ecosystem that benefits both consumers and businesses alike.

Breakage Calculation and its Components

Calculation of Breakage

For businesses, properly calculating breakage is essential for accurate financial reporting. The calculation involves several key components to determine the revenue gained from unused gift cards or prepaid services.

To calculate breakage, the first component is the customer purchase. This refers to the initial sale of the gift card or prepaid service.

When a customer buys a $100 gift card, for example, the full $100 is recorded as a liability because the company owes the customer the value of the card. The second component is the leftover amount.

This represents the portion of the customer’s initial purchase that remains unused. If the customer ends up spending $75 of the $100 gift card, the $25 difference becomes the leftover amount.

Finally, the breakage is determined by subtracting the leftover amount from the initial customer purchase. In this case, the breakage would be $100 – $75 = $25.

This $25 represents the revenue gained by the company due to the gift card going unredeemed.

Components of Breakage

Understanding the components of breakage provides businesses with insights into how this revenue stream is generated and managed. The first component is the gift card purchase.

When a customer purchases a gift card, the company initially records the full value of the card as a liability. This liability remains on the company’s books until the gift card is redeemed or expires.

The second component is the future liability associated with the gift cards. As customers purchase and hold onto gift cards, the company needs to account for the potential future liabilities that may arise when these cards are eventually redeemed.

Until redemption occurs, the company must maintain records of these outstanding liabilities. The third component is the redemption itself.

When a customer uses a gift card or prepaid service, the company must reverse the liability previously recorded and recognize the revenue associated with the redemption. For example, if a customer redeems a $50 gift card, the company will no longer have a liability for that amount, and they will recognize $50 in revenue.

The final component is the discarded amount. Unfortunately, not all gift cards or prepaid services are redeemed.

Some individuals may simply forget or choose not to use them, resulting in a portion of the initial purchase being discarded. This discarded amount contributes to the breakage revenue gained by the company.

Solutions and Guidelines for Breakage Accounting

Financial Accounting Standards Board (FASB) Model

In order to guide companies in accounting for breakage, the Financial Accounting Standards Board (FASB) introduced a new model. This model provides a framework for businesses to follow when reporting breakage in their financial statements.

Under the FASB model, entities that offer prepaid services or gift cards are required to recognize breakage as revenue when it is deemed probable that the customer will not redeem the full value of the asset. This can be estimated using historical redemption patterns, customer behavior, and other relevant factors.

The FASB model also requires the recognition of a liability for the potential future redemption of gift cards or prepaid services. This ensures that companies properly account for the future financial obligations they may incur.

Implementation and Compliance with New Guidelines

To ensure compliance with the new FASB guidelines on breakage accounting, companies must carefully consider how they record and report breakage in their financial statements. The first step is to adopt the appropriate accounting standards.

The FASB regularly updates its guidelines, and it is crucial for companies to stay informed and implement any changes as necessary. This may involve adjusting internal accounting practices, training employees, and updating financial reporting systems.

Recording liabilities accurately is another key aspect of compliance. Companies should maintain detailed records of their outstanding liabilities related to unredeemed gift cards and prepaid services.

This includes tracking the amount of breakage that has been recognized as revenue and the potential future liabilities associated with unredeemed assets. When recognizing breakage revenue, companies should consider the impact it has on sales and revenue figures.

It is important to accurately reflect the breakage revenue in the appropriate financial reporting periods, ensuring transparency and clarity for investors and stakeholders. By adhering to the new guidelines and implementing robust accounting practices, companies can effectively manage breakage and minimize the risk of misinformation or discrepancies in their financial statements.

In conclusion,

Calculating breakage and understanding its components are key steps in managing this often overlooked revenue stream. Adoption of the FASB model provides a standardized framework for breakage accounting, promoting transparency and accurate financial reporting.

By carefully implementing and complying with the new guidelines, businesses can navigate the complexities of breakage and ensure their financial statements reflect the true value of unredeemed gift cards and prepaid services.

Legal Mandates and Jurisdiction Specifics

Variances in Legal Mandates for Unexercised Gift Cards

When it comes to unexercised gift cards, the legal mandates and jurisdiction specifics can vary greatly. Different countries, states, and even municipalities may have their own regulations and requirements regarding the treatment of unclaimed or unused gift card balances.

In some jurisdictions, unexercised gift cards are subject to escheatment laws, which require businesses to transfer the unused funds to the state treasury after a certain period of time. The length of time before escheatment kicks in can differ, with some jurisdictions ranging from two to five years of inactivity.

This means that businesses must actively monitor and report unclaimed gift card balances to comply with the escheatment laws of that particular jurisdiction. However, it is important to note that not all jurisdictions have escheatment laws for gift cards.

Some governments take a different approach, considering gift card balances as revenue for the issuer, allowing businesses to retain these funds even if they go unclaimed. This difference in legal mandates greatly impacts how businesses manage and account for unexercised gift cards, depending on the jurisdictions in which they operate.

Compliance and Regulations for Gift Cards

Given the variability in legal mandates, businesses must closely monitor compliance and adhere to specific regulations governing gift cards in each jurisdiction they operate. One important aspect of compliance is ensuring transparency in gift card terms and conditions.

Regulators often require businesses to clearly disclose any fees, expiration dates, or other restrictions associated with gift cards. This information must be easily accessible to customers, both online and at the point of sale.

By providing detailed and accurate information, businesses can avoid legal disputes and maintain the trust of their customers. Additionally, some jurisdictions have specific regulations regarding the treatment of gift card funds.

For example, certain states in the United States have laws in place that prohibit the imposition of certain fees, such as inactivity fees or fees for checking the card balance. These regulations aim to protect consumers from unfair practices and ensure that the full value of the gift card is available for redemption.

Compliance with regulations also extends to financial reporting and accounting practices. Businesses must properly account for gift card liabilities and the associated breakage revenue based on the specific legal mandates in each jurisdiction.

This may involve working closely with accountants and legal advisors to ensure accurate financial reporting and adherence to the local requirements. It is important for businesses to stay up to date with any changes to gift card regulations in the jurisdictions they operate.

Government agencies responsible for consumer protection and business oversight regularly update their guidelines and may introduce new mandates. By proactively monitoring and complying with these regulations, businesses can minimize legal risks and maintain their reputation among both customers and regulators.

In conclusion, legal mandates and jurisdiction specifics regarding unexercised gift cards can vary significantly. Compliance with regulations is crucial for businesses operating in multiple jurisdictions to ensure transparency, protect consumer rights, and accurately account for gift card liabilities.

By understanding and adhering to the specific legal requirements, businesses can navigate the complex landscape of gift card regulations and maintain compliance, benefiting both themselves and their customers.

Popular Posts