What is breakage?
Breakage is a term used to describe revenue earned by retailers from unused gift cards or other prepaid services that are never claimed. In these cases, the business pockets the money paid for these items, without actually providing the service or item the customer originally paid for. Although almost all of this money is considered profit for the company, accounting uncertainty due to breakage has been a recurring problem over the years.
How breakage works
Breakage has been an accounting problem for a long time. Some companies have been accused of inflating their turnovers with breaking estimates. In 2006, it was estimated that consumers lost over $8 billion per year due to damage.
Most retailers no longer place restrictions (i.e. inactivity fees, expiration dates, etc.) on their gift cards in a concerted effort to eliminate accounting uncertainty. In 2007, the Federal Trade Commission (FTC) settled a case brought against Darden Restaurants for non-disclosure of its gift cards dormancy fees. He achieved the same result in a similar action he previously filed against Kmart. The rulings required both companies to reimburse customers who lost money due to the improperly disclosed gift card charges.
Consider the following example of a breakage: if a customer buys a $50 gift card, the business receives $50, plus a future liability for $50 worth of goods or services. It can be a clothing retailer, restaurant chain, or any other merchant that sets up such gift card programs.
Now suppose the recipient of the gift card uses it to make a purchase for $48. In this case, the business would withdraw $48 from its liability, which would be recorded as revenue. And if after the purchase, the customer disposes of the gift card, the remaining $2 will never be used. This remaining amount is considered a breakage.
Key points to remember
- The term “breakage” describes the revenue that retailers make from unused gift cards or other prepaid services.
- In these cases, the business pockets the money paid for these items, without actually providing the service or item that the customer or customer originally paid for.
- The Financial Accounting Standards Board (FASB) has designed a new model for accounting for prepaid services and goods that addresses the breakage that accompanies the sale of these items.
- The FASB issued an update to accounting standards in 2016, which required companies to comply with the new guidelines by December 15, 2019.
The Financial Accounting Standards Board (FASB) has developed a new model for accounting for prepaid goods and services that addresses the breakage that accompanies the sale of these items. The FASB intended to create a more transparent method of financial reporting through these improved measures.
To help reduce accounting ambiguity caused by breakage reporting, the FASB issued an update to accounting standards in 2016, which requires companies to comply with new guidelines for recording card-related liabilities. gift and other prepaid service sales and breakage related revenue/profits. All companies affected should adopt the new measures before 15 December 2019.
[Important: The legal mandates for remedying unexercised gift cards differ from one jurisdiction to another.]