One of the five issues considered at the March 19, 2015 meeting of the Emerging Issues Task Force, (“The Task Force”) was the issue of whether liabilities arising from the sale of prepaid stored value cards under three party arrangements should be categorized as financial or non-financial liabilities.
Consumers may purchase prepaid stored value cards (gift cards) under a two party arrangement, directly from vendors who stand ready to provide goods and services to the consumer upon redemption of the card. Alternatively, consumers may purchase gift cards under a three party arrangement from an intermediary such as a financial institution or a prepaid network provider.
Generally, gift cards do not expire, are not and redeemable for cash and may or may not be subject escheatment laws. Often times, gift cards go unredeemed in entirety or in part. These unredeemed balances are commonly referred to as “breakage.”
When gift cards as sold under a two party arrangement, the vendor recognizes deferred revenue (a non-financial liability) at that time of sale, with revenue being recognized when gift cards are redeemed. In addition, the vendor may also recognize revenue for the breakage it expects to be entitled to keep. The recognition of breakage, as currently practiced is consistent with the new revenue recognition standard, ASC606 – Revenue from Contracts with Customers, which becomes effective from calendar year 2017.
When gift cards are sold by an intermediary, the intermediary recognizes a liability for the obligation to provide the consumer with the ability to redeem the gift card in exchange for goods and services to be provided by third party vendors. Upon redemption of the cards the intermediary relives the liability and remits the funds to the vendor and recognizes revenue for any transaction fees and commissions earned.
Whether the intermediary is entitled to breakage revenue or not depends on whether or not the obligation to stand ready to provide payment to third party vendors is a financial or non-financial liability. If the obligation is a non-financial obligation, the intermediary may recognize revenue for the breakage it expects to be entitled to keep.
To the contrary, if the obligation is considered a financial liability should be derecognized upon redemption pursuant to ASC 405-20- Extinguishments of Liabilities. However, if consumers never redeem gift cards that have no expiration dates and are not subject to escheatment laws, the liability remains in perpetuity unless the card is destroyed or there is no longer an obligation to the consumer.
The Task Force reached a consensus for exposure that when an entity issues a gift card that is redeemable for goods and services to be provided by third party vendors, the liability meets the definition of a financial liability. In reaching this consensus the Task Force noted that the intermediary’s obligation is ultimately settled in cash or not at all, if there is breakage.
Additionally, the Task Force expanded the scope of the issue to include prepaid cards that can also be redeemed for cash. In order to permit de-recognition of unredeemed balances. A scope exception was provided under ASC 405-20 to de-recognition the financial liability using a breakage model similar to the model prescribed under the new revenue recognition standard, ASC606 – Revenue from Contracts with Customers.
The proposed guidance will be applied on a modified retrospective basis. Entities adopting the proposed entities would be required to provide disclosures related to recognition of breakage similar to those required under the new revenue recognition standard, in addition to the disclosures required for financial liabilities.
Debra ‘CAS’ Findlay FCCA, CPA is a senior audit manager with Krost Baumgarten Kniss & Guerrero. Ms. Findlay has been in the audit/accounting profession for more than 25 years and provides services to small to medium size closely held corporations across a range of industries, not for profit organizations and employee benefit plans.