06/02/2011

Breakage Revenue Recognition for Bank Issued "No Fee, No Expiration" Gift Cards

By Mike Lochmann & Karen Garrett

Gift cards are a type of prepaid, stored-value card designed to be purchased by one consumer and given to another. Gift cards are issued by a wide variety of retailers and certain banks. Some gift cards can only be redeemed at specific locations, while others may be redeemed at any location where a major credit card is accepted. Recipients typically redeem their gift cards for goods or services, but many recipients leave a small portion of their gift card balances unspent. The unspent balance is referred to in the gift card industry as "breakage."

Gift cards present unique accounting issues. Card issuers must determine how to account for the initial sale of the gift card. Generally, because the card issuer receives money but is obligated in the future to provide goods or services, the issuer debits cash (an asset account on its balance sheet) for the purchase price and credits deferred revenue (a liability account on its balance sheet). As the recipient redeems card balances, the deferred revenue is recognized and the liability of the card issuer is reduced. Some gift cards impose service or inactivity fees that periodically reduce and eventually eliminate unspent card balances. Other cards have expiration dates that eliminate the card issuer's future liability for unspent card balances. However, if a card has no expiration date and no service or inactivity fees, the liability could stay on the card issuer's books indefinitely. Such liability retention would result in the card issuer overstating its liabilities and understating its income, if it fails to recognize that a portion of the unused gift card balances will never be redeemed. A card issuer must determine at what point it will recognize the unspent portion of a gift card as breakage income.

Read the white paper co-authored by Banking & Financial Services Attorneys Mike Lochmann & Karen Garrett: Breakage Revenue Recognition for Bank Issued "No Fee, No Expiration" Gift Cards