What is Breakage
Breakage is a term that refers to revenue gained by retailers through unredeemed gift cards or other prepaid services which are never claimed. In these cases, money for prepaid phone cards, gift cards or other prepaid services is received by the company, but the company never ends up providing the service or item for which the client paid. Nearly all of this money is considered profit to the company. Accounting uncertainty due to breakage has been a recurring problem throughout the years.
BREAKING DOWN Breakage
Breakage has been an accounting issue for a long time. Some companies have been accused of inflating their revenue figures with breakage estimates. In 2006, it was estimated that consumers lost over $8 billion annually due to breakage. Most retailers no longer place restrictions (i.e., dormancy fees, expiration dates, etc.) on their gift cards to eliminate the accounting uncertainty they create. In 2007, the FTC settled a case it brought against Darden Restaurants for failure to disclose its gift cards dormancy fees and reached the same outcome in a similar action it filed against Kmart. The rulings required both companies to reimburse customers who lost money due to the inadequately disclosed gift card fees.
The FASB's new model for accounting for prepaid services and goods and the breakage that goes along with selling these items is aimed at creating a more transparent method of financial reporting.
To help reduce the accounting ambiguity caused by reporting breakage, the Financial Accounting Standards Board (FASB) released an Accounting Standards Update in 2016 requiring that companies start complying with new guidelines for recording liabilities associated with gift card and other prepaid service sales and revenue/profits associated with breakage. The new standards rolled out in waves according to company type, and all affected companies are expected to adopt the changes by their fiscal year before December 15, 2019.