Maybe it’s good news for the bottom line that new accounting guidance will allow companies to bring into earnings certain unredeemed gift card balances, but complying with the new rules will not be easy.
Given the complexity and uncertainty around state unclaimed property law, companies will have a lot of work to do just sorting out which gift cards are affected by the new pronouncement. “For me, the hardest part of this guidance is not the guidance itself, but determining which liabilities are subject to the guidance to start with,” says Angela Newell, national assurance partner at BDO USA.
On the recommendation of its Emerging Issues Task Force, the Financial Accounting Standards Board adopted Accounting Standards Update No. 2016-04 to address differences in practice with respect to unredeemed gift card balances. Some companies treat certain gift cards as financial liabilities, which under existing accounting rules can never be written off, even if a given gift card is never redeemed. Some companies regard those liabilities as non-financial liabilities that eventually could be derecognized, but followed different methods for doing so.
The new guidance says prepaid stored-value products as described in the guidance are considered financial liabilities. It goes on to say companies are required to calculate “breakage,” or the pattern of unredeemed balances, which should be written down and recognized as earnings.
“We see a broad range from our clients. Some are not derecognizing the liability at all. Some are taking breakage on day one, and everything in between. There’s clear diversity in practice, which means less comparability in financials.”
Nathan Lane, Asst. VP for Operations & Accounting Technologies, Card Compliant
“We see a broad range from our clients,” says Nathan Lane, assistant vice president for operations and accounting technologies at card services firm Card Compliant. “Some are not derecognizing the liability at all. Some are taking breakage on day one, and everything in between. There’s clear diversity in practice, which means less comparability in financials.”
Companies will have to work through two huge sets of issues before they can confidently recognize unredeemed gift cards through earnings, says Peter Bible, partner and chief risk officer at audit firm EisnerAmper. “If you’re in a state that has unclaimed property law, that trumps everything,” he says. “It goes to the state, and you can’t take it into income. For states that don’t have that, it’s really just about how good is your system to produce data to support the cardholder’s behavior?”
PREPAID STORED-VALUE PRODUCTS
Below is an excerpt from FASB’s guidance on prepaid stored value products. 405-20-40-3 Prepaid stored-value products are products in physical and digital forms with stored monetary values that are issued for the purpose of being commonly accepted as payment for goods or services. While the holder of a prepaid stored-value product also may be permitted to redeem the product for cash, prepaid stored-value products do not include products that only can be redeemed by the product holder for cash (for example, nonrecourse debt, bearer bonds, or trade payables). Examples of prepaid stored-value products include prepaid gift cards issued on a specific payment network and redeemable at network-accepting merchant locations, prepaid telecommunication cards, and traveler’s checks. The derecognition guidance in paragraph 405-20-40-4 does not apply to liabilities related to either of the following:
a. Prepaid stored-value products (or portions of those products) for which any breakage (that is, the portion of the dollar value of prepaid stored- value products that ultimately is not redeemed by product holders for cash or not used to purchase goods and/or services) must be remitted in accordance with unclaimed property laws
b. Prepaid stored-value products that are attached to a segregated bank account like a customer depository account.
The guidance also does not apply to customer loyalty programs or transactions within the scope of other Topics (for example, Topic 606 on revenue from contracts with customers). 405-20-40-4 If an entity expects to be entitled to a breakage amount for a liability resulting from the sale of a prepaid stored-value product in the scope of paragraph 405-20-40-3, the entity shall derecognize the amount related to the expected breakage in proportion to the pattern of rights expected to be exercised by the product holder only to the extent that it is probable that a significant reversal of the recognized breakage amount will not subsequently occur. If an entity does not expect to be entitled to a breakage amount for prepaid stored-value products in the scope of paragraph 405-20-40-3, the entity shall derecognize the amount related to breakage when the likelihood of the product holder exercising its remaining rights becomes remote. At the end of each period, an entity shall update the estimated breakage amount to represent faithfully the circumstances present at the end of the period and the changes in circumstances during the period. Changes to an entity’s estimated breakage amount shall be accounted for as a change in accounting estimate in accordance with paragraphs 250-10-45-17 through 45-20. 4. Add paragraph 405-20-50-2 and its related heading, with a link to transition paragraph 405-20-65-1, as follows:
> Prepaid Stored-Value Products
405-20-50-2 An entity that recognizes a breakage amount in accordance with paragraph 405-20-40-4 shall disclose the methodology used to recognize breakage and significant judgments made in applying the breakage methodology.
5. Add paragraph 405-20-65-1 and its related heading as follows:
Transition Related to Accounting Standards Update No. 2016-04, Liabilities—Extinguishments of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products
405-20-65-1 The following represents the transition and effective date information related to Accounting Standards Update No. 2016-04, Liabilities— Extinguishments of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products:
a. A public business entity, a not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market, and an employee benefit plan that files or furnishes financial statements with or to the Securities and Exchange Commission shall apply the pending content that links to this paragraph for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. All other entities shall apply the pending content that links to this paragraph for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019.
b. Earlier application of the pending content that links to this paragraph is permitted, including adoption in an interim period.
c. An entity shall apply the pending content that links to this paragraph by electing to use one of the following two methods:
1. Retrospectively to each prior period presented in accordance with the guidance on accounting changes in paragraphs 250-10-45-5 through 45-10
2. Retrospectively by means of a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year in which the pending content that links to this paragraph is adopted.
d. An entity shall provide the disclosures required in paragraphs 250-10-50- 1(a) and (b)(3) and 250-10-50-2, as applicable, in the period the entity adopts the pending content that links to this paragraph. If an entity elects to apply the pending content that links to this paragraph retrospectively in accordance with (c)(1) above, the entity also shall provide the disclosure required by paragraph 250-10-50-1(b)(1).
Determining what is in scope of the new guidance will require a careful understanding of state law, says Newell. “The breakage concept is limited legally state by state,” she says. “And it varies a lot.” Some states require companies to “escheat,” or hand over to the state, any unclaimed gift card balances after some defined period of time. Some states allow companies to charge dormancy fees. And some states have different rules for different types of prepaid cards. “A prepaid wireless card might have different rules than a restaurant gift card,” she says.
An added wrinkle to state unclaimed property law is determining which state might have jurisdiction depending on where a company is located, where or how a card was purchased, and who purchased it, says Brad Hale, a shareholder with audit firm Mayer Hoffman McCann. “Each state is a little different in terms of how they treat it,” he says.
A huge ongoing case in Delaware, a state known for its aggressive pursuit of unclaimed property with some 800,000 companies incorporated there, might also have some bearing on what ultimately will be subject to unclaimed property law, says Bob Peters, managing director at financial advisory firm Duff & Phelps. Delaware is pursuing allegations of unreported unclaimed property against a number of retail giants who are clients of Card Compliant in a case that is scheduled for trial in late 2017.
“Hundreds of thousands of companies that issue gift cards are following this case very closely,” says Peters. The case centers on whether companies can shift unredeemed gift card liabilities to a third party, located in a state that does not regard those liabilities as unclaimed property, so as to ultimately keep the unredeemed balances.
Card Compliant is one such company that provides such a third-party service, but many companies have entered into similar arrangements, says Peters. “The judge, at least initially, is fairly critical of the defendants,” he says. Card Compliant had no comment on the case.
In addition to unclaimed property law, companies also need to study the new pronouncement to understand what types of cards are subject to the new accounting, says Hale. FASB’s guidance says it applies to prepaid stored-value cards such as those issued on a specific payment network redeemable at multiple locations, prepaid telecommunication cards, and traveler’s checks. It does not include cards where unclaimed property law applies or to those that are attached to a segregated bank account.
The guidance also does not apply to customer loyalty programs or transactions that fall within the scope of revenue recognition guidance. That includes gift cards issued by a retailer and redeemable through that retailer, says Doug Reynolds, a partner with Grant Thornton. “That’s a contract between a vendor and a customer,” he says.
“Once you determine what is in scope, next is determining whether breakage should be recognized,” says Robert Malhotra, a partner with KPMG and a member of FASB’s Emerging Issues Task Force that helped develop the new rule. That includes an analysis of the amount of breakage that should be recognized as well as the timing, assuring a company doesn’t recognize breakage that might subsequently have to be reversed. “Each reporting period, to the extent there’s a change in facts and circumstances, the reporting entity would need to update its expectations of breakage,” he says. “It’s an ongoing assessment.”
All of that analysis will require good data, says Reynolds. “Companies are going to need to have very rigorous estimation processes, which means they have to have very good, reliable information on card usage and redemption,” he says.
Malhotra agrees companies will need strong controls around their processes to comfortably assert that a gift card liability can be taken into earnings. “Given the variety of products in the marketplace and the jurisdictional differences in unclaimed property law, companies will need internal controls to assure the guidance is applied only to in-scope products,” he says. “They’ll also need to consider internal controls that will need to be designed to estimate expected breakage on an ongoing basis.”