Breakage: Understanding, Examples, and Strategies
BP
Summary:
Breakage in retail refers to revenue gained from unredeemed gift cards or prepaid services, presenting a challenge in accounting. This article explores the concept, its historical issues, examples, and solutions, with a focus on the Financial Accounting Standards Board’s (FASB) guidelines.
Breakage is a critical aspect of retail revenue, involving unclaimed gift cards or prepaid services. This article delves into the dynamics of breakage, its historical significance, and recent developments by the Financial Accounting Standards Board (FASB).
Defining breakage
Breakage is the financial gain for retailers resulting from unclaimed prepaid services or gift cards. Essentially, it represents the money pocketed by a company without delivering the corresponding goods or services to the paying customer.
Historical accounting challenges
In the past, breakage has posed accounting challenges, with accusations of revenue inflation through breakage estimates. In 2006, consumers reportedly lost over $8 billion annually due to breakage, prompting regulatory intervention.
Regulatory actions
To curb potential abuses, the Federal Trade Commission (FTC) took action against companies, such as Darden Restaurants and Kmart, for undisclosed dormancy fees on gift cards. The rulings required reimbursement for affected customers, highlighting the need for transparency in gift card practices.
Illustrative scenario
Consider a practical example to grasp breakage better. When a customer buys a $50 gift card, the company receives $50 as revenue and establishes a future liability of $50. If the recipient uses the card for a $48 purchase, the company recognizes $48 as revenue, leaving $2 as potential breakage when the card is discarded.
Addressing breakage: FASB’s role
Recognizing the need for transparent financial reporting, the FASB devised a new accounting model for prepaid services and goods in 2016. This model aimed to standardize the treatment of breakage, providing a clearer picture of a company’s financial health.
Accounting standards update
In 2016, the FASB released an Accounting Standards Update, compelling companies to adhere to revised guidelines by December 15, 2019. These guidelines ensure consistent recording of liabilities associated with gift cards and prepaid service sales, along with the proper treatment of revenue and profits related to breakage.
FASB’s accounting model
The FASB’s accounting model provides a comprehensive solution to breakage-related challenges, promoting transparency in financial reporting. By addressing breakage, companies can better manage their liabilities and provide accurate financial statements.
Hidden impact on consumer spending
Unredeemed gift cards not only affect a company’s bottom line but also have a hidden impact on consumer spending behavior. Consider a scenario where a consumer holds a gift card with a $20 balance. The psychological effect of “free money” often leads individuals to make purchases exceeding the card value. If, however, the entire card balance isn’t utilized, the leftover amount contributes to breakage.
Industry-specific breakage challenges
Breakage manifests differently across industries. In the travel sector, for instance, unredeemed prepaid hotel bookings or airline tickets contribute to breakage. Understanding industry-specific challenges is crucial for businesses implementing effective strategies to manage breakage and maintain financial stability.
Proactive communication with customers
Transparent communication with customers is a proactive strategy to mitigate breakage-related challenges. Retailers can educate customers on the benefits of timely gift card redemption and provide clear information on expiration policies. This not only enhances customer satisfaction but also reduces the likelihood of breakage.
Dynamic gift card programs
Implementing dynamic gift card programs is another effective strategy. This involves offering personalized promotions and discounts to encourage gift card usage. By creating incentives for customers to redeem their gift cards promptly, businesses can actively manage breakage and foster positive customer relationships.
Blockchain solutions for transparency
Emerging technologies, such as blockchain, offer innovative solutions to enhance transparency in breakage-related transactions. Blockchain can provide an immutable record of gift card transactions, reducing fraud and ensuring accurate accounting practices. Exploring technological advancements is crucial for staying ahead in managing breakage.
Big data analytics for predictive modeling
Big data analytics plays a pivotal role in predicting and managing breakage. By analyzing customer spending patterns and redemption behaviors, businesses can develop predictive models to estimate future breakage. This data-driven approach allows companies to make informed decisions and optimize their breakage mitigation strategies.
The bottom line
In conclusion, breakage is a nuanced aspect of retail revenue that has historical accounting challenges. The FASB’s intervention with updated guidelines ensures standardized accounting practices, offering companies a transparent method for reporting breakage-related transactions. As the retail landscape evolves, adherence to these guidelines becomes crucial for maintaining financial integrity and customer trust.
Frequently asked questions
What does breakage mean in retail?
Breakage in retail refers to the revenue gained by retailers from unredeemed gift cards or prepaid services that customers never claim.
How does breakage impact a company’s financial health?
Breakage can influence a company’s financial health by introducing uncertainties in accounting and potentially inflating revenue figures.
What historical challenges has breakage presented for companies?
Historically, breakage has posed challenges such as accusations of revenue inflation and substantial annual consumer losses, prompting regulatory intervention.
How has the Federal Trade Commission (FTC) addressed breakage?
The FTC has taken regulatory action against companies with undisclosed dormancy fees on gift cards, requiring reimbursement for affected customers and emphasizing transparency in gift card practices.
What is the FASB’s role in addressing breakage?
The Financial Accounting Standards Board (FASB) plays a crucial role by devising accounting models and releasing updates to standardize the treatment of breakage, enhancing transparent financial reporting for companies.
How do industries other than retail experience breakage?
Breakage manifests differently across industries; for example, in the travel sector, unredeemed prepaid hotel bookings or airline tickets contribute to breakage.
Key takeaways
- Breakage represents revenue gained from unredeemed gift cards or prepaid services.
- The FASB’s 2016 Accounting Standards Update provides guidelines for consistent treatment of breakage in financial reporting.
- Companies must adhere to the FASB guidelines by December 15, 2019, for transparent accounting practices.
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