9.4 Derecognition of Liabilities for Prepaid Stored-Value Products

9.4.1 Background

Prepaid stored-value products are products with a preloaded monetary value (e.g., a gift card, phone card, or traveler’s check) that are commonly accepted as a means of payment for goods or services. For example, a prepaid stored-value product might be issued by a financial services company and used as a means of payment at network-accepting merchant locations. Sometimes, the holder also has an option to redeem all or part of the stored monetary value for cash. Unlike a credit card, which is backed by a line of credit, or a debit card, which is linked to a bank account, a prepaid stored-value product typically is prefunded by the initial holder of the product (e.g., through a cash payment).

When an entity sells a prepaid stored-value product, it incurs a liability for the obligation associated with the stored monetary value. If the holder uses all or a portion of the product’s stored monetary value to buy goods or services from a third party, the issuer must reimburse the third party. When the issuer settles all or part of its obligation to the third-party provider, a corresponding portion of the issuer’s liability is extinguished. However, the issuer often expects “breakage,” which refers to the portion of the stored monetary value that will never be used by holders. For instance, some holders might misplace the product and others might decide not to use the full amount if the remaining balance is small.

ASC 606-10 includes breakage guidance for liabilities associated with revenue contracts with customers (e.g., a retailer’s obligation for a gift certificate that a customer can redeem for goods or services at that retailer). However, ASC 606-10 does not apply to liabilities that meet the definition of a financial liability (such as contractual obligations to pay cash; see Section 2.3.4). Although the holder of a prepaid stored-value product can redeem it for goods or services with a merchant, the issuer has an obligation to pay cash to the merchant. Since a derecognition approach on the basis of a settlement or legal release of an obligation may not reflect the economics of prepaid stored-value products, such liabilities are exempt from the general extinguishment accounting guidance in ASC 405-20-40-1.

9.4.2 Scope

ASC 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:

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
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).

The guidance in ASC 405-20 on prepaid stored-value products does not apply to:

Financial liabilities that can be redeemed for cash only (e.g., nonrecourse debt, bearer bonds, and trade payables). The extinguishment conditions in ASC 405-20-40-1 (see Section 9.3) apply to such liabilities.
Financial liabilities “for which any breakage . . . must be remitted in accordance with unclaimed property laws.” Since unclaimed property laws vary among jurisdictions, an issuer may have breakage liabilities that are subject to different legal requirements. The determination of whether unclaimed property laws apply to a specific breakage liability is a legal question that may need to be evaluated with the assistance of legal specialists.
Financial liabilities related to “[p]repaid stored-value products that are attached to a segregated bank account like a customer depository account.” For example, the guidance does not apply to a debit card that is attached to a bank account.
Obligations under customer loyalty programs, such as frequent flier miles and credit card reward programs (see Deloitte’s Roadmap Revenue Recognition).
Transactions within the scope of other GAAP, such as closed-system prepaid gift cards that are issued by a merchant to permit the holder to purchase goods or services from that merchant in the future; see Deloitte’s Roadmap Revenue Recognition.

9.4.3 Accounting

ASC 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.

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.

ASC 405-20 requires an issuer to recognize breakage associated with prepaid stored-value products (see Section 9.4.2) in a manner similar to breakage associated with revenue transactions within the scope of ASC 606-10 (see Deloitte’s Roadmap Revenue Recognition). Under the breakage guidance in ASC 405-20, an issuer of a prepaid stored-value product must first determine whether it expects to be entitled to a breakage amount. Expected breakage amounts can only be recognized to the extent that it is probable that a significant reversal of the recognized breakage amount will not subsequently be required. In evaluating whether it is entitled to a breakage amount, the issuer may, by analogy to ASC 606-10-55-48, consider factors similar to those in ASC 606-10-32-12. That guidance provides examples of “[f]actors that could increase the likelihood or the magnitude of a . . . reversal,” including the following:

“The uncertainty about the amount . . . is not expected to be resolved for a long period of time.”
“The entity’s experience (or other evidence) with similar types of contracts is limited, or that experience (or other evidence) has limited predictive value.”

If the issuer expects to be entitled to a breakage amount, it derecognizes a portion of its liability for the prepaid stored-value product over time to reflect expected breakage amounts. Breakage is not recognized immediately upon issuance of the prepaid stored-value product. Instead, expected breakage amounts are recognized over time in proportion to the pattern of rights expected to be exercised by the holder (i.e., in proportion to amounts redeemed). At the end of each reporting period, the issuer updates its breakage estimates to reflect current circumstances and accounts for the changes as a change in accounting estimate under ASC 250-10-45-17 through 45-20.

Example 9-11

Derecognition of Prepaid Gift Cards — Breakage Anticipated

On the basis of a portfolio assessment, an issuer of prepaid gift cards within the scope of ASC 405-20 expects breakage of 20 percent of the initial dollar balance on each card. Upon issuance of a gift card, the issuer recognizes the full stated balance as the initial carrying amount of its liability for the gift card. Each time holders redeem gift cards and the issuer pays its associated obligation, the issuer derecognizes a portion of its liability for prepaid gift cards equal to the amount extinguished, plus an additional amount equal to 25 percent of amounts redeemed, to reflect expected breakage (20% ÷ 80%). When a gift card holder redeems $80 of the card balance to purchase goods or services from a third-party merchant, the issuer reimburses the merchant in $80 of cash. Accordingly, the issuer derecognizes $80 of its liability to reflect the amount extinguished and derecognizes another $20 to reflect expected breakage (25% × $80). When a gift card holder redeems another $160, another $40 of breakage is recognized (25% × $160). If the pattern of rights expected to be exercised by holders slows so that expected breakage declines to 70 percent of initial dollar balances, the issuer accounts for the change as a change in estimate under ASC 250-10.

If the issuer does not expect to be entitled to a breakage amount, it derecognizes a portion of its liability to reflect such an amount only when the likelihood that the holder will exercise its remaining rights becomes remote.

Example 9-12

Derecognition of Prepaid Gift Cards — Breakage Not Anticipated

An issuer of prepaid gift cards within the scope of ASC 405-20 does not expect to be entitled to any breakage. Upon the cards’ issuance, the issuer recognizes the full stated balance as a liability. Over time, the issuer derecognizes any amount that it settles. Any remaining unused balance is derecognized only when the likelihood is remote that such amounts will ultimately be redeemed.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.