Memo No.
Issue Summary No. 1
∗
Issue Date March 5, 2015
Memo
Meeting Date EITF March 19, 2015
Contact(s)
Mark Barton
Project Lead/Lead Author
(203) 956-3467
Jennifer Hillenmeyer
EITF Coordinator
(203) 956-5282
Mark Bielstein
EITF Liaison
Project
EITF Issue No. 15-B, "Recognition of Breakage for Prepaid Stored-Value Cards"
Project Stage
Initial Deliberations
Dates
previously
discussed by
EITF
None
Previously
distributed
Memo
Numbers
None
Objective of This Memo
1.
The purpose of this memo is to assist the Task Force in determining how the liability that
exists between a Card Issuer or Prepaid Network Provider and a Consumer prior to when
a prepaid stored-value card is redeemed by the Consumer should be derecognized. The
parties involved in the sale of a prepaid stored-value card and their respective roles are
discussed in paragraphs 9 through 12 of this memo.
2.
This Issue applies to all Card Issuers and Prepaid Network Providers that offer prepaid
stored-value cards that may be redeemed only for goods and services from a third-party
(that is, a Content Provider).
∗
The alternative views presented in this Issue Summary are for purposes of discussion by
the EITF. No individual views are to be presumed to be acceptable or unacceptable
applications of Generally Accepted Accounting Principles until the Task Force makes such
a determination, exposes it for public comment, and it is ratified by the Board.
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Background Information
3.
In November 2012, the FASB received an unsolicited letter from a stakeholder addressed
to both the EITF and the IFRIC Chairman (see Appendix A). The letter requested that the
EITF address the recognition of breakage for prepaid stored-value cards sold specifically
by financial institutions. The letter requested that the EITF clarify how (and whether)
breakage for prepaid stored-value cards should be recognized following adoption of the
final FASB/IASB joint revenue recognition standard.
4.
The FASB staff decided to wait to address the agenda request until completion of the
joint revenue recognition project. The staff was concerned that if the EITF addressed this
issue prior to completion of the joint project, its decisions could potentially conflict with
ongoing Board deliberations regarding customers’ unexercised rights (that is, breakage). 1
The joint project was completed in May 2014 with the issuance of FASB Accounting
Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606).
5.
In November 2014, the FASB voted to add the issue to the EITF agenda. Subsequent to
that date, the EITF chairman received a second unsolicited letter from a stakeholder that
included additional information about other types of prepaid stored-value card
arrangements for the EITF’s consideration (see Appendix B).
6.
The IFRS Interpretations Committee discussed this issue at its November 11, 2014 and
January 27, 2015 meetings. The Interpretations Committee tentatively agreed that the
liability in question meets the definition of a financial liability. However, the
Interpretations Committee was concerned about other similar arrangements and requested
that the IASB staff determine the basis for distinguishing between those arrangements
and prepaid stored-value cards. The IASB staff is expected to present its findings to the
Interpretations Committee at a future meeting. The FASB staff has coordinated with the
IASB staff on this issue.
7.
Common examples of prepaid stored-value cards include prepaid gift, telecom, and debit
cards, in physical and digital forms. Prepaid stored-value cards fall into three categories:
1
The staff considered whether this issue should be addressed by the FASB/IASB Joint Transition Resource Group
for Revenue Recognition. The staff determined that the issue arises from the application of the guidance in Subtopic
405-20, Liabilities—Extinguishment of Liabilities. Accordingly, the staff determined that the issue should not be
discussed with a group designed only to assist with implementation of the guidance in Update 2014-09.
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(a) closed-loop cards, which are cards that typically are redeemable for goods and
services only at a specified Content Provider; (b) semi-closed loop cards, which are cards
that are redeemable at a limited number of unaffiliated Content Providers (such as a
prepaid shopping center card that is redeemable only at the merchants within the
shopping center); and (c) open-loop cards that are redeemable at any Content Provider
that operates on a specified card network (such as a national credit card network).
8.
Prepaid stored-value cards generally have the following characteristics:
a.
They typically do not have expiration dates
b.
They are redeemable for goods and services only at designated Content
Providers (for example, only at Content Providers that accept prepaid storedvalue cards on a specific card network)
c.
They are not demand instruments that can be redeemed for cash from the Card
Issuer
d.
They are not redeemable for cash from any Content Provider or ATM machine
e.
They are not directly attached to a segregated bank account like a debit card or a
checking account
f.
The terms of the contract allow the Card Issuer to settle the obligation by paying
cash to a third party to provide the goods or services.
9.
When a Card Issuer sells a prepaid stored-value card directly to a Consumer, it
recognizes a liability for its obligation to provide the Consumer with the ability to
purchase goods or services at a Content Provider. When the Consumer redeems the
prepaid stored-value card at a Content Provider, the Card Issuer processes the card
payment via a bank card network and the liability between the Card Issuer and the
Consumer is extinguished. At the same time, the Card Issuer incurs a liability to the
Content Provider. This liability is typically settled within a few days through a cardsettlement process. A Card Issuer typically will settle the liability net of a fee for its
services.
10.
Prepaid stored-value cards are sometimes sold through Prepaid Network Providers.
Those entities provide services for the promotion, distribution, activation, and settlement
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of prepaid stored-value cards on behalf of third-party Content Providers. The gift cards
are distributed to Consumers through Distribution Partners (for example, a kiosk at a
grocery store). The value “loaded” onto the prepaid stored-value card is referred to as the
“load value” and is the amount that can later be redeemed by the Consumer to pay for
purchases at a Content Provider. Prepaid Network Providers often provide Distribution
Partners with advertising dollars, marketing materials, and display items that assist the
Distribution Partners in selling the prepaid stored-value cards offered by the Prepaid
Network Provider.
11.
In exchange for a Prepaid Network Provider’s services, a Content Provider pays the
Prepaid Network Provider a negotiated commission. In some cases, the commission is
equal to a percentage of the load value of each prepaid stored-value card sold. The
commission is funded through a net-settlement exchange of cash from the Distribution
Partner who collects the initial load value of the purchased card from the Consumer. The
Distribution Partner then remits the load value of the purchased card, net of its share of
the distribution commission, to the Prepaid Network Provider, who then remits the
remaining load value, net of its share of the commission, to the Content Provider.
12.
In other cases, the Prepaid Network Provider does not remit funds to the Content
Provider until certain actions are taken by the Consumer. For example, the Prepaid
Network Provider may sell stored-value cards through its website or through an online
Distribution Partner. For those transactions, the Prepaid Network Provider collects the
prepaid stored-value card’s load value directly from the Consumer or from the electronic
Distribution Partner and remits the card’s load value less its commission to the Content
Provider only upon activation of the stored-value card by the Consumer. In cases in
which the Consumer does not activate the stored-value card, the Prepaid Network
Provider is not required to remit the collected funds to the Content Provider.
13.
In the past, prepaid stored-value cards often were subject to contractual front-end fees or
back-end fees. For example, the Consumer might have been required to pay $52.50 for a
$50 prepaid stored-value card. The additional $2.50 represented a front-end fee charged
by the Card Issuer. Similarly, Card Issuers would charge Consumers who did not redeem
the $50 balance within a designated period of time (for example, 12 months) a monthly
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back-end fee against the balance of the card (typically ranging from $2 to $3.50). Card
Issuers utilized those back-end fees, which reduced the financial institution’s obligation
to the card holder over time, to recognize unused card balances into income.
14.
Due to recent changes in regulation, consumer demands, and a growing number of
jurisdictions that have exemptions for prepaid stored-value cards in their unclaimed
property (escheat) laws, 2 many financial institutions have migrated from fee models to
fee-free models.
15.
The movement to fee-free prepaid stored-value cards has raised questions about whether
and when a Card Issuer should derecognize the liability that exists prior to redemption of
the card at a Content Provider. Some prepaid stored-value cards may be partially or
wholly unused indefinitely (for example, a Consumer may physically lose the prepaid
stored-value card or otherwise not use it). The Master Glossary of the Codification
defines a financial liability as a contract that imposes on one entity an obligation to do
either of the following:
a.
Deliver cash or another financial instrument to a second entity
b.
Exchange other financial instruments on potentially unfavorable terms with the
second entity.
16.
Subtopic 405-20, Liabilities—Extinguishments of Liabilities, provides that a liability is
only extinguished when either of the following conditions is met:
a.
The debtor pays the creditor and is relieved of its obligation for the
liability. Paying the creditor includes the following:
i.
Delivery of cash
ii.
Delivery of other financial assets
iii.
Delivery of goods or services
iv.
Reacquisition by the debtor of its outstanding debt securities,
whether the securities are cancelled or held as so-called
treasury bonds.
2
In some jurisdictions, escheat laws require the Card Issuer or Prepaid Network Provider to remit funds related to
unredeemed prepaid stored-value cards to the jurisdiction after a specified period of time. As a result, breakage on
prepaid stored-value cards subject to escheat laws is not recognized. Rather, the liability associated with the
unredeemed prepaid stored-value card is derecognized upon transfer of funds to the jurisdiction. Products subject to
escheat laws are not within the scope of this Issue.
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b.
17.
The debtor is legally released from being the primary obligor under the
liability, either judicially or by the creditor. For purposes of applying
this Subtopic [405-20], a sale and related assumption effectively
accomplish a legal release if nonrecourse debt (such as certain
mortgage loans) is assumed by a third party in conjunction with the
sale of an asset that serves as sole collateral for that debt.
In a 2005 speech (see Appendix C), the SEC staff indicated that a vendor should apply
the derecognition guidance in Subtopic 405-20 in an arrangement in which a customer
makes a payment in advance of vendor performance. However, the SEC staff
acknowledged that derecognition may be acceptable in certain circumstances if the
vendor can demonstrate that it is remote that a customer will require performance. The
SEC staff speech addressed several approaches to recognizing breakage that the SEC
staff stated it may consider appropriate, depending on the facts and circumstances of a
particular arrangement. Some stakeholders think it is unclear whether the SEC staff
speech addresses arrangements in which the card issuer does not directly provide goods
or services to the card holder.
18.
Although the SEC staff views are not included in the Codification, some Card Issuers and
Prepaid Network Providers have applied those views in the absence of authoritative
breakage guidance in GAAP prior to the issuance of the guidance in Update 2014-09. As
a result, those prepaid stored-value card liabilities are derecognized sooner than would
otherwise be permitted under Subtopic 405-20. Other Card Issuers and Prepaid Network
Providers have interpreted the derecognition criterion in Subtopic 405-20 regarding legal
release from an obligation to allow for derecognition if the probability of redemption is
remote.
19.
The guidance in Update 2014-09 is effective in fiscal years beginning after December 15,
2016, for public business entities or December 15, 2017, for nonpublic entities.
20.
Paragraphs 606-10-55-46 through 55-49 in Update 2014-09 include breakage concepts
similar to the views previously expressed in the SEC staff speech. The guidance requires
an entity that expects to be entitled to a breakage amount to recognize the expected
breakage amount as revenue in proportion to the pattern of rights exercised by the
customer. If an entity does not expect to be entitled to a breakage amount, the guidance
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in Update 2014-09 requires that the entity recognize the expected breakage amount as
revenue when the likelihood of the customer exercising its remaining rights becomes
remote. Unlike the views expressed in the SEC staff speech, the breakage guidance in
Update 2014-09 is authoritative. Some stakeholders have questioned whether the views
expressed in the SEC staff speech may be applied to the sales of prepaid stored-value
cards within the scope of this Issue subsequent to the adoption of the authoritative
breakage guidance in Update 2014 -09.
21.
The scope of Update 2014-09 excludes financial instruments that are within the scope of
Topic 405, Liabilities. The liability a Card Issuer recognizes when it sells a prepaid
stored-value card that can only be redeemed for goods or services that it offers as the
Content Provider typically does not meet the definition of a financial liability discussed
above (that is, when the Card Issuer also is the Content Provider). Accordingly, sales of
those prepaid stored-value cards are within the scope of Update 2014-09. Conversely,
the liability that a Card Issuer recognizes upon the sale of a prepaid stored-value card that
allows a Consumer to redeem the card for cash would meet the definition of a financial
liability and would be outside the scope of Update 2014-09.
Question for the Task Force
1. How should the liability that exists between a Card Issuer or Prepaid Network Provider
and a Content Provider prior to redemption of a prepaid stored-value card be
derecognized (that is, using Alternatives A, B, or D identified in this memo)?
Staff Analysis
22.
Certain stakeholders question whether the liability that exists between the Card Issuer and
the Consumer prior to when a prepaid stored-value card is redeemed by the Consumer
meets the definition of a financial liability. Some stakeholders state that the
determination of whether a financial liability exists depends on whether the transaction
between the Card Issuer and the Consumer is viewed as a separate transaction from the
transaction between the Card Issuer and the Content Provider. That is, the obligation the
Card Issuer has to the Content Provider is settled in cash and would meet the definition of
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a financial liability while the obligation the Card Issuer has to the Consumer is settled
through the delivery of goods and services by the Content Provider and would not meet
the definition of a financial liability.
23.
However, other stakeholders view the substance of prepaid stored-value card sales as a
single transaction settled in cash through the Content Provider. Accordingly, those
stakeholders support the view that the liability recognized by the Card Issuer or Prepaid
Network Provider upon sale of a prepaid stored-value card to a Consumer meets the
definition of a financial liability.
24.
Diverse views also exist for arrangements in which a Consumer purchases a prepaid
stored-value card through a Prepaid Network Provider and Consumer action is required
before the Prepaid Network Provider is obligated to remit funds to the Content Provider
(that is, the Consumer must activate or redeem the card). Some stakeholders support the
view that in these arrangements the Prepaid Network Provider has a financial liability to
the Content Provider that should not be derecognized until the prepaid stored-value card
is activated or redeemed by the Consumer (that is, until the Prepaid Network Provider is
required to remit cash to the Content Provider).
25.
Other stakeholders support the view that although the liability that exists between the
Prepaid Network Provider and the Content Provider in the above example meets the
definition of a financial liability, the liability should be derecognized when activation of
the prepaid stored-value card is deemed to be remote (assuming the Network Provider
otherwise is not required to remit any funds to the Content Provider).
Staff Outreach
26.
The staff performed outreach with four audit firms and several preparers. A majority of
the stakeholders with whom the staff performed outreach stated that the liability between
a Card Issuer and a Content Provider prior to redemption of a prepaid stored-value card
by the Consumer meets the definition of a financial liability. Those stakeholders also
stated that recognition of breakage should be permitted for prepaid stored-value cards.
However, the stakeholder who submitted the initial agenda request does not agree that
those liabilities meet the definition of a financial liability because in that stakeholder's
opinion the transaction between the Card Issuer and the Consumer is separate from the
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transaction between the Card Issuer and the Content Provider at which the prepaid card is
redeemed. As a result, the stakeholder is of the view that the transaction between the
Card Issuer and the Consumer is within the scope of Update 2014-09 and the breakage
guidance in that standard should be applied.
27.
The stakeholder who submitted the second unsolicited comment letter stated that in
arrangements in which a prepaid stored-value card must be activated by the Consumer,
the liability that exists between a Prepaid Network Provider and a Content Provider prior
to activation could meet the definition of a financial liability. However, that stakeholder
also stated that derecognition of that liability should be permitted prior to when required
by the guidance in Subtopic 405-20. That is, in the stakeholder's opinion, the potential for
a liability to exist in perpetuity is not reflective of the economics of these arrangements.
Alternatives
28.
The staff has identified the following potential alternatives to address this Issue:
a.
Alternative A – The liability that exists between a Card Issuer or Prepaid
Network Provider (if a Consumer activation is required) and a Content Provider
prior to when a prepaid stored-value card is redeemed by a Consumer meets the
definition of a financial liability. Accordingly, an entity should follow the
derecognition guidance in Subtopic 405-20. Under this alterative, amendments
to Subtopic 405-20 would be limited to adding a statement that prepaid storedvalue cards are within the scope of the Subtopic, as well as a description of
prepaid stored-value cards.
b. Alternative B – The liability described in Alternative A meets the definition of a
financial liability. However, under Alternative B, a narrow-scope exception
would be made to the derecognition guidance in Subtopic 405-20 for prepaid
stored-value cards to require the recognition of breakage if an entity expects to
be entitled to a breakage amount. The breakage guidance would be the same as,
or substantially the same as, the breakage guidance in Topic 606. Accordingly,
an entity would be required to recognize breakage if it expects to be entitled to a
breakage amount. If an entity does not expect to be entitled to a breakage
amount, the entity should recognize the expected breakage amount as revenue
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when the likelihood of the customer exercising its remaining rights becomes
remote.
c.
Alternative C – The liability described in Alternative A does not meet the
definition of a financial liability. Accordingly, an entity should follow the
breakage guidance in Topic 606 and would be required to recognize breakage if
it expects to be entitled to a breakage amount. If an entity does not expect to be
entitled to a breakage amount, the entity should recognizethe expected breakage
amount as revenue when the likelihood of the customer exercising its remaining
rights becomes remote. Under this alterative, amendments to Subtopic 405-20
and/or Topic 606 would be limited to a statement that prepaid stored-value cards
are within the scope of Topic 606, as well as a description of prepaid storedvalue cards.
d.
Alternative D – The liability discussed in Alternative A meets the definition of a
financial liability. However, unlike Alternative A, under Alternative D, an entity
would be given the option to make a one-time policy election to measure an
existing prepaid stored-value card liability at fair value in accordance with Topic
825, Financial Instruments. Under this alterative, amendments to Subtopic 40520 would be limited to adding a statement that prepaid stored-value cards are
within the scope of the Subtopic, as well as a description of prepaid stored-value
cards. In addition, a potential amendment could be made to the Codification to
clarify that the prepaid stored-value cards would not be in the scope of the
financial instruments in paragraph 825-10-15-5(e) for which the fair value option
may not be applied.
Alternative A
29.
Proponents of Alternative A observe that the liability that exists between a Card Issuer or
Prepaid Network Provider (if a Consumer action is required) and a Content Provider prior
to when a prepaid stored-value card is redeemed by a Consumer meets the definition of a
financial liability. They note that the substance of the arrangement is a transaction
between a Card Issuer and the Consumer that is ultimately settled in cash through a
Content Provider (that is, the Card Issuer pays cash to the Content Provider on the
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Consumer’s behalf). They also note that in arrangements in which a Consumer must take
action before a Prepaid Network Provider is required to remit funds to a Content
Provider, the liability that exists between the Prepaid Network Provider and the Content
Provider also is ultimately settled in cash. As a result, proponents of Alternative A note
that prepaid stored-value are outside the scope of the new revenue standard and,
therefore, the breakage guidance in that standard is not applicable.
30.
Proponents of Alternative A observe that prepaid stored-value cards are similar to
customer demand deposits and should be treated as a financial liability and derecognized
in accordance with Subtopic 405-20.
31.
Opponents of Alternative A, regardless of whether they agree that the liabilities meet the
definition of a financial liability, question whether the application of the derecognition
guidance in Topic 405-20 sometimes would result in providing information to financial
statement users that is not useful. For example, if a card holder loses the card or
otherwise will not use the card, opponents question whether the indefinite recognition of
the liability provides useful information.
Alternative B
32.
Proponents of Alternative B share similar views with proponents of Alternative A about
the nature of the liability described under Alternative A. That is, proponents of
Alternative B support the view that prepaid stored-value cards are subject to the
derecognition guidance in Subtopic 405-20. However, proponents of Alternative B also
support the view that recognition of a liability (potentially in perpetuity) when a
Consumer has no expectation of performance from an entity and settlement of that
liability is remote does not provide useful information. Accordingly, proponents of
Alternative B suggest that GAAP should allow a narrow-scope exception to the
derecognition guidance in Subtopic 405-20 to allow breakage to be recognized for
prepaid stored-value cards. Proponents also note that Alternative B is closest to the way
in which entities account for these liabilities today.
33.
Proponents of Alternative B note that today, a narrow-scope exception to the broad
derecognition guidance in Subtopic 405-20 exists in paragraph 924-405-35-1. That
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guidance permits a gaming chip liability to be adjusted periodically to reflect an estimate
of chips that will never be redeemed.
34.
Opponents of Alternative B note that prepaid stored-value cards are no different from any
other financial liability subject to the derecognition guidance in Subtopic 405-20.
Accordingly, opponents of Alternative B do not agree that narrow-scope derecognition
guidance should be provided for prepaid stored-value cards. Opponents of Alternative B
observe that providing such an accommodation may lead to unintended consequences.
For example, opponents of Alternative B observe that some entities may attempt to apply
the accommodation by analogy to other types of financial liabilities. The Task Force
could, however, mitigate the risk of unintended consequences by including an explicit
statement in Subtopic 405-20 that states that the guidance should not be applied by
analogy.
35.
Some opponents of Alternative B observe that it may be difficult for the Task Force to
justify the scope of the exception, which might increase the risk that stakeholders apply
the exception by analogy. If the scope of the exception includes prepaid stored-value
cards that may be redeemed only for goods and services at a Content Provider, prepaid
cards that can be redeemed for goods, services, and/or cash (for example, a customer can
use the card to withdraw cash at an ATM) would be prohibited from using the exception
and, therefore, would apply the derecognition guidance in Subtopic 405-20.
Consequently, a liability for a card with a cash option might be recognized indefinitely if
the card holder loses the card or otherwise does not use the card. Those opponents
acknowledge that a card with a cash option is not the same as a card without a cash
option, but they question whether the economics of the arrangements are sufficiently
different to justify completely different accounting models.
36.
Opponents of Alternative B also observe that prepaid stored-value cards are similar to
customer demand deposits and should be treated as a financial liability and derecognized
in accordance with Subtopic 405-20.
Alternative C
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37.
Proponents of Alternative C say that the liability described under Alternative A does not
meet the definition of a financial liability. In their view, there are only two parties to a
prepaid stored-value card agreement—the Card Issuer or Prepaid Network Provider and
the Consumer. They do not agree that the Content Provider is a party to the cardholder
agreement. Therefore, proponents of Alternative C support the view that the liability
does not meet the definition of a financial liability because the Consumer cannot demand
or receive cash. Proponents of Alternative C also support the view that prepaid storedvalue cards are within the scope of Update 2014-09 and should apply the breakage
guidance in that standard, similar to how prepaid cards issued by a merchant to its
customers will be treated.
38.
Proponents of Alternative C note that if breakage were not recognized for prepaid storedvalue cards, the related liability would be recognized in perpetuity. Proponents of
Alternative C note that such a liability is not reflective of a customer’s expectation of the
Card Issuer or Prepaid Network Provider’s performance.
39.
Proponents of Alternative C also point to an FASB/IASB staff paper discussed at the
February 16-18, 2011 Joint FASB/IASB meeting that described how the new revenue
standard would apply to breakage and prepayments for future goods or services.
Appendix A of that memo includes a brief discussion of prepaid cards and states:
The staff note that an entity’s obligation from the sale of a gift card
does not meet the definition of a ‘financial liability’ under U.S. GAAP or
IFRSs as the entity does not have an obligation to either deliver cash or
another financial instrument to the customer or to exchange other financial
instruments on potentially unfavorable terms with the customer. The
entity instead has an obligation to provide the customer with future goods
or services in exchange for the value included on the gift card.
40.
Opponents of Alternative C observe that prepaid stored-value cards are similar to
customer demand deposits and should be treated as a financial liability and derecognized
in accordance with Subtopic 405-20.
41.
Opponents of Alternative C observe that the FASB/IASB staff paper referenced above
applies only to contracts in which a vendor directly provides goods and services to a
customer, and, therefore, prepaid stored-value cards were not contemplated in the paper.
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Alternative D
42.
Proponents of Alternative D agree that the liability discussed under Alternative A meets
the definition of a financial liability. However, they also note that application of the
derecognition guidance in Subtopic 405-20 could result in the recognition of a liability
indefinitely. Proponents of Alternative D also say that indefinite recognition of a liability
in many cases is not reflective of a Consumer’s expectation of a Card Issuer or Prepaid
Network Provider’s Performance.
43.
Proponents of Alternative D state that a narrow-scope exception to the broad
derecognition guidance in Subtopic 405-20 is not appropriate because it may result in
unintended consequences. That is, proponents of Alternative D say that a narrow-scope
exception may result in entities analogizing to the exception for derecognition of
liabilities that were not contemplated by the Task Force. Proponents of Alternative D
note that giving an entity the ability to elect the fair value option to account for an
existing prepaid stored-value card liability would allow entities to reduce the liability as
redemption of the card becomes less likely without creating a narrow scope exception in
Subtopic 405-20.
44.
Opponents of Alternative D acknowledge that permitting an entity to elect the fair value
option to account for a prepaid stored-value card could be a means through which an
entity could derecognize that liability over time. However, opponents of Alternative D
question how changes in the fair value of that liability should be reported in an entity’s
statement of income (that is, it raises questions as to whether those changes should be
presented as revenue).
45.
Some opponents of Alternative D also point out that application of the fair value option
could be costly and burdensome due to the effort that would be required to determine the
fair value of the prepaid stored-value liability on a recurring basis (that is, potentially
indefinitely) as well as the effort that would be required to satisfy any related fair value
disclosures.
Staff Recommendation
46.
The staff recommends Alternative B primarily on the basis that it: (a) most faithfully
applies the definition of a financial liability; (b) results in the recognition of a liability
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over a period of time that most faithfully represents the expected performance of the Card
Issuer or Prepaid Network Provider; and (c) would not take significant effort or cost to
apply.
Disclosures
47.
If the Task Force decides that recognition of breakage for a prepaid stored-value card
liability should be permitted through a narrow scope exception to the guidance in
Subtopic 405-20 (Alternative B), additional disclosures may be warranted. For example,
an entity could be required to disclose the methodology used to calculate the breakage
amount.
48.
If the Task Force decides that an entity should be permitted to elect the fair value option
for a prepaid stored-value card (Alternative D), an entity would be subject to the
disclosure requirements in paragraphs 825-40-50-24 through 50-32 regarding use of the
fair value option.
49.
Similar to Alternative D, Alternatives A and C have existing GAAP disclosure
requirements pursuant to Section 405-20-50 and Topic 606-10-50, respectively.
Question for the Task Force
2. Does the Task Force want to require entities to provide additional disclosures related
to the recognition of breakage for a prepaid stored-value card liability?
Staff Analysis and Recommendation
50.
The staff believes that an entity’s methodology for calculating breakage provides
meaningful information to users of the financial statements. Accordingly, if the Task
Force elects Alternative B, the staff recommends that disclosures similar to those
required by paragraph 606-10-50-18 be provided. Paragraph 606-10-50-18 requires
disclosure of the judgments, and changes in judgments used in determining the timing of
satisfaction of performance obligations, including an explanation of why the methods
used provide a faithful depiction of the transfer of goods or services. That paragraph
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requires disclosure of an entity’s methodology for calculating breakage for transactions
within the scope of Topic 606.
51.
The staff does not believe that additional disclosure requirements are necessary for
Alternatives A, C, or D because there are existing disclosures requirements in GAAP that
provide the relevant information associated with each of those alternatives.
Transition
52.
The Task Force could require retrospective transition or prospective transition, or it could
allow reporting entities to choose between retrospective transition and prospective
transition.
Question for the Task Force
3. Does the Task Force want to require retrospective transition or prospective transition,
or does it want to allow reporting entities to choose retrospective transition or
prospective transition?
Staff Analysis and Recommendation
53.
If the Task Force elects Alternative B or Alternative C, the staff recommends prospective
transition. The staff does not believe that there would be significant benefit to
retrospective transition because those alternatives would not represent a significant
change in practice for many entities and, therefore, comparability of the information
across periods would not be significantly affected.
54.
If the Task Force elects Alternative A, the staff recommends retrospective transition
because it would represent a change in practice for many entities. In many cases,
prospective transition would not provide for comparability because an entity may have
recognized breakage for transactions that occurred in the comparative periods.
Accordingly, users of the financial statements may not be provided with certain trend
information that would be afforded under the retrospective transition method.
55.
If the Task Force elects Alternative D, the staff recommends modified retrospective
transition, with a cumulative catch-up adjustment to opening retained earnings in the
Page 16 of 46
period of adoption. The staff does not believe that Alternative D would significantly
change how many entities derecognize a prepaid stored-value card liability (that is, the
fair value option would likely result in derecognition of the liability in a manner similar
to recognition of breakage). In addition, the staff does not believe that providing the
related fair value disclosures on a full retrospective basis would provide meaningful
information to users of the financial statements.
Transition Disclosures
56.
Subtopic 250-10, Accounting Changes and Error Corrections—Overall, requires the
following disclosures in the period in which a change in accounting principle is made:
250-10-50-1 An entity shall disclose all of the following in the fiscal period in
which a change in accounting principle is made:
a. The nature of and reason for the change in accounting principle, including an
explanation of why the newly adopted accounting principle is preferable.
b. The method of applying the change, including all of the following:
1. A description of the prior-period information that has been retrospectively
adjusted, if any.
2. The effect of the change on income from continuing operations, net income
(or other appropriate captions of changes in the applicable net assets or
performance indicator), any other affected financial statement line item, and
any affected per-share amounts for the current period and any prior periods
retrospectively adjusted. Presentation of the effect on financial statement
subtotals and totals other than income from continuing operations and net
income (or other appropriate captions of changes in the applicable net assets
or performance indicator) is not required.
3. The cumulative effect of the change on retained earnings or other
components of equity or net assets in the statement of financial position as
of the beginning of the earliest period presented.
4. If retrospective application to all prior periods is impracticable, disclosure
of the reasons therefore, and a description of the alternative method used to
report the change (see paragraphs 250-10-45-5 through 45-7).
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c. If indirect effects of a change in accounting principle are recognized both of
the following shall be disclosed:
1. A description of the indirect effects of a change in accounting principle,
including the amounts that have been recognized in the current period, and
the related per-share amounts, if applicable
2. Unless impracticable, the amount of the total recognized indirect effects of
the accounting change and the related per-share amounts, if applicable, that
are attributable to each prior period presented. Compliance with this
disclosure requirement is practicable unless an entity cannot comply with it
after making every reasonable effort to do so.
Financial statements of subsequent periods need not repeat the disclosures required
by this paragraph. If a change in accounting principle has no material effect in the
period of change but is reasonably certain to have a material effect in later periods,
the disclosures required by (a) shall be provided whenever the financial statements
of the period of change are presented.
250-10-50-2 An entity that issues interim financial statements shall provide the
required disclosures in the financial statements of both the interim period of the
change and the annual period of the change.
250-10-50-3 In the fiscal year in which a new accounting principle is adopted,
financial information reported for interim periods after the date of adoption shall
disclose the effect of the change on income from continuing operations, net income
(or other appropriate captions of changes in the applicable net assets or performance
indicator), and related per-share amounts, if applicable, for those post-change
interim periods.
Questions for the Task Force
4. Does the Task Force agree that the proposed amendments should refer reporting
entities to the transition disclosures in paragraphs 250-10-50-1 through 50-3?
5. Are there any additional transition disclosures the Task Force believes are necessary?
Staff Analysis
57.
The staff recommends that transition disclosures follow the guidance in paragraphs 25010-50-1 through 50-3. Although certain disclosure requirements would not be applicable
Page 18 of 46
to this Issue depending on which alternative the Task Force elects, the staff does not
believe that preparers will have difficulty identifying the inapplicable disclosures.
58.
In addition, paragraphs 250-10-50-1 through 50-3 require an entity to disclose the nature
and reason for an accounting change, the method of applying the change, and any indirect
effects of the accounting change. The staff believes that all of these disclosure
requirements would sufficiently explain the change in accounting principle. Accordingly,
the staff does not recommend requiring any transition disclosures beyond the existing
disclosure requirements in Topic 250.
59.
The staff considered the level of effort that may be required to provide the disclosures
required by paragraph 250-10-50-3 under certain alternatives. If the Task Force pursues
an alternative that is not expected to have a material effect on an entity’s historical
financial statements (for example, Alternative B), the staff recommends that the
disclosures in paragraph 250-10-50-3 not be required because that information likely
would not be useful to users of financial statements.
Page 19 of 46
Appendix A: Card Compliant Memorandum
AR-2012
Comment Letter No. 3
460 Nichols Rd., Suite 300
Kansas City, MO 64112
(913) 871-7430 Main Phone
(866) 498-1735 Fax
November 15, 2012
Ms. Susan M. Cosper
Emerging Issues Task Force Chairman
Financial Accounting Standards Board
401Merritt 7, P.O. Box 5116
Norwalk,CT 06856-5116
Mr. Michael Stewart
Director of Implementation Activities
International Accounting Standards
Board First Floor
30 Cannon Street
London EC4M
6XH United
Kingdom
Dear Ms. Cosper and Mr. Stewart:
Thank you for the opportunity to address the EITF and IFRIC regarding an issue of growing importance in the
prepaid card and mobile payments industry. We believe you will find the enclosed paper to describe an
emerging accounting issue within the prepaid card and mobile payments industry which we believe will have a
significant financial statement impact if left unaddressed.
We respectfully request the EITF and the IFRIC closely examine the facts outlined in the paper and comment on
the proper classification of prepaid cards and mobile payment instruments which are issued by a financial
institution where the right acquired and held by the holder is a right to receive goods and services only from
specified merchants. Card Compliant does not believe the liability held by the card issuer is a financial liability
and requests the EITF and the IFRIC specifically address the issue.
Card Compliant is available to answer any questions the EITF or the IFRIC may have and look forward to further
discussions.
Best Regards,
Page 20 of 46
Card Compliant provides technology driven regulatory and accounting compliance solutions for the
prepaid card industry. The industry, a $500B+ load sector of financial services, develops and
distributes prepaid cards and mobile payment solutions, such as gift, incentive, rebate, payroll,
government benefit, HSA, FSA and general purpose reloadable (“GPR”) cards. Industry products range
from a closed-loop retail gift card program to a bank or financial institution issued card program that
operates using the MasterCard, Visa, AMEX or Discover networks.
Bac k g r ound
Some of the prepaid cards (i.e., payroll, government benefit, and GPR cards) operate a lot like
debit cards in that they are usable to buy goods or services and are redeemable for cash upon
demand at ATMs, certain financial institutions or at designated retail outlets. Other prepaid cards
(primarily gift cards and promotional cards) are unique in that they are usable only to buy goods
and services at designated merchants and are not refundable or redeemable for cash.
This paper is directed only at the later “no-cash” prepaid cards. These cards fall into three
subcategories: (1) closed-loop cards that are typically redeemable for goods and services only at a
single retailer or franchisees bearing a common brand (such as the Target gift card or the Subway gift
card); (2) semi-closed loop cards that are redeemable at a limited number of unaffiliated merchants
(such as a shopping center gift card that is redeemable only at the merchants in the shopping center);
and (3) open-loop cards that are redeemable at any merchant that operates on the card network
(such as a Visa open-loop gift card that is usable only at the merchants on the Visa network). Some of
these cards are issued by non-financial institutions and others are issued by financial institutions and
banks. 1
The no-cash prepaid cards fall into three subcategories of cards which usually have the following
characteristics: (1) they are recorded on the card issuers books as liabilities when purchased by a
consumer; (2) they typically do not have expiration dates which releases the liability2; (3) they
typically do not have back-end fees which reduce the liability over time3; (4) they are redeemable for
goods and services only at designated merchants; (5) they are not demand instruments which can be
redeemed for cash from the card issuer; (6) they are not redeemable for cash from any third party,
merchant or ATM machine; (7) they are not directly attached to a segregated bank account like a
debit card or a checking account; and (8) the terms of the contract allows the issuer to settle the
obligation by paying a third party to provide the goods or services.
1
Because this paper addresses only the no-cash prepaid cards, throughout this submission, when the phrases “bank issued
card program” and “bank issued card” are used, it is assumed the program and/or cards addressed are cards that are
redeemable for goods and services only. These cards cannot be redeemed or exchanged for cash.
2
Federal and State regulations have banned or limited the use of expiration dates on gift cards to the point where most
gift cards do not have an expiration date. In addition, an expiration free card is a popular consumer card.
3
Back-end fees are fees charged periodically (usually monthly) against the balance of the gift card. Federal and State
regulations have banned or limited the use of back-end fees for gift cards to the point where most gift cards do not have
back-end fees. In addition, fee free gift cards are popular with consumers.
Page 21 of 46
In the past, a card in a prepaid card program issued by a financial institution was subject to
contractual front-end or back-end fees. For example, if a card purchaser purchases a $50 card, they
might have to pay $52.50 in order to purchase the card. The additional $2.50 is a front-end fee
charged by the card issuer. As another example, if a card purchaser purchases a $50 card and does
not redeem any of the $50 balance for a designated period of time (typically 12 months), the card
issuer may charge a monthly back-end fee against the balance of the card (typically ranging from $2
to $3.50). Bank issuers utilized these fees to recognize card balances, including breakage, into income
and, thus, there was no need for derecognition of card liabilities. Due to increased regulation over
the past couple of years and heavy pressure from consumers, bank card issuers have migrated from
fee models and are quickly converting to fee-free models.
These fee-free models operate exactly as promoted: 100% fee free. Having done so, bank issuers
have a significant problem regarding unredeemed, broken, card balances: inflated card liabilities
which will never be reduced even though it is unlikely the cards will ever be presented for
redemption. In the United States, state chartered banks are banned by law from charging back-end
fees in certain states (i.e. Connecticut). Additionally, some federal banks are becoming reluctant to
use the doctrine of preemption to overcome state law bans on back-end fees. In some Canadian
provinces (i.e. Saskatchewan), banks are banned by law from charging back-end fees. In many of
these same states/territories, the cards do not escheat.
Many of these gift cards are not used by the cardholders, resulting in unexercised customer rights
commonly known as “breakage.” Typically these gift cards do not have expiration dates or backend fees which reduce or eliminate the liability overtime. In many jurisdictions, gift cards do not
escheat.4 As a result, there is a question as to when a card issuer can derecognize its prepaid card
liability to properly reflect the true nature of the customers unexercised rights (i.e. not reflected as
a liability in perpetuity).
Current Ac c o unti ng Gui d anc e
Currently, there is limited guidance on the accounting for prepaid card breakage not subject to
escheatment. As we understand it, current U.S. GAAP allows an entity to recognize revenue on the
sale of a prepaid card at the time of redemption5. The entity would only be allowed to recognize the
portion which was redeemed (i.e. if a consumer purchases product worth $20 with a gift card
carrying a $50 balance, the entity would only be allowed to recognize the $20 which was presented
for redemption). While this accounting practice works, it neglects to address when to recognize the
portion of a card which is never redeemed (the “breakage”).
4
Depending upon the gift card program, 32 States have exemptions in their unclaimed property laws that exempt all or
some portion of the gift card liability from escheat.
5
A redemption occurs when a gift card holder presents a gift card as tender in exchange for a product or service.
Page 22 of 46
The SEC presented a speech6 in December 2005 (the “SEC speech”) which addressed the recognition
of prepaid card breakage. The SEC speech allows an entity to derecognize a prepaid card liability
when there is a remote chance the liability will be called upon. The SEC speech also provides
examples of acceptable and unacceptable methods for derecognizing the liability. Since this speech,
it appears that non-bank issuers, whom are SEC Registrants, widely accept that they are able to
derecognize stale card liabilities. We also believe that bank issuers, whom are also SEC Registrants,
believe they are able to derecognize the stale card liabilities for their card programs, and many are in
the practice of doing so. This guidance only applies to those bank issuers whom are SEC Registrants
and there is not currently any comparable guidance applicable to non SEC Registrants. The only other
guidance to which an issuer arguably could look is ASC 405-20-40, Extinguishment of Liabilities. ASC
405-20-40 provides that a liability shall be derecognized “if and only if it has been extinguished.” The
threshold for a liability being extinguished is high: delivery of cash, other financial assets, goods,
services, or legally released by either the creditor or judicially. Prepaid card breakage arguably does
not meet these criteria.
Card Compliant is not aware of any breakage guidance for prepaid cards under IFRS.
Gu id anc e i n the Joi nt R e venue R e c o g n i t i o n Projec t
In June 2010, the Boards jointly released an initial Exposure Draft as part of the Revenue Recognition
Project. Because of concerns regarding the lack of guidance around the accounting treatment of
prepaid card breakage, Card Compliant submitted a Comment Letter to the Boards requesting the
Boards address the recognition of prepaid card breakage within the proposed Revenue Recognition
standard.
In November 2011 the Boards jointly released a revised Exposure Draft (“ED”) as part of the Revenue
Recognition Project. The ED included a proposal on the revenue recognition of Customer’s
Unexercised Rights (IG25 – IG28) which included guidance on prepaid cards. At this time it appears
the Boards have tentatively decided to incorporate a version of this concept in the final standard.
There appears to be an unintended consequence or an unaddressed issue regarding the proposed
guidance specified in the ED. It appears clear that breakage on a prepaid gift card which is not issued
by a financial institution can be recognized under the scope of the proposed standard. However, there
remains much confusion and disagreement on the issue about whether a bank issuer would also be
able to recognize breakage on a prepaid card under the scope of the proposed standard. Bank issuers
believe they will no longer be able to derecognize the prepaid card liability for their card programs as
it is not apparent whether or not the Boards feel the liability being derecognized is a financial liability7
6
The speech was delivered at the December 5, 2005 AICPA National Conference on Current SEC and PCAOB Developments by
Pamela Schlosser (Professional Accounting Fellow, U.S. SEC).
7
Per the ED, “an entity shall apply this proposed guidance to all contracts with customers, except…contractual
obligations…within the scope of … Topic 405 on liabilities … Topic 825 on financial instruments…”.
Page 23 of 46
and not in the scope of the standard, or is not a financial liability and thus falls under the scope of the
standard. They believe the proposed standard has potentially increased the threshold necessary for
them to derecognize the breakage and are concerned about the viability of their card programs in an
environment where derecognition is not possible.
Card Complaint often receives questions regarding the application of derecognition in a bank issued
card program, including questions about the impact of ASC 405-20-40 and whether or not the liability
to be derecognized is considered a financial liability. It is Card Compliant’s belief that the liability to be
derecognized is not a financial liability and should be within the scope of the proposed Revenue
Recognition guidance.
The liability to be derecognized in a bank issued card program is a liability to the consumer in
possession of the card. In a bank issued card program, the bank issuer holds a liability to the consumer
until the consumer redeems the card. At that time, the bank has honored its obligation to the
consumer and a new obligation to the entity which honored the redemption is created. The bank
issuer settles the obligation to the entity which honored the redemption through the card settlement
process. The liability which is being derecognized is not the liability to the entity which honored the
redemption, rather the liability being held by the consumer. That liability is a right to the consumer
which can only exchanged, or redeemed, for goods and services. The right cannot be exchanged, nor
redeemed, for cash.
Ac c o unti ng I s s u e
Card Compliant has had conversations with many of the largest public accounting firms, as well as
many of the largest bank card issuers, regarding whether or not a bank issued card should be
considered to be a financial liability. The results of our conversations have shown that there is not a
consensus on the proper treatment of these card products. Some believe that the bank issuer’s
liability is a financial liability which can only be derecognized in accordance with ASC 405-20-40.
Others believe that the bank issuer’s liability is not a financial liability and can be derecognized in
accordance with the SEC speech.
Card Compliant believes the prepaid card obligation held by a bank issuer should not be considered a
financial liability.
Why a Prepai d Card Ob lig a ti on i s not a Financ i a l L i abi l i t y
ASC 405-20-40 states a liability should be derecognized only if “(a) the debtor pays the creditor and is
relieved of its obligation for the liability…or (b) the debtor is legally released from being the primary
obligor under the liability, either judicially or by the creditor.” The SEC speech provides another option
for gift cards. In the December 2005 speech delivered by SEC Professional Accounting Fellow Pamela
R. Schlosser regarding the derecognition of breakage, Ms. Schlosser states: “In the past, the staff has
stated that a vendor should apply the derecognition guidance found in Statement 140 to these
arrangements, but derecognition may also be acceptable in certain circumstances if the vendor can
demonstrate that it is remote8 that the customer will require performance.” Ms. Schlosser goes on to
8
“Remote” is defined in ASC 450-20-20 to mean “The chance of the future event or events occurring is slight.”
Page 24 of 46
state: “Consistent with staff’s previous views, recognizing prepaid card breakage as the vendor is
legally released from its obligation, for example at redemption or expiration, or at the point
redemption becomes remote may both be acceptable methods.” The “remote” derecognition
technique referenced in this speech has been used by companies derecognizing prepaid card liabilities
across the United States for many years.
The FASB Staff presented a paper to the Board which used the SEC Speech as the foundation for the
decisions made within the Revenue Recognition Project. Appendix A of the FASB Staff Paper
specifically addressed the question as to whether cards9 are a Financial Liability. Paragraph A2 states
“gift cards can be exchanged for numerous goods or services and are therefore similar to a restricted
currency. Because of this difference, some question whether gift cards are within the scope of the
Exposure Draft or whether they should be accounted for as a financial liability.” The staff further
notes, in Paragraph A3 “an entity’s obligation from the sale of gift cards does not meet the definition
of a ‘financial liability’ under US GAAP or IFRSs as the entity does not have an obligation to either
deliver cash or another financial instrument to the customer or to exchange other financial
instruments on potentially unfavourable terms with the customer. The entity instead has an
obligation to provide the customer with future goods or services in exchange for the value included
on the gift card.”
As it relates to financial instrument classification, ASC 825-10-15-4 indicates the following on
insurance contracts and warranty obligations:
“(d.) The rights and obligations under an insurance contract that has both of the following
characteristics: (1) The insurance contract is not a financial instrument (because it requires or permits
the insurer to provide goods or services rather than a cash settlement). (2) The insurance contract’s
terms permit the insurer to settle by paying a third party to provide those goods or services. (e.) The
rights and obligations under a warranty that has both of the following characteristics: (1) The
warranty is not a financial instrument (because it requires or permits the warrantor to provide goods
or services rather than a cash settlement). (2) The warranty’s terms permit the warrantor to settle by
paying a third party to provide those goods or services.”
The guidance in ASC 825-10-15-4 appears to closely relate to the bank issued prepaid card program
whereby (1) the cardholder agreement requires the issuer to provide goods and services rather than
a cash settlement and (2) the cardholder agreement permits the issuer to settle the obligation by
paying a third party to provide those goods or services.
ASC 825-10-20 defines a Financial Liability to mean “A contract that imposes on one entity [an]
obligation (a) to deliver cash or another financial instrument to a second entity or (b) to exchange
other financial instruments on potentially unfavorable terms with the second entity.” (Emphasis
added.) The parameters of most bank issued prepaid card programs, through the agreed terms of
9
It is unclear whether Appendix A of the Staff Paper is addressing bank issued prepaid cards.
Page 25 of 46
the cardholder agreement with the consumer, strictly prohibit the delivery of cash to a cardholder,
except where specifically required by state law.
Furthermore, it is important to note the two parties to the cardholder agreement are the card issuer
and the cardholder. The redeeming merchant is not a party to the cardholder agreement. This is
especially important in identifying the liability which is to be derecognized. It is also important in
knowing whether the cardholder, as opposed to the redeeming merchant, is in a position to demand
or receive cash.
When a prepaid card liability is derecognized, it is imperative to understand the nature of the
liability which is held on the books of the prepaid card issuer. The liability held is the liability to the
cardholder and not a liability to the redeeming merchant. A prepaid card issuer and a cardholder
enter into an agreement at the time the card is issued. The agreement binds the issuer to honor the
card issued when the cardholder presents the card for redemption. In a prepaid program where the
issuer is a financial institution, the card issuer is not the same person which will be physically
redeeming the card(s) when presented for redemption. Instead, the card issuer is required, via a
bank card network such as MasterCard, Visa, American Express, etc., to process the card payment
when the card is presented for redemption.
At the time the card is presented for redemption, the card issuer incurs a liability to the merchant
acquiring bank which is quickly settled by the card issuer within a few business days. The liability to
the redeeming merchant/merchant acquiring bank is not created until the prepaid card is presented
for redemption and is not the liability for which there is a question on derecognition. The liability for
which derecognition is being questioned is the liability to the cardholder. The right which is being
held by the cardholder is a right to redeem the prepaid card for goods and services only and is not a
right to exchange the prepaid card for cash.
Paragraph A2 of the Staff Paper states “gift cards can be exchanged for numerous goods or services
and are therefore similar to a restricted currency.” It is Card Compliant’s belief that the use of the
term “restricted currency” applies to bank issued prepaid cards as well as retailer issued cards as the
term includes dollars which can be spent at multiple retailers and is restricted to retailers whom
accept, for example, MasterCard. The prepaid cards can only be exchanged for goods or services at a
merchant whom has executed an agreement with the transaction processor identified on the face of
the card (i.e. MasterCard, Visa, American Express, Discover). If a cardholder attempted to exchange
the right they were holding for goods and services from a merchant whom had not executed an
agreement with the transaction processor on the face of the card, they would be denied. Card
Compliant therefore believes bank issued prepaid cards are within the scope of the Revenue
Recognition project.
At the February 17, 2011 joint meeting the Boards generally upheld the staff recommendations
provided in the Staff Paper. The Boards have since tentatively decided to include the recognition of
Unexercised Customer Rights in the final standard. If the final standard is released as expected, it is
our belief that a significant divergence in practice will be created regarding the proper treatment of
prepaid cards issued by a financial institution.
Why Addi t i onal Gu idanc e i s Cri t ic al to the Indu s t ry
Current industry practice relies upon the SEC speech to support the derecognition of card breakage.
When the Revenue Recognition standard is finalized, the new guidance will potentially supersede the
Page 26 of 46
SEC speech. Bank card issuers that are now derecognizing stale card liabilities under the SEC speech
will not know which guidance to apply: Revenue Recognition (Topic 605) or Liability Derecognition
(ASC 405-20-40). Due to the vagueness of the scope of Topic 605, the issuer may determine the
obligation is a financial liability and the issuer may only be able to utilize the derecognition guidance
within ASC 405-20-40 which states a liability can only be derecognized if the obligation has been
extinguished either from (a) the payment to creditor or (b) the debtors legal release of the obligation.
Under ASC 405-20-40, the breakage would never be derecognized and would continue to grow over
time.
Prepaid cards which are issued by an entity other than a financial institution are clearly within the
scope of Topic 605. If it is determined that prepaid cards issued by a financial institution do not fall
within the scope of Topic 605, or if the issue is not addressed and it is left vague, the accounting
standards will have effectively eliminated a product from the marketplace as the income from
derecognizing the breakage is a material component to the business models for bank issued prepaid
cards. These cards would likely have no choice but to return to the back-end fees model, and in the
face of additional regulation on those back-end fees. These fee’d cards would be at a huge
competitive disadvantage due to consumer acceptance of the product. Given the choice between
buying a card with fees and a card without fees, the consumer will almost always select the card
without fees.
Public policy indicates fees should not exist as they are not “consumer friendly,” yet the accounting
standards would be forcing fees. A decision by the Boards to not address the issue, or to determine
the cards do not fall within the scope of Topic 605, could very well lead to the demise of the openloop prepaid card, which represents a $25B industry10.
Card Compliant does not believe the liability held by the card issuer is a financial liability. The liability
is an obligation to the consumer in possession of the prepaid card and only allows the consumer to
exchange the prepaid card for goods and services. The obligation does not allow the consumer to
receive cash. The obligation appears to closely relate to the guidance provided in on insurance
contracts and warranties which are not financial instruments as noted in ASC 825-10 Lastly, the
prepaid card should be considered a form of a “restricted currency” as the card is only accepted at
merchants that operate on the card network.
Conclusion
Card Compliant believes the Boards should provide guidance to clarify if a bank issued card is a
financial liability, and if so, how do we derecognize it.
10
Per the Mercator Advisory Group’s 2012-2015 U.S. Prepaid Cards Market Forecasts, the gift cards segment of the U.S.
open- loop market is expected to go from $14.9B in 2011 to $24.4B in 2015.
Page 27 of 46
Appendix B: Blackhawk Network Memorandum
February 5, 2015
Via email: [email protected] and [email protected]
Ms. Susan M. Cosper, Task Force Chairman
Ms. Jennifer Hillenmeyer, EITF Coordinator
Financial Accounting Standards Board
401 Merritt 7, P.O. Box
5116
Norwalk, CT 068565116 (203) 956-5225
FAX (203) 849-9714
[email protected]
Delivery via email
Re: EITF Issue No. 15-B, “Recognition of Breakage for No-Cash Prepaid Cards”
Dear Ms. Cosper and Ms. Hillenmeyer:
We appreciate the Board’s recent addition to the Financial Accounting Standards Board’s (“FASB”)
Emerging Issues Task Force’s (“EITF”) agenda of Issue No. 15-B, “Recognition of Breakage for NoCash Prepaid Cards” (“Issue No. 15-B”) as we believe there are practice issues and diversity in practice
associated with this issue and that further standard-setting is needed for this area. The purpose of this
letter is to provide the EITF with additional facts and circumstances that relate to our industry and that we
believe should be considered as part of the EITF’s deliberations. We request that the EITF carefully
examine and consider the facts and circumstances and the related analysis that we’ve included herein as
the scope of Issue No. 15-B further develops into an issues summary and the issues are then deliberated.
We are available to answer any questions that the EITF may have.
Introduction
Blackhawk Network Holdings, Inc., together with its subsidiaries (collectively, “BHN”, “we”, “our” or
the “Company”), is a leading prepaid payment network utilizing proprietary technology to offer a broad
range of prepaid gift, telecom and debit cards, in physical and digital forms, as well as related prepaid
Page 28 of 46
products and payment services in the United States and 21 other countries. Our payment network
supports our key constituents: consumers who purchase or receive the products and services we offer,
Content Providers who offer branded gift cards and other prepaid products that are redeemable for goods
and services, Distribution Partners who sell those products, and business partners that distribute our
products as incentives and rewards.
Our product offerings include gift cards, prepaid telecom products and prepaid financial services
products, including general purpose reloadable (“GPR”) cards and our reload network (collectively,
prepaid products). We offer prepaid cards from leading consumer brands (known as closed loop) as
well as branded gift and incentive cards from leading payment network card associations such as
American Express, Discover, MasterCard and Visa (known as open loop) and prepaid telecom products
offered by prepaid wireless telecom carriers. We also distribute GPR cards, including Green Dot and
NetSpend branded cards, as well as PayPower, our proprietary bank-issued GPR card. We operate a
proprietary reload network named Reloadit, which allows consumers to reload funds onto their
previously purchased GPR cards.
We distribute products across multiple high-traffic channels such as grocery, convenience, specialty
and online retailers (referred to as “Distribution Partners”) in the Americas, Europe, Africa, Australia
and Asia.
We are a publicly traded company, whose equity securities are registered with the SEC. The
accounting matters addressed in this letter are of growing significance to our Company and we expect
them to become material to our consolidated financial statements in the future. We also believe the
issues are of growing significance to companies in our industry.
Product Background
We provide services for the promotion, distribution, activation and settlement of prepaid stored-value
gift cards on behalf of third-party “Content Providers” (described below). The gift cards are distributed
to end consumers through various retail points of sale, for example grocery stores, that we refer to as
“Distribution Partners” (described below). End consumers purchase the prepaid cards to provide as a gift
to others or for personal use. The value, or amount “loaded” onto the prepaid card is referred to as the
“load value” and is the amount that can later be redeemed to pay for in-store purchases.
We have established our competitive position in the industry primarily through our ability to attract and
retain distribution rights for leading third party Content Provider card programs and our ability to
provide an extensive distribution network of grocery, convenience and other retail store outlets. Content
Providers include national retailers and restaurants such as Applebee’s, Best Buy, The Home Depot®,
iTunes Music Store, Sears, Starbucks, Target and various telecom service providers which have entered
into contractual arrangements with us for the promotion, distribution, activation and other services
related to the issuance of their prepaid cards.
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The Content Provider is directly responsible for the redemption of its prepaid cards and is the primary
obligor for the monetary liability to the end consumer. These prepaid cards are referred to as third-party
or “closed loop” cards because they can only be redeemed by the issuing Content Provider at its own
retail locations, affiliate locations or online web site. In exchange for our services, the Content
Providers contractually agree to pay a distribution commission that is negotiated between us and the
Content Provider and is equal to a percentage of the load value of each prepaid card sold. This
commission is funded through a net-settlement exchange of cash from the Distribution Partner who
collects the initial load value of the purchased card from the end consumer. The Distribution Partner
remits the load value of the purchased card net of its share of the distribution commission to us and we
remit the remaining load value net of our share of the commission to the Content Provider.
We also have separate and distinct contractual arrangements with a network of retail grocery,
convenience and other retail store outlets, our Distribution Partners, for the sale of these prepaid cards
in their stores. Distribution Partners are companies such as Giant Eagle, Kroger, Safeway, Publix and
Albertsons. In exchange, we share with the Distribution Partner a portion of the distribution
commission funded by the Content Provider. The Distribution Partner earns commissions for
displaying and supporting activation of Content Provider prepaid cards, collecting funds from the end
consumers for the load value amount loaded onto the card, activating the card through a point of sale
terminal and transmitting the funds to us. We then transmit the relevant portion of the funds to the
Content Provider, retaining the commission that we earn. We have contractually agreed to provide
certain Distribution Partners with allotments of advertising dollars, marketing materials, and display
items which assist the Distribution Partners in selling all card types offered by us.
The Content Providers have contractual approval rights over our array of Distribution Partners through
which their prepaid cards will be sold. We directly negotiate with the Content Provider the gross
amount of the commission that will apply to sales of their respective prepaid cards. However, we and
each Distribution Partner separately negotiate the allocation or “split” of these gross commissions
between both parties, as reflected in the respective Distribution Partner contracts. Although the Content
Provider is involved in the approval (or any later cancellation) of the Distribution Partners that can offer
and sell their prepaid cards, the Distribution Partner also has contractual approval rights over the
selection of prepaid cards that it will accept and offer for sale in its stores. Also, if a prepaid card sale
transaction is affected through fraudulent payment instruments or means, the Distribution Partner bears
the risk of loss.
In a typical closed loop card transaction, a consumer will buy a Content Provider’s prepaid card (e.g. a
$100 load value Home Depot gift card) at a Distribution Partner’s store for the full load value of the card.
The card will be immediately activated at the Distribution Partner’s point of sale via our electronic
network and related software and the electronic network of the Content Provider. The Distribution Partner
also collects the $100 load value of the prepaid card, retains its share of the commission (e.g., $5), and
then remits the net amount (e.g., $95) to us. We, in turn, deduct our share of the distribution commission
(e.g., $3), and then remit the net amount (e.g., $92) to the Content Provider. The consumer redeems the
full $100 load value of the card in exchange for product at the Content Provider’s business establishment.
For closed loop prepaid cards, the distribution commission is thus always funded by the Content Provider.
Page 30 of 46
For a retail open loop card or GPR card transaction, the consumer purchases a network-branded (e.g.
Visa, MasterCard or American Express) gift or GPR card from a Distribution Partner who collects the
load value and a purchase fee. Unlike closed loop cards, the commission shared between the
Distribution Partner and us is not a percentage of the load value, but instead is a percentage of the
purchase fee. Thus, after collecting the funds from the purchaser, the Distribution Partner then forwards
to us the load value and purchase fee, less the Distribution Partner’s share of the purchase fee. We then
remit the load value of each card to the card issuing bank partner and a portion of the purchase fee,
retaining the balance of the purchase fee. The cardholder can access the value they loaded on an open
loop or GPR card by transacting for goods or services with any merchant that accepts the networkbranded card. For such transactions, the card issuing bank transfers funds through the network
association to the merchant’s bank following the consumer’s use of the card to purchase goods or
services.
As described above, for most prepaid products sold in our retail distribution network, we remit the
funds loaded onto the prepaid product (less our commissions on closed loop or less part of the purchase
fee on open loop cards) to the Content Provider or issuing bank based on contractual settlement terms
after activation which occurs at the Distribution Partner’s point-of-sale.
Unlike the products described above, we also offer certain other prepaid products, as described below,
that require the consumer to take additional actions before redeeming the funds stored on the product.
For such products, we retain the funds loaded onto the cards until either the required consumer action is
taken or the card is redeemed.
•
In the first case, certain prepaid phone cards (the “Telecom Transactions”) that are sold by
Distribution Partners require the consumer to complete a process to link, or associate, the card
with the consumer’s existing telecom account using our proprietary network. We remit the
funds from such Telecom Transactions to the telecom Content Providers when the consumer
completes the process to activate the card. Because of this incremental step to activate the
prepaid card, a certain amount of Telecom Transactions are never activated by the end
consumer and as a result we are not required to remit any funds to the related telecom Content
Provider. After purchase from the Distribution Partner, these cards are nonrefundable for the
consumer. After the consumer associates the card with their account and we remit the funds to
the Content Provider, the Content Provider may elect to provide refunds and other adjustments
to the consumer. However, until the consumer associates the card with their existing telecom
account, no refunds or other adjustments are available to the consumer.
•
In the second case, we also sell prepaid cards through our own websites or with the involvement
of an online or “digital” Distribution Partner (e.g. Amazon). For these transactions, we collect
the prepaid card’s load value directly from the consumer or from the electronic Distribution
Partner and remit the card’s load value less our commission directly to the Content Provider
upon activation of the card by the end consumer (the “Activation Transactions”). For security
reasons, we ship a portion of these cards to the consumer unactivated. Because some of these
Page 31 of 46
cards are shipped by us to the consumer unactivated, a certain amount of Activation
Transactions are never completed by the end consumer and we are not required to remit those
collected funds to the Content Provider. Upon shipment to the consumer, these cards are
nonrefundable for the consumer. After the consumer activates the card and we remit the funds
to the Content Provider, the Content Provider may elect to provide refunds and other
adjustments to the consumer. However, until the consumer activates the card, no refunds or
other adjustments are available to the consumer.
•
Lastly, in the third case, we enter into transactions (the “Performance Transactions”) with
Content Providers whereby consumers purchase cards from a Distribution Partner who collects
the load value and remits the load value less their commission to us. We agree to remit the load
value less our commission directly to the Content Provider at the time and to the extent that the
consumer redeems the card at the Content Provider’s place of business (that is, unlike the
aforementioned transactions, we do not remit the proceeds to the Content Provider upon
activation). Because the consumer may never fully redeem the card from the Content Provider,
a certain amount of Performance Transactions are never redeemed by the end consumer and we
have the contractual right to retain such unredeemed amounts. After purchase from the
Distribution Partner, these cards are nonrefundable for the consumer. The Content Provider
may elect to provide refunds and other adjustments to the consumer. At the time of such
election, we would remit these funds to the Content Provider who would then provide the
refunds or other adjustments to the consumer.
Prior to the consumer taking the additional actions described above for Telecom, Activation, and
Performance Transactions, we have no obligation to remit the funds we have received to any party. We
are not required (whether by contract or by law) to retain the cash received from the Telecom,
Activation, or Performance Transactions in a third-party escrow account. Rather, the cash proceeds are
commingled with our other general corporate cash accounts and may be used for general corporate
purposes. Further, because the prepaid cards related to these transactions do not expire, there are
situations where all or a portion of the original card value may never redeemed by the end consumer
(either because the card is never activated/associated or because the consumer does not demand full
performance from the Content Provider). Accordingly, similar to retailers that issue gift cards and gift
certificates with no expiration date that may go unredeemed in whole or in part, the Telecom,
Activation, and Performance Transactions result in the Company incurring a liability (the “Prepaid Card
Liabilities”) that may remain unclaimed or unredeemed for an indefinite period of time.
We recognize that if the funds from the transactions are escheatable under state laws for
unclaimed property, we would continue to hold the liability until we escheat the funds pursuant to
such laws. However, for purposes of the analysis in this paper, we are only considering instances
where the unclaimed property is not subject to escheatment.
Page 32 of 46
Background Accounting Considerations
We view the Content Provider as our customer and we report total gift card commissions from
Content Providers as revenue and the amount shared with the Distribution Partner as an expense or
cost of services. With respect to Content Providers (our standard closed loop business), we are not the
primary obligor related to the prepaid cards and do not take on credit or inventory risk related to the
load value of the cards. Therefore, we have concluded that revenues recognized for our involvement
in providing our services to the Content Provider should be limited to the total amount of
commissions paid by the Content Provider rather than the gross load value ($100 in the above
example) of the card purchased by the end consumer. We believe this treatment is consistent with the
guidance in Accounting Standards Codification (“ASC”) Subtopic 605-45, Revenue Recognition –
Principal Agent Considerations.
Since Telecom and Activation Transactions require the consumer to take the appropriate action prior to
using the funds loaded onto the cards, we have experienced a very short timeframe, generally a few
days between the purchase of the card and the consumer’s full redemption of the funds. For
Performance Transactions, we experience redemption transactions for a significant period of time after
the purchase of the card. However, for each of these Transactions, we believe we can objectively
demonstrate a point at which redemption by the consumer is remote1. We have historically experienced
minimal activity after such time period.
Since we market, distribute and sell each of these Transactions almost exclusively in the United States
and have over two years of history for each of these transactions, we consider our history to have
consistency and to be based on a large pool of homogenous transactions for each of these transaction
types. Additionally, given the nature of Telecom and Activation Transactions which require the
association or activation by the consumer prior to use of the funds loaded onto the cards, we believe
that this trend will continue for any similar products that we introduce.
In the event of our bankruptcy, we believe consumers who purchased Telecom, Activation and
Performance Transactions and have not yet associated the cards or redeemed for products would
be considered general creditors.
Accounting Discussion
Application of a Breakage Model Prior to Adoption of ASC 606, Revenue from Contracts with Customers
(“ASC 606”)
1
In our fact pattern and throughout this section of the letter “redemption” refers to activation/association of the prepaid card
for the Telecom and Activation transactions or for the Performance Transactions when the consumer does not demand full
performance from the content provider.
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For Telecom, Activation, and Performance Transactions that are not subject to escheatment we believe
that based on our unique facts and circumstances that it would be acceptable to analogize to the
accounting principles that govern the recognition of prepaid gift card breakage and therefore to
recognize into our income statement the Prepaid Card Liabilities once redemption is deemed to be
remote. In reaching this conclusion, we noted that as discussed in the “Background Accounting
Considerations” section of this letter, we have determined that we can reasonably and objectively
determine when redemption is deemed to be remote2.
At the 2005 National Conference on Current SEC and PCAOB Developments, Ms. Pamela R.
Schlosser, a Professional Accounting Fellow of the Office of the Chief Accountant, expressed the
SEC’s views on recognition of prepaid gift card breakage as follows (emphasis added):
Let me start off with the topic of "breakage." In an arrangement in which a customer makes a
payment in advance of vendor performance, the vendor would recognize deferred revenue at the
time the payment is received. In some cases, the customer will, for various reasons, not end up
demanding full performance. This is often referred to as "breakage." The question is when can the
vendor derecognize the deferred revenue liability in the absence of performance?
In the past, the staff has stated that a vendor should apply the derecognition guidance found in
Statement 140 [footnote omitted] to these arrangements, but derecognition may also be
acceptable in certain circumstances if the vendor can demonstrate that it is remote that the
customer will require performance.
In a recent registrant matter, the staff addressed breakage for gift cards sold to consumers. Based on
historical redemption rates, the registrant determined that some percentage of gift cards sold, for
example 10%, would go unredeemed. As a result, each time a gift card was sold, 10% of the value
of the gift card was recorded as a credit to the income statement with the remaining 90% value being
recorded as deferred revenue. In this case, the staff objected to the immediate recognition of
breakage as we did not believe the delivery criterion had been met. That is, the company believed it
was still required to perform under the gift card arrangement, just perhaps not for the full amount of
value of the gift card sold. Since there has as of yet been no performance, we did not believe income
recognition, in any amount, was appropriate, immediately upon the sale of the gift card.
Given that immediate recognition of breakage was not considered appropriate in this fact pattern,
we were asked what approaches may be acceptable. Consistent with the staff's previous views,
recognizing gift card breakage as the vendor is legally released from its obligation, for example at
redemption or expiration, or at the point redemption becomes remote may both be acceptable
methods.
2
“Remote” is defined in ASC Topic 450, Contingencies as “the chance of the future event or events occurring is slight”.
Page 34 of 46
Another approach may be to recognize breakage for unused gift card amounts in proportion to actual
gift card redemption. Gift cards sold over a certain period of time would be considered on a
homogenous pool basis. The estimated values of gift cards expected to go unused would then be
recognized over the period of performance, that is, as the remaining gift card values are redeemed.
To utilize this approach, a vendor would be required to not only reasonably and objectively
determine the amount of gift card breakage, but also reasonably and objectively determine the
estimated time period of actual gift card redemption.
Using my previous example of a 10% breakage rate, assume an entity issues $1,000 of gift cards in
a certain period and has objective evidence to support that those gift cards would be redeemed on a
prorata basis over the next twenty-four months. The estimated breakage amount of $100 would,
therefore, be recognized ratably over the twenty-four month redemption period.
One final comment. My discussion relates to breakage in a broad sense. However, if you believe
your particular circumstances warrant an approach that is unique to the general models covered
today, I would encourage you to talk with members from our office.
Ms. Schlosser addressed a fact pattern where a vendor has an obligation to a customer that can be
redeemed by a customer upon demand. Notwithstanding the fact that a customer could technically
present a gift card to the vendor for redemption of goods or services sold by the vendor, the vendor has
been able to determine based on historical experience that not all gift cards are redeemed by the gift card
holder. While historically the SEC Staff had only supported application of the principles of Statement
140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, Ms.
Schlosser indicated that other methods of recognition of gift card breakage would be acceptable to the
SEC Staff premised on an entity being able to reasonably and objectively determine when redemption is
deemed to be remote.
In considering whether the application of the guidance to account for breakage as illustrated by the
prepaid card example is appropriate in our facts and circumstances, we considered Ms. Schlosser’s
comment that “my discussion relates to breakage in a broad sense.” When considering our facts and
circumstances, we recognize that Prepaid Card Liabilities differ from prepaid gift cards in that our
ultimate transfer of funds to a Content Provider does not result in the future delivery of a good or
service, whereas the Content Provider does deliver a good or service when it redeems a gift card (e.g. in
the event of a product sale, the redemption of a gift card will result in the recognition of revenue and
cost of goods sold, in addition to the relief of inventory and relief of the gift card obligation). However,
we do not believe that the payment of funds as opposed to delivery of a good or service precludes us
from applying the principles prescribed for accounting for breakage for gift cards given the fundamental
similarity between a Prepaid Card Liability and a gift card deferred revenue liability; both are liabilities
under GAAP. Fundamentally, both the sale of a gift card by a third party vendor or the sale of a prepaid
card through our website or through our Distributors creates a liability that is redeemable based on the
future actions of the holder of the prepaid card. Additionally the period of time during which a customer
can redeem the prepaid card is unlimited.
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In both the unredeemed gift card described in Ms. Schlosser’s speech and in our fact pattern, a
substantive legal liability is established by acceptance of funds from a customer. The nature of the
obligation in the gift card transaction described by Ms. Schlosser is also a legal liability in that the
vendor must stand ready to provide goods or services upon redemption of the gift card by the ultimate
gift card holder. When we receive funds from the sale of a prepaid card through either our website or
through a Distributor, we believe that our initial liability (i.e., the Prepaid Card Liabilities) should be
viewed similarly to a vendor obligation. We acknowledge that we are not the primary obligor in these
transactions and we do not have an obligation to provide goods or services to the consumer; however, we
believe that until the consumer demands redemption, we have an on-going obligation to ensure that the
consumer’s card is activated (via our propriety network) and that the funds are appropriately remitted to
the Content Provider. That is, the consumer depends on us, as well as the Content Provider, to ensure
that the prepaid card is valid and can be exchanged for goods and services. Accordingly, until the
consumer activates the card or demands performance from the Content Provider (in the case of the
Performance Transactions), we do not have an obligation to the Content Provider. Rather, prior to that
event occurring, our obligation is similar to the obligation incurred by the Content Provider (i.e., the
obligation to stand ready to perform based on the consumer’s decision). Similarly, because we are acting
on behalf of a Content Provider as an agent to facilitate the use of a prepaid card, we believe that the
nature of the obligation we incur should be subject to a similar accounting framework that would be
applied to a Content Provider’s obligation. That is, both obligations are contingent on action by the
consumer that purchased the card. For these reasons, we believe that it would be acceptable to apply
breakage to our obligation.
Further, the fact that the SEC Staff acknowledged that the acceptability of both the liability
extinguishment framework and the breakage model described in Ms. Schlosser’s speech seems to
suggest that the SEC Staff does not believe that the liability extinguishment model is the only model that
applies to situations where a substantive legal liability exists. In our view, the application of a gift card
breakage model as described by the SEC Staff in the 2005 speech is acceptable by analogy to our
Prepaid Card Liabilities upon the determination that redemption of the prepaid card is remote.
Accordingly, we do not believe that we are required to apply the principles in paragraph 40-1 of ASC
Subtopic 405-20 Liabilities – Extinguishment of Liabilities (“ASC 405-20”) which states:
A debtor shall derecognize a liability if and only if it has been extinguished. A liability has
been extinguished if either of the following conditions is met:
a. The debtor pays the creditor and is relieved of its obligation for the liability. Paying
the creditor includes the following:
1.
2.
3.
4.
Delivery of cash
Delivery of other financial assets
Delivery of goods or services
Reacquisition by the debtor of its outstanding debt securities whether the securities
are cancelled or held as so-called treasury bonds.
Page 36 of 46
b.
The debtor is legally released from being the primary obligor under the liability,
either judicially or by the creditor. For purposes of applying this Subtopic, a sale and
related assumption effectively accomplish a legal release if nonrecourse debt (such as
certain mortgage loans) is assumed by a third party in conjunction with the sale of an
asset that serves as sole collateral for that debt
The guidance at ASC 405-20-40-1 addresses a situation where debt has been issued to a borrower. In
the typical fact pattern most likely contemplated by this guidance, debt repayments are based on a
scheduled maturity date and are intended to provide a mechanism for financing for the borrower. In
contrast, in our fact pattern, there is no stated “maturity date” for the Prepaid Card Liabilities as the card
holder’s right to utilize the prepaid card never lapses with the passage of time. Rather, similar to an
obligation incurred by a retailer that issues prepaid gift cards, our obligation to remit funds to the
Content Provider is contingent on whether the consumer chooses to exercise their right to utilize the
prepaid card. Moreover, we have a large volume of relatively homogenous prepaid card transactions,
rather than an individually significant liability that would more be within the scope of ASC 405-20. For
these reasons we believe that the Prepaid Card Liabilities have similar characteristics and more closely
resemble a vendor’s obligation for an unredeemed gift card (where a customer has a right to make a
claim of goods or services and never exercises that right) as opposed to an outstanding debt transaction
as contemplated in ASC 405-20. As noted in the “Background Accounting Considerations” section to
this letter, we are subject to limited legal or regulatory requirements that would require us to remit
payment received from a customer for rights that remain unexercised to a government entity (i.e.,
unclaimed property or “escheat” laws”). To the extent that we are subject to escheat laws, we do not
believe that it would be acceptable to analogize to the breakage model and to recognize estimated
breakage on the Prepaid Card Liabilities because any unredeemed consideration received from a
customer must be eventually remitted to a governmental entity.
Additionally, the application of an ASC 405-20 framework to the Prepaid Card Liabilities where the
right has no expiration date results in an impractical outcome which is evident in our fact pattern. If we
were to continue to apply an ASC 405-20 framework, the Prepaid Card Liabilities would continue to
grow over time with no apparent mechanism to relieve the obligation as discussed in the following
paragraph. This view is consistent with a PwC interpretative view at section .728 Breakage in Sales
Incentives in their Revenues and Receivables manual dated July 24, 2009, in which they describe their
interpretive views regarding the acceptability of three models for breakage. In the “liability model”
below, PwC acknowledges that this model may be impractical for situations where unclaimed rights do
not expire and states (emphasis added):
Liability Model - ASC 405-20-40-1 states that a liability may be de-recognized when the entity
has been "legally released from being the primary obligor" under the arrangement. By analogy, it
is generally acceptable to de-recognize an unredeemed incentive obligation and record income
when the right expires. This approach may be most appropriate for vendors who cannot reliably
estimate breakage. However, for rights which do not expire, this model may be impractical.”
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Lastly, in developing our point of view we considered the alternative that some may view our obligation
under the arrangements described above as meeting the GAAP definition of a financial liability. We
believe the Content Providers may be able to argue that their obligation to stand ready to perform does
not meet the definition of a financial liability because the customer only has the right to demand
fulfillment of goods or services when the customer undertakes a redemption transaction or activity with
the Content Provider and because the customer has no rights to demand cash or another financial
instrument. However, in our case, the funds that we hold and must remit to the Content Provider upon
customer action as described above do represent an obligation for us to deliver cash to the Content
Provider even though there is no obligation for either us or the Content Provider to ultimately deliver
anything other than goods or services to the customer or card holder. Accordingly, we acknowledge that
in that manner our obligation can be viewed as a financial liability. In our view, if one takes the position
that the obligation is a financial liability, we would argue that the financial liability should not be subject
to the scope of ASC 405-20 because we believe the nature of this obligation was not contemplated to be
subject to that standard when the standard was written. We also believe that for the following reasons the
obligations should be excluded from being in the scope of financial liability derecognition under ASC
405-20:
1. Our obligation to the cardholder that is settled by our payment to the third party Content
Provider who provides the cardholder with fulfillment of goods or services is more akin to an
insurance or warranty contract obligation than to a financial liability. ASC 825-10-15-4 (d) and
(e) describe the terms of such insurance or warranty contracts that under that related guidance
are not deemed to be a financial instrument. We and the customer/cardholder are parties to the
cardholder agreement. Under those related card terms the cardholder only has a right to redeem
the card value for goods and services at certain designated Content Providers. Our obligation to
the cardholder is for the card to be honored as payment for goods and services when it is
presented as payment at the Content Provider. As we are not the Content Provider who will
fulfill that obligation to deliver the related goods or services, we have an obligation to transfer
the collected funds to the Content Provider in accordance with the terms described above in this
letter.
2. Although this is redundant with some of the discussion earlier in the letter, we note that the
guidance at ASC 405-20-40-1 addresses a situation where debt has been issued to a borrower. In
the typical fact pattern most likely contemplated by this guidance, debt repayments are based on
a scheduled maturity date and are intended to provide a mechanism for financing for the
borrower. In contrast, in our fact pattern, there is no stated “maturity date” for the Prepaid Card
Liabilities as the card holder’s right to utilize the prepaid card never lapses with the passage of
time. Rather, similar to an obligation incurred by a retailer that issues prepaid gift cards, our
obligation to remit funds to the Content Provider is contingent on whether the consumer chooses
to exercise their right to utilize the prepaid card. Moreover, we have a large volume of relatively
homogenous prepaid card transactions, rather than an individually significant liability that would
more be within the scope of ASC 405-20.
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3. In the type of Prepaid Card Liability transactions described above that we are involved in that
are affected by Issue No. 15-B, we view that we have an agency relationship with the related
Content Providers and that we are in exactly the same economic position that the Content
Provider would be in if the Content Provider issued the prepaid cards directly to the cardholder
rather than using us or our distribution channels to issue the cards. Although the SEC speech
referenced above was written for Content Providers who act as the card issuer in prepaid gift
card transactions, we believe applying the same approach to the breakage that we have the right
to retain for generally the same types of prepaid cards is a reasonable approach. In particular, for
obligations with no expiration, we believe that an accounting approach that results in an
indefinite deferral of breakage recognition by application of the ASC 405-20 guidance is not
reasonable nor does it reflect the economics of the transactions.
Accordingly, based on the reasons described above, we believe that it is acceptable to analogize to the
accounting principles that govern the recognition of prepaid card breakage and therefore to recognize
into our income statement the Prepaid Card Liabilities once redemption is deemed to be remote.
Alternative View Prior to Adopting ASC 606
Under this view the Prepaid Card Liabilities are financial liabilities that are subject to the scope of ASC
405-20. Because the Prepaid Card Liabilities do not represent a right to a consumer which can only be
exchanged, or redeemed, for goods and service we cannot apply the breakage model that was accepted by
the SEC Staff. Instead, we would view the Prepaid Card Liabilities as a financial liability subject to the
derecognition provisions of ASC 405-20. ASC 405-2-40 provides that a liability shall be derecognized if
and only if it has been extinguished. The guidance states two conditions that must be met in order to
derecognize a liability: (1) the debtor pays the creditor and is relieved of the obligation for the liability
and (2) the debtor is legally released from being the primary obligor under the liability, either judicially or
by the creditor. Accordingly, we would be unable to derecognize the Prepaid Card Liabilities until we
remitted cash to the Content Provider, and in the absence of that, such liabilities would remain on our
balance sheet (and grow) in perpetuity.
Accounting Analysis under ASC 606
In reaching the above conclusions, we also noted that we are required to adopt ASC 606 as of January 1,
2017. ASC 606-10-15-2 states that “an entity shall apply the guidance in this Topic to all contracts with
customers, except the following (in part):
[…]
c. Financial instruments and other contractual rights or obligations within the scope of
the following Topics:
5. Topic 405, Liabilities
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In consideration of the ASC 606 scope exception for contracts that are subject to the scope of ASC 405,
we made the same considerations regarding the question of whether our Prepaid Card Liabilities are
financial liabilities as are described in our accounting analysis above. Accordingly, as stated in the
earlier sections of this letter, we believe that an argument can be made that either 1) the Prepaid Card
Liabilities are not a financial liability or 2) if they are a financial liability, we believe the arguments
presented above would support an exception to applying the ASC 405-20 liability derecognition
guidance and in lieu of that guidance we would support the application by analogy of the breakage
guidance for contracts that is addressed in ASC 606-10.
Paragraph 55-48 of ASC 606-10 includes authoritative guidance on breakage for contract liabilities
and states:
If an entity expects to be entitled to a breakage amount in a contract liability, the entity should
recognize the expected breakage amount as revenue in proportion to the pattern of rights
exercised by the customer. If an entity does not expect to be entitled to a breakage amount, the
entity should recognize the expected breakage amount as revenue when the likelihood of the
customer exercising its remaining rights becomes remote. To determine whether an entity expects
to be entitled to a breakage amount, the entity should consider the guidance in paragraphs 606-1032-11 through 32-13 on constraining estimates of variable consideration.
Under ASC 606 breakage represents a form of variable consideration that is subject to the constraint on
variable consideration. That is, if it is probable that a significant revenue reversal would occur for any
estimated breakage amounts, an entity should not recognize those amounts until the potential for
reversal has passed. If breakage is not subject to the variable constraint, breakage is recognized as
revenue in proportion to the pattern of rights exercised by the customer or, if an entity is unable to
estimate the breakage amount, when the likelihood of the customer exercising its remaining right
becomes remote. This is a change from current GAAP that permits the use of three acceptable
accounting models to recognize breakage including (i) recognition as redemption occurs, (ii)
recognition when the right expires, and (iii) recognition when it becomes remote that the holder of the
right will demand performance.
Financial Statement Presentation
We believe that the relief of Prepaid Card Liabilities can be recognized into the income statement as
other revenue given that the Prepaid Card Liabilities directly relates to the Company’s major operations.
Paragraph 78 of Statement of Financial Accounting Concepts No. 6 Elements of Financial Statements
(“CON 6”) defines revenues as follows (emphasis added):
Revenues are inflows or other enhancements of assets of an entity or settlements of its liabilities
(or a combination of both) from delivering or producing goods, rendering services, or other
activities that constitute the entity’s ongoing major or central operations.
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We also considered the description of gains in paragraph 82, and the comparison of revenues and gains
in paragraph 87 of CON 6 which states (emphasis added):
Gains are increases in equity (net assets) from peripheral or incidental transactions of an entity
and from all other transactions and other events and circumstances affecting the entity except
those that result from revenues or investments by owners.
Revenues and gains are similar, and expenses and losses are similar, but some differences are
significant in conveying information about an enterprise's performance. Revenues and
expenses result from an entity's ongoing major or central operations and activities—that is,
from activities such as producing or delivering goods, rendering services, lending, insuring,
investing, and financing. In contrast, gains and losses result from incidental or peripheral
transactions of an enterprise with other entities and from other events and circumstances
affecting it. Some gains and losses may be considered "operating" gains and losses and may be
closely related to revenues and expenses. Revenues and expenses are commonly displayed as
gross inflows or outflows of net assets, while gains and losses are usually displayed as net
inflows or outflows.
The recognition of Prepaid Card Liabilities into the income statement arises as a consequence of our
providing a service (i.e. remitting money to the Content Providers and providing activation via our
proprietary network) that is part of our ongoing major/central operations and the failure of the customer
to activate and/or use the prepaid cards, as opposed to peripheral or incidental transactions of the
Company. Accordingly, we believe that classification of the credit within revenue is acceptable.
To summarize, we believe a breakage model is acceptable to apply by analogy to our specific facts
and circumstances. Relevant facts that support this conclusion are as follows:
•
The liabilities arise in the normal course of our business activities, and are not borrowing
or financing activities.
•
The liabilities are comprised of a large pool of homogenous transactions (high volume,
low magnitude).
•
We have sufficient internal historical data to be able to reasonably estimate the portion of
such liabilities for which ultimate payment is remote.
Because the liability has no maturity date and is not subject to escheat, an ASC 450-20 model would
present an obligation in our financial statements that would grow in perpetuity, when in fact historical
experience informs us that we will be able to use the funds in our operations because it is remote that
we will transfer those funds to someone else.
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Fair Value Model Alternative
If the EITF does not conclude on Issue No. 15-B that it would be acceptable to analogize to the
breakage model for the Prepaid Card Liabilities, we have also considered and we believe that it would
be acceptable to elect the fair value option pursuant to ASC 825, Financial Instruments (formerly
FASB 159) (“ASC 825”) for the Prepaid Card Liabilities as they arise in the future (the fair value
model would not be available for previously incurred liabilities). We suggest that the FASB Staff
consider adding the application of the fair value option to Prepaid Card Liabilities as part of the scope
of Issue No. 15-B to assist entities in considering another reasonable accounting alternative to account
for such obligations.
Paragraph 15-4 of ASC 825-10 outlines the items for which an entity may elect the fair value option
and states in part:
All entities may elect the fair value option for any of the following eligible items:
a. A recognized financial asset and financial liability, except any listed in the
following paragraph
[…]
The ASC Master Glossary defines a financial liability as follows:
A contract that imposes on one entity an obligation to do either of the following:
a. Deliver cash or another financial instrument to a second entity
b. Exchange other financial instruments on potentially unfavorable terms with the second
entity.
Under this view, the Prepaid Card Liabilities would be viewed as a financial liability because it imposes
an obligation on us to deliver cash to the Content Providers and therefore the Prepaid Card Liabilities
would be within the scope of ASC 825. Additionally, ASC 825 allows entities to elect the fair value
option for any financial liabilities, except for those listened in paragraph 15-5 of ASC 825-10, which
states:
No entity may elect the fair value option for any of the following financial assets and
financial liabilities:
a. An investment in a subsidiary that the entity is required to consolidate.
b. An interest in a variable interest entity (VIE) that the entity is required to consolidate.
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c. Employers' and plans' obligations (or assets representing net overfunded positions)
for pension benefits, other postretirement benefits (including health care and life
insurance benefits), postemployment benefits, employee stock option and stock
purchase plans, and other forms of deferred compensation arrangements, as defined
in Topics 420; 710; 712; 715; 718; and 960.
d. Financial assets and financial liabilities recognized under leases as defined in Subtopic 84010. (This exception does not apply to a guarantee of a third-party lease obligation or
a contingent obligation arising from a cancelled lease.)
e. Deposit liabilities, withdrawable on demand, of banks, savings and loan associations,
credit unions, and other similar depository institutions.
f.
Financial instruments that are, in whole or in part, classified by the issuer as a component of
shareholders' equity (including temporary equity) (for example, a convertible debt
instrument with the scope of the Cash Conversion Subsections of Subtopic 470-20 or a
convertible debt security with a noncontingent beneficial conversion feature).
We do not believe that any of these exceptions apply and therefore we could elect the fair value option
for the Prepaid Card Liabilities. In reaching this conclusion, we noted that the Prepaid Card Liabilities
may be viewed as having similar characteristics as deposit liabilities; however, we believe that our
Prepaid Card Liabilities are substantially different from a deposit liability because we do not provide the
Content Provider with the right to withdrawal of deposited funds at some point in the future. Rather,
funds are remitted to the Content Provider only upon the consumer exercising his or her redemption
right. Further, we are not subject to the same laws and regulations as depository institutions such as
banks.
Moreover, we believe that the scope exclusion is based on the legal form of the financial liability rather
than the substance of the financial liability. That is, we do not believe that the FASB intended to create a
principle based scope exception that would be applicable to all financial liabilities with similar
characteristics as bank held deposit liabilities. Instead, the deposit liabilities were excluded from the
scope of FASB 159 because of concerns expressed during the FASB’s deliberations on FASB 159 by the
Federal Deposit Insurance Corporation (the “FDIC”) and the Federal Reserve regarding demand deposit
accounts. Specifically, during the FASB’s deliberations on July 6, 2006, the FDIC expressed concerned
about the nonfinancial components of demand deposit accounts and the Federal Reserve expressed
concern regarding the reliability surrounding fair value measurements of demand deposit accounts.
Because of these concerns, during the FASB’s deliberations on August 31, 2006, the Board agreed by a
vote of 6 to 1 with the staff recommendations to consider demand deposit liabilities in the second
phase3 of the fair value option project and to define demand deposit liabilities as financial liabilities of
3
The FASB decided not to pursue the second phase of the fair value option project.
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financial institutions with demand features in a manner consistent with the IASB. Accordingly, based
on our review of the board minutes from the FASBs deliberations, demand deposit liabilities were
discussed in the context of financial institutions such as banks, savings and loan associations, credit
unions, and other similar depository institutions, and were specifically excluded from the scope of
FASB 159 because of concerns expressed during the deliberations by the regulators of those
institutions. Therefore because we are not a depository institution and we are not subject to the same
laws and/or regulations as a depository institutions, we do not believe that the scope exception in
paragraph 15-5(e) of ASC 825 is applicable to our facts and circumstances.
This conclusion is consistent with E&Y’s publication, Summary of FASB Statement No. 159, The Fair
Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB
Statement No. 115, which states (emphasis added):
The Board decided to exclude deposit liabilities, withdrawable on demand, from the scope of
Statement 159 because those liabilities are often significantly affected by nonfinancial components.
However, the scope exclusion was limited specifically to demand deposit liabilities of banks,
thrifts, or other similar depository institutions. Based on our interpretation of Board deliberations
and our discussions with the FASB Staff, it is our understanding that insurance and investment
contracts, as defined under Statement 97, that allow the holder to withdrawal or demand amounts
specified in the contract (e.g., cash surrender value) would be eligible for the fair value option.
We thank you for your time in reviewing our facts and circumstances and related analysis. We welcome
the opportunity to answer any question s you may have. In that event, please reach out to Joan Lockie,
our Corporate Controller and Chief Accounting Officer ((925)226-9337;
[email protected]).
Sincerely yours,
Jerry Ulrich
Chief Financial and Administrative Officer
Blackhawk Network Holdings,
Inc. (925) 226-9278
Jerry.Uirich@BHNetwor k.com
6220 Stoneridge Mall Rd.
Pleasanton, CA 94588
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Appendix C: Excerpts from December 5, 2005 SEC Speech
Statement by SEC Staff: Remarks Before the 2005 AICPA National Conference on Current
SEC and PCAOB Developments by Pamela R. Schlosser, Professional Accounting Fellow,
Office of the Chief Accountant, U.S. Securities and Exchange Commission
Washington, D.C., December 5, 2005
As a matter of policy, the Securities and Exchange Commission disclaims responsibility for
any private publication or statement of any SEC employee or Commissioner. This speech
expresses the author's views and does not necessarily reflect those of the Commission, the
Commissioners, or other members of the staff.
Breakage
Let me start off with the topic of "breakage". In an arrangement in which a customer makes a
payment in advance of vendor performance, the vendor would recognize deferred revenue at the
time the payment is received. In some cases, the customer will, for various reasons, not end up
demanding full performance. This is often referred to as "breakage." The question is when can
the vendor derecognize the deferred revenue liability in the absence of performance?
In the past, the staff has stated that a vendor should apply the derecognition guidance found in
Statement 140 to these arrangements, but derecognition may also be acceptable in certain
circumstances if the vendor can demonstrate that it is remote that the customer will require
performance.
In a recent registrant matter, the staff addressed breakage for gift cards sold to consumers. Based
on historical redemption rates, the registrant determined that some percentage of gift cards sold,
for example 10%, would go unredeemed. As a result, each time a gift card was sold, 10% of the
value of the gift card was recorded as a credit to the income statement with the remaining 90%
value being recorded as deferred revenue.
In this case, the staff objected to the immediate recognition of breakage as we did not believe the
delivery criterion had been met. That is, the company believed it was still required to perform
under the gift card arrangement, just perhaps not for the full amount of value of the gift card
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sold. Since there has as of yet been no performance, we did not believe income recognition, in
any amount, was appropriate, immediately upon the sale of the gift card.
Given that immediate recognition of breakage was not considered appropriate in this fact pattern,
we were asked what approaches may be acceptable. Consistent with the staff's previous views,
recognizing gift card breakage as the vendor is legally released from its obligation, for example
at redemption or expiration, or at the point redemption becomes remote may both be acceptable
methods.
Another approach may be to recognize breakage for unused gift card amounts in proportion to
actual gift card redemption. Gift cards sold over a certain period of time would be considered on
a homogenous pool basis. The estimated values of gift cards expected to go unused would then
be recognized over the period of performance, that is, as the remaining gift card values are
redeemed. To utilize this approach, a vendor would be required to not only reasonably and
objectively determine the amount of gift card breakage, but also reasonably and objectively
determine the estimated time period of actual gift card redemption.
Using my previous example of a 10% breakage rate, assume an entity issues $1,000 of gift cards
in a certain period and has objective evidence to support that those gift cards would be redeemed
on a pro-rata basis over the next twenty-four months. The estimated breakage amount of $100
would, therefore, be recognized ratably over the twenty-four month redemption period.
One final comment. My discussion relates to breakage in a broad sense. However, if you
believe your particular circumstances warrant an approach that is unique to the general models
covered today, I would encourage you to talk with members from our office.
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