Businesses are increasingly seeking clearer accounting methods for unredeemed liabilities, a practice that enables the recognition of "breakage revenue." This financial mechanism, highlighted by industry observers like Patrick McKenzie, allows companies to convert unutilized customer prepayments into recognized income, significantly impacting their financial statements. The evolution of global accounting standards has provided more definitive pathways for this process.
Breakage revenue refers to the value of prepaid services, gift cards, or loyalty points that customers purchase but never fully redeem. This unutilized value, which initially sits on a company's balance sheet as a liability, can eventually be recognized as revenue once the likelihood of redemption becomes remote. Common examples include unused balances on gift cards or unexercised credits for future services.
The Financial Accounting Standards Board (FASB) introduced clearer guidance on breakage revenue with ASC 606, "Revenue from Contracts with Customers," implemented for public companies in 2018 and non-public companies in 2019. This standard allows companies to estimate and recognize breakage when it is probable that the customer will not exercise their rights and the amount can be reliably estimated. Companies typically leverage historical data and statistical models to forecast these non-redemption rates.
For businesses, the recognition of breakage revenue represents a substantial financial gain, often translating into pure profit that directly boosts the bottom line. It provides a more accurate reflection of a company's financial health and can enhance investor confidence. As Patrick McKenzie stated in a recent tweet, "> Many businesses will eventually want their unredeemed liabilities to expire. It’s a much more definitive way of doing the accounting, and also allows them to recognize so-called breakage revenue."
However, the recognition of breakage revenue is subject to stringent regulatory oversight, including state escheatment laws in various jurisdictions. These laws may require companies to remit certain unredeemed funds to the state after a specified dormancy period, preventing businesses from indefinitely retaining all unutilized balances. This adds a layer of complexity, requiring careful compliance alongside the pursuit of financial clarity.