Gift Card Breakage

Gift card breakage is the portion of the value loaded onto gift cards that customers never redeem. When a shopper buys a $50 card and spends only $46, the remaining $4 is breakage. Retailers, restaurants and other sellers of prepaid gift cards estimate it from their own redemption history, and accounting standards decide when that unspent value can be counted as revenue rather than left sitting on the balance sheet as an amount still owed.

Breakage is an accounting and business concept rather than a fee. It differs from a dormancy fee, which actively deducts money from an idle card, and from unclaimed property, which is unspent value that a state requires the seller to hand over. Until breakage is recognized, the unspent balance is part of the seller's deferred revenue (contract liability).

Think of a coffee shop that sells a hundred gift cards before the holidays. Most people use their cards in full, some leave a few coins on them, and a handful lose the card in a drawer and forget it exists. The shop knows from experience that, out of every hundred dollars loaded, roughly a few dollars will never come back to the counter.

That forgotten money is breakage. The shop cannot simply treat it as earned on the day the cards are sold, because any customer could still walk in and spend the full balance. Instead, the shop counts the forgotten share gradually, as the cards that do get used come back, so its books reflect what it really expects to happen. In places where the law requires unused balances to be handed to the state, the shop never gets to keep that money at all.

Under the US revenue standard, ASC 606, and its international twin, IFRS 15, the cash received for a gift card is first recorded as a contract liability. Revenue is recognized when the card is redeemed for goods or services. For the part a seller expects never to be redeemed, the standards (ASC 606-10-55-46 to 55-49 and IFRS 15 paragraphs B44 to B47) set two paths:

• The proportional method. If the seller expects to be entitled to a breakage amount, it recognizes that amount as revenue in proportion to the pattern of rights the customers actually exercise.
• The remote method. If the seller cannot reliably estimate breakage, it waits and recognizes the unspent value only when the likelihood of the customer redeeming it becomes remote.

Estimates are constrained so that revenue is not recognized if a significant reversal is likely later. Any amount the seller must remit to a government under unclaimed property laws is excluded and stays a liability. Banks and other issuers of open-loop cards that are not selling their own goods follow a separate rule for prepaid stored-value products, adopted through ASU 2016-04, which applies the same proportional idea when the liability is derecognized.

Under the proportional method, breakage recognized in a period is the expected breakage scaled by the share of expected redemptions that occurred in that period:

• $V$ is the total value loaded onto the cards in the pool.
• $b$ is the expected breakage rate, the share of value never redeemed, written as a decimal.
• $R_{t}$ is the value actually redeemed during period $t$.
• $V \times (1 - b)$ is the total value the seller expects customers to redeem.

Suppose a retailer sells cards worth $1,000,000 and history shows 8% is never used. Expected breakage is $80,000 and expected redemptions are $920,000. If customers redeem $460,000 in the first year, half of expected redemptions, the retailer recognizes $80{,}000 \times 0.5 = 40{,}000$ dollars of breakage revenue alongside the redemption revenue.

Breakage can be material for large card sellers, which is why public companies discuss their breakage estimates in financial statement notes and why auditors test the historical data behind them. It also shapes the economics of a card program. A closed-loop card sold by a single merchant tends to carry more breakage than an open-loop card usable anywhere a network brand is accepted, because a store-specific card is easier to forget. Sellers also benefit from float: cash arrives at purchase, often months before the goods are delivered. When cards are sold through third-party racks, distributors and program managers negotiate how fees and breakage are shared.

In the United States, consumer protection limits how much unspent value a seller can capture actively. The federal Regulation E gift card rules require that funds last at least five years and restrict inactivity fees, so most breakage today comes from customers simply not spending, not from balances being taken. Several states go further; California, for example, generally bans expiration dates and requires small remaining balances to be paid out in cash on request. State escheatment laws in some places claim unused balances outright.

Consumer advocates argue that breakage represents value paid for and never received, and that marketing which encourages people to buy cards for others relies partly on that loss. Sellers respond that card programs carry real costs for printing, processing and fraud control, including losses from gift card scams. Outside the US, rules differ by country; Ontario in Canada, for instance, has prohibited expiry dates on most gift cards since 2007.

• IFRS Foundation: IFRS 15 Revenue from Contracts with Customers
• Financial Accounting Standards Board
• Faisal Khan: Gift Card Economics Explained