IFRS 15 Customers unexercised rights and breakage
INTRO An entity may receive a non-refundable prepayment from a customer that gives the customer the right to receive goods or services in the future. Common examples include gift cards, vouchers and non-refundable tickets. Typically, some customers do not exercise their right – this is referred to as ‘breakage’.
An entity recognises a prepayment received from a customer as a contract liability and recognises revenue when the promised goods or services are transferred in the future. However, a portion of the contract liability recognised may relate to contractual rights that the entity does not expect to be exercised – i.e. a breakage amount. [IFRS 15.B44–B45]
The timing of revenue recognition related to breakage depends on whether the entity expects to be entitled to a breakage amount – i.e. if it is highly probable that recognising breakage will not result in a significant reversal of the cumulative revenue recognised. [IFRS 15.B46]
An entity considers the variable consideration guidance to determine whether – and to what extent – the constraint applies (see estimate the amount of variable consideration in the link). It determines the amount of breakage to which it is entitled as the amount for which it is considered highly probable that a significant reversal will not occur in the future. This amount is recognised as revenue in proportion to the pattern of rights exercised by the customer (proportional method) when the entity expects to be entitled to breakage. Otherwise, the entity recognises breakage when the likelihood of the customer exercising its remaining rights becomes remote (remote method). [IFRS 15.B46]
If an entity is required to remit to a government entity an amount that is attributable to customers’ unexercised rights – e.g. under applicable unclaimed property or escheatment laws – then it recognises a financial liability until the rights are extinguished, rather than revenue. [IFRS 15.B47]
Worked example – Sale of a prepaid phone card: Entity expects to be entitled to breakage
Retailer R sells a prepaid phone card to Customer C for 100. On the basis of historical experience with similar prepaid phone cards, R estimates that 10% of the prepaid phone card balance will remain unredeemed and that the unredeemed amount will not be subject to escheatment. Because R can reasonably estimate the amount of breakage expected and it is highly probable that including the amount in the transaction price will not result in a significant revenue reversal, R recognises the breakage revenue of 10 in proportion to the pattern of exercise of C’s rights.
Specifically, when it sells the prepaid phone card R recognises a contract liability of 100, because C prepaid for a non-refundable card. No breakage revenue is recognised at this time.
If C redeems an amount of 45 in 30 days, then half of the expected redemption has occurred (45 / (100 – 10) = 50%). Therefore, half of the breakage – i.e. (10 × 50% = 5) – is also recognised.
On this initial prepaid phone card redemption, R recognises revenue of 50 – i.e. revenue from transferring goods or services of 45 plus breakage of 5.
Worked example – Sale of a prepaid phone card: Entity does not expect to be entitled to breakage
Retailer C implements a new prepaid phone card programme. C sells Customer D a prepaid phone card for 50. C does not have an obligation to remit the value of unredeemed cards to any government authority or other entity – i.e. the unredeemed amount will not be subject to escheatment. The prepaid phone card expires two years from the date of issue.
Because this is a new programme, C has very little historical information.
Specifically, C does not have sufficient entity-specific information, nor does it have knowledge of the experience of other service providers. Therefore, C concludes that it does not have the ability to estimate the amount of breakage that, if it were included in the transaction price, would be highly probable of not resulting in a significant revenue reversal.
C therefore recognises the breakage when the likelihood of D exercising its remaining rights becomes remote. This may occur at expiry of the prepaid phone card or earlier if there is evidence to indicate that the probability has become remote that D will redeem any remaining amount on the prepaid phone card.
Worked example – Airline expects ticket breakage and can estimate it reliably
Airline B sells 100 non-refundable, flexible tickets for a flight from London to Melbourne. The price of each ticket is 1,000. If a customer does not fly on the scheduled flight date, then it can reschedule the flight within 12 months at no additional charge. B’s historical data indicates that:
Based on this historical data, B estimates that for these 100 tickets 95 customers will fly on the scheduled date, one will reschedule the flight and four will not take their flight – i.e. the estimated breakage is 4,000 (4% × (100 × 1,000)).
B can reasonably estimate the amount of breakage expected and it is highly probable that including the amount in the transaction price will not result in a significant revenue reversal. Therefore, B recognises the estimated ticket breakage of 4,000 in proportion to the pattern of exercise of the rights by the customers as follows.
Worked example – Accounting for the sale of a gift card
Entity A sells a CU500 non-refundable gift card that can be redeemed at any of its retail locations. Any unused balance is not subject to laws that require from the entity to remit the payment to another party. When the gift card is sold, Entity A recognises a contract liability of CU500 (i.e., the full amount that was prepaid by the customer). No breakage is recognised as revenue upon sale of the gift card.
Scenario A – Entity expects to be entitled to a breakage amount
Based on historical redemption rates, Entity A expects 90% of the gift card (or CU450) to be redeemed. That is, Entity A expects breakage of 10% (or CU50). Upon its first use, the customer redeems CU225 of the gift card. That is, 50% of the expected redemption has occurred (i.e., CU225 redemption / CU450 total expected redemption).
Upon this redemption, Entity A recognises revenue and reduces the contract liability by CU250. This is equal to CU225 for the transfer of goods or services purchased by the customer, as well as breakage of CU25 (50% redemption x CU50 breakage estimate) that is recognised in proportion to the exercise of the customer’s rights. Similar accounting would occur for future redemptions.
Scenario B – Entity does not expect to be entitled to a breakage amount
Based on historical redemption experiences that customers fully redeem similar gift cards (or possibly the lack of historical experience due to a new gift card programme that means Entity A is unable to estimate the redemption rates), Entity A does not expect to be entitled to a breakage amount. Upon its first use of the gift card, the customer redeems CU225.
Entity A recognises revenue and reduces the contract liability by the same amount as the redemption (or CU225). That is, no additional amounts are recognised for breakage. Similar accounting would occur for future redemptions.
If no further redemptions occur, Entity A recognises the remaining gift card balance (or CU275) as revenue (and reduces the contract liability by the same amount) when the likelihood of the customer exercising its remaining rights becomes remote.
Constraint applies even though consideration amount is known
If an entity does not have a basis for estimating breakage – i.e. the estimate is fully constrained – then it recognises the breakage as revenue only when the likelihood becomes remote that the customer will exercise its rights.
When the entity concludes that it is able to determine the amount of breakage to which it expects to be entitled, it estimates the breakage. To determine the breakage amount, the entity assesses whether it is highly probable that including revenue for the unexercised rights in the transaction price will not result in a significant revenue reversal.
Applying the guidance on the constraint in this context is unique – the amount of consideration is known and has already been received, but there is uncertainty over whether and when the customer will redeem the amount paid by requiring the entity to transfer goods or services in the future. Conversely, in other situations to which the constraint applies – e.g. variable consideration – the total amount of consideration is unknown.
Breakage does not constitute variable consideration
Although an entity considers the variable consideration guidance to determine the amount of breakage, breakage itself is not a form of variable consideration because it does not affect the transaction price. It is a recognition rather than a measurement concept in the standard. For example, the transaction price for a sale of a 50 gift card is fixed at 50; the possibility of breakage does not make the transaction price variable. However, the expected breakage affects the timing of revenue recognition. [IFRS 15.B46]
Prepaid stored-value products may be financial liabilities
A prepaid stored-value product is a card with a monetary value stored on the card itself – e.g. a gift card. The guidance under the standard on the recognition of breakage excludes prepaid stored-value products that meet the definition of financial liabilities. [IAS 32.11, IFRS 9]
These are instead accounted for using the applicable guidance under the financial instruments standard.
If the prepayment element (e.g., the sale of a gift card, loyalty points) is part of a multiple-element arrangement, an entity needs to allocate the transaction price between the identified performance obligations. As a result, the deferred revenue associated with this element would be less than the ‘prepaid’ amount received for the unsatisfied performance obligations.
Portfolio of data can be used for estimating expected breakage
An entity can use a portfolio of similar transactions as a source of data to estimate expected breakage for an individual contract if the entity has a sufficiently large number of similar transactions or other history. Doing so is not using the portfolio approach (see portfolio approach in the link).
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