Peeling away financial reporting issues one layer at a time

Proposed ASU EITF 2015-15B: Lipstick for a Pig of a Revenue Presentation Standard

The FASB has issued Proposed Accounting Standards Update EITF 2015-15B, Recognition of Breakage for Certain Prepaid Stored-Value Cards.  If finalized, it would change the way that retail merchants who sell gift cards for redemption at other stores account for “breakage” — the curious term used for gift card values (and similar items) that ultimately will not be redeemed.

This post is not primarily about the Proposed Update.  Rather, I am going to focus on the accounting rules it supplements.  My goal is to convince you that the way in which merchants currently account for gift cards is a pig.  That makes the Proposed Update essentially lipstick, the specious quality of which I will reluctantly address in closing.

The following simple fact pattern is a sufficient basis for our luau:*

  • Gary the grocer sells a $50 gift card for its face value, redeemable at any one of the hundreds of retail outlets operated by Rick’s Sporting Goods.
  • Gary remits $45 to Rick and keeps the remainder.
  • The gift card does not have an expiration date, and it is nonrefundable.  However, Gary is obligated to refund the full $50 in the (extremely unlikely) event that Rick does not honor the card.

For simplicity but without loss of generality, let’s stipulate that Gary’s cost of the plastic card and the expected present value of Gary’s contingent liability are trivial; and therefore, may be ignored.  Also, the remittance of the $45 to Rick occurs instantaneously with the receipt of the $50 by Gary.  Setting aside GAAP, and using only common sense, a reasonably thoughtful student or practitioner should make the following journal entry (I apologize for the formatting, I’m no HTML whiz):

Dr. Cash                                     $5
Cr. Gift card revenue                       $5

The intuition for this entry is as straightforward as accounting can be.  Gary is merely Rick’s agent and has earned a $5 commission.  Moreover, unless something really strange happens, Gary has no further obligations to its customer or to Rick.

But, as is becoming more and more the case, GAAP diverges from common sense for this simple fact pattern.  The following GAAP journal entries hinge on the fact, however inconsequential it may be, that Gary is the “primary obligor” to the purchaser of the gift card.  Accordingly, it would require the following entry at the point of sale by Gary the grocer:

Dr. Cash                                      5
Dr. Deferred cost of sales         45
Cr. Deferred revenue                    50

When the gift card is used (redeemed), Gary would make the following entry:

Dr. Cost of sales                       45
Dr. Deferred Revenue              50
Cr. Deferred cost of sales              45
Cr. Revenue                                   50


Kindly ponder the following questions, the answers to which are so self-evident, I won’t insult you, or waste my time (I’m on vacation in Hawaii), by putting them in writing:

Is the common sense accounting treatment or the GAAP treatment a more “faithful representation” of Gary the grocer’s role in the sale of the sporting goods?

Do the deferred revenues and deferred costs recognized by GAAP meet the respective conceptual definitions of “liability” and “asset”?

Which accounting treatment provides more “relevant” information to readers of Gary’s financial statements?  To put it another way, which accounting treatment recognizes earnings in a more timely manner?

In aggregate (both to Gary and the economy), the costs to make and audit the GAAP accounting entries must be significant.  Can the incurrence of these costs be justified by any benefits?

What can be said about the GAAP criteria for presentation of revenues on a gross or net basis if they result in merchant grocers like Gary presenting their income statement as if they had sold the sporting goods themselves?

Conclusion: the GAAP accounting treatment for gift card sales is not just a pig, it’s a big fat pig.

There is a much better line of reasoning to obtain the appropriate presentation of revenues.The $45 Gary pays to Rick does not meet any reasonable definition of an expense.  And since the gross margin of $5 is known, the only possible measure of revenue is $5.

Finally, the Lipschtick

The Proposed ASU addresses only whether, in recognizing breakage, the deferred revenue meets the definition of a “financial liability” or a “non-financial liability.”  That’s a whole other level of mumbo jumbo, which I don’t feel very motivated to get into, since all we would be discussing is the lipstick on the pig.  Nonetheless, I am compelled to simply that the FASB is choosing to overlook the fact that the deferred revenue doesn’t even meet its own conceptual definition of a liability.

* * * * * *

Comments on the Proposed Update are due by June 29, 2014.  If you are into hopeless causes, I urge you to write a comment letter.  Otherwise, feel free to snort like pig and get on with the rest of your life.



*I drafted the bulk of this post while en route to Hawaii.




  1. Reply Martin May 21, 2015

    If Rick’s probability to go bankrupt widens, the FASB accounting enables one to at least guess the contingent liability.

    If the gift card were 100 and gift card revenue still 5, the revenue would be 100? This makes no sense and revenues would be useless.

    Shouldn’t a marketplace like ebay/amazon or credit card companies account just for net revenues e.g. their profit on other’s sales, too?

  2. Reply Millard Souers May 21, 2015


    I was previously unaware of the accounting treatment for such sales – now I wish that I didn’t know. To your point, I’d love for our Norwalk friends to explain exactly how Gary has incurred $45 of expense and earned $50 of revenue. Ridiculous.

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