Memo No. Issue Summary No. 1. Issue Date March 5, Meeting Date EITF March 19, EITF Liaison

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1 Memo No. Issue Summary No. 1 Memo Issue Date March 5, 2015 Meeting Date EITF March 19, 2015 Contact(s) Mark Barton Project Lead/Lead Author (203) Jennifer Hillenmeyer EITF Coordinator (203) Mark Bielstein EITF Liaison Project Project Stage Dates previously discussed by EITF Previously distributed Memo Numbers EITF Issue No. 15-B, "Recognition of Breakage for Prepaid Stored-Value Cards" Initial Deliberations None 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. Page 1 of 46

2 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 , 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 , 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 Page 2 of 46

3 (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 Page 3 of 46

4 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 Page 4 of 46

5 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 , 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. iii. iv. 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. 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. Page 5 of 46

6 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 [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. 17. In a 2005 speech (see Appendix C), the SEC staff indicated that a vendor should apply the derecognition guidance in Subtopic 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 As a result, those prepaid stored-value card liabilities are derecognized sooner than would otherwise be permitted under Subtopic Other Card Issuers and Prepaid Network Providers have interpreted the derecognition criterion in Subtopic regarding legal release from an obligation to allow for derecognition if the probability of redemption is remote. 19. The guidance in Update is effective in fiscal years beginning after December 15, 2016, for public business entities or December 15, 2017, for nonpublic entities. 20. Paragraphs through in Update 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 Page 6 of 46

7 in Update 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 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 The scope of Update 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 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 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 Page 7 of 46

8 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 Page 8 of 46

9 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 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 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 Under this alterative, amendments to Subtopic 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 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 Page 9 of 46

10 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 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 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 (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 Page 10 of 46

11 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 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 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 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 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 exists in paragraph That Page 11 of 46

12 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 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 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 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 Alternative C Page 12 of 46

13 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 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 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. Page 13 of 46

14 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 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 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 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 Page 14 of 46

15 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 (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 through regarding use of the fair value option. 49. Similar to Alternative D, Alternatives A and C have existing GAAP disclosure requirements pursuant to Section and Topic , 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 be provided. Paragraph 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 Page 15 of 46

16 requires disclosure of an entity s methodology for calculating breakage for transactions within the scope of Topic 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

17 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 , Accounting Changes and Error Corrections Overall, requires the following disclosures in the period in which a change in accounting principle is made: 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 through 45-7). Page 17 of 46

18 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 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 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 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 through Although certain disclosure requirements would not be applicable Page 18 of 46

19 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 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 The staff considered the level of effort that may be required to provide the disclosures required by paragraph 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 not be required because that information likely would not be useful to users of financial statements. Page 19 of 46

20 Appendix A: Card Compliant Memorandum AR-2012 Comment Letter No Nichols Rd., Suite 300 Kansas City, MO (913) Main Phone (866) 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 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

21 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 liability 2 ; (3) they typically do not have back-end fees which reduce the liability over time 3 ; (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

22 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 redemption 5. 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

23 The SEC presented a speech 6 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 , Extinguishment of Liabilities. ASC 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 liability 7 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