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Customers sometimes do not exercise all of their rights or options in an arrangement. These unexercised rights are often referred to as “breakage” or forfeiture. Breakage applies to not only sales incentive programs, but also to any situations where a reporting entity receives prepayments for future goods or services. The revenue standard requires breakage to be recognized as follows.

ASC 606-10-55-48

If an entity expects to be entitled to a breakage amount in a contract liability, the entity should 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 entity should recognize the expected breakage amount as revenue when the likelihood of the customer exercising its remaining rights becomes remote. To determine whether an entity expects to be entitled to a breakage amount, the entity should consider the guidance in paragraphs 606-10-32-11 through 32-13 on constraining estimates of variable consideration.

Receipt of a nonrefundable prepayment creates an obligation for a reporting entity to stand ready to perform under the arrangement by transferring goods or services when requested by the customer. A common example is the purchase of gift cards. Gift cards are often not redeemed for products or services in their full amount. Another common example is “take-or-pay” arrangements, in which a customer pays a specified amount and is entitled to a specified number of units of goods or services. The customer pays the same amount whether they take all of the items to which they are entitled or leave some rights unexercised.
Both prepayments and customer options create obligations for a reporting entity to transfer goods or services in the future. All or a portion of the transaction price should be allocated to those performance obligations and recognized as revenue when those obligations are satisfied. A reporting entity should recognize revenue when control of the goods or services is transferred to the customer in satisfaction of the performance obligations.
A reporting entity should recognize estimated breakage as revenue in proportion to the pattern of exercised rights. For example, a reporting entity would recognize 50 percent of the total estimated breakage upon redemption of 50 percent of customer rights. Management that cannot conclude whether there will be any breakage, or the extent of such breakage, should consider the constraint on variable consideration, including the need to record any minimum amounts of breakage. Refer to RR 4.3 for further discussion of variable consideration. Breakage that is not expected to occur should be recognized as revenue when the likelihood of the customer exercising its remaining rights becomes remote.
The assessment of estimated breakage should be updated at each reporting period. Changes in estimated breakage should be accounted for by adjusting the contract liability to reflect the remaining rights expected to be redeemed. Estimating breakage and updating these estimates could be complex, particularly for customer loyalty programs, which may extend for significant periods of time, or never expire. The accounting for these programs will often require a significant amount of data tracking in order to update estimates each reporting period. Management should not adjust the standalone selling price originally allocated to a customer option when updating its estimate of breakage (for example, when updating the number of loyalty points it expects customers to redeem).
Legal requirements for unexercised rights vary among jurisdictions. Certain jurisdictions require reporting entities to remit payments received from customers for rights that remain unexercised to a governmental reporting entity (for example, unclaimed property or “escheat” laws). A reporting entity should not recognize estimated breakage as revenue related to consideration received from a customer that must be remitted to a governmental reporting entity if the customer never demands performance. Management must understand its legal rights and obligations when determining the accounting model to follow.
Example RR 7-12, Example RR 7-13, and Example RR 7-14 illustrate the accounting for breakage related to customer prepayments (gift cards) and customer options (loyalty programs).
EXAMPLE RR 7-12

Breakage – sale of gift cards
Restaurant Inc sells 1,000 gift cards in 20X1, each with a face value of $50, that are redeemable at any of its locations. Any unused gift card balances are not subject to escheatment to a government reporting entity. Restaurant Inc expects breakage of 10%, or $5,000 of the face value of the cards, based on history with similar gift cards.
Customers redeem $22,500 worth of gift cards during 20X2.
How should Restaurant Inc account for the gift cards redeemed during 20X2?
Analysis
Restaurant Inc should recognize revenue of $25,000 in 20X2, calculated as the value of the gift cards redeemed ($22,500) plus breakage in proportion to the total rights exercised ($2,500). This amount would be calculated as the total expected breakage ($5,000) multiplied by the proportion of gift cards redeemed ($22,500 redeemed / $45,000 expected to be redeemed).
EXAMPLE RR 7-13

Breakage – customer loyalty points
Hotel Inc has a loyalty program that rewards its customers with two loyalty points for every $25 spent on lodging. Each point is redeemable for a $1 discount on a future stay at the hotel in addition to any other discount being offered. Customers collectively spend $1 million on lodging in 20X1 and earn 80,000 points redeemable for future purchases. The standalone selling price of the purchased lodging is $1 million, as the price charged to customers is the same whether the customer participates in the program or not. Hotel Inc expects 75% of the points granted will be redeemed. Hotel Inc therefore estimates a standalone selling price of $0.75 per point ($60,000 in total), which takes into account the likelihood of redemption.
Hotel Inc concludes that the points provide a material right to customers that they would not receive without entering into a contract; therefore, the points provided to the customers are separate performance obligations.
Hotel Inc allocates the transaction price of $1 million to the lodging and points based on their relative standalone selling prices as follows:
Lodging ($1,000,000 x ($1,000,000 / $1,060,000))
$
943,396
Points ($1,000,000 x ($60,000 / $1,060,000))
$
56,604
Total transaction price
$
1,000,000
View table
Customers redeem 40,000 points during 20X2 and Hotel Inc continues to expect total redemptions of 60,000 points.
How should Hotel Inc account for the points redeemed during 20X2?
Analysis
Hotel Inc should recognize revenue of $37,736, calculated as the total transaction price allocated to the points ($56,604) multiplied by the ratio of points redeemed during 20X2 (40,000) to total points expected to be redeemed (60,000). Hotel Inc would maintain a contract liability of $18,868 for the consideration allocated to the remaining points expected to be redeemed.
EXAMPLE RR 7-14

Breakage – customer loyalty points, reassessment of breakage estimate
Hotel Inc has a loyalty program that rewards its customers with two loyalty points for every $25 spent on lodging. Each point is redeemable for a $1 discount on a future stay at the hotel in addition to any other discount being offered. Customers collectively spend $1 million on lodging in 20X1 and earn 80,000 points redeemable for future purchases. The standalone selling price of the purchased lodging is $1 million, as the price charged to customers is the same whether the customer participates in the program or not. Hotel Inc expects 75% of the points granted will be redeemed. Hotel Inc therefore estimates a standalone selling price of $0.75 per point ($60,000 in total), which takes into account the likelihood of redemption.
Hotel Inc concludes that the points provide a material right to customers that they would not receive without entering into a contract; therefore, the points provided to the customers are separate performance obligations.
Hotel Inc allocates the transaction price of $1 million to the lodging and points based on their relative standalone selling prices as follows:
Lodging ($1,000,000 × ($1,000,000 / $1,060,000))
$943,396
Points ($1,000,000 × ($60,000 / $1,060,000))
$56,604
Total transaction price
$1,000,000

In 20X2, customers redeem 40,000 points and Hotel Inc recognizes $37,736 related to the points. In 20X3, customers redeem an additional 20,000 points and Hotel Inc increases its estimate of total points to be redeemed from 60,000 to 70,000.
How should Hotel Inc account for the points redeemed during 20X3?
Analysis
Hotel Inc should recognize revenue of $10,782 calculated as follows:
Total points redeemedcumulatively (40,000 + 20,000)
60,000
Divided by
/
Total points expected to be redeemed
70,000
Multiplied by
X
Amount originally allocated to the points
$
56,604
Cumulative revenue to be recognized
$
48,518
Less: Revenue previously recognized
$
37,736
Revenue recognizedin 20X3
$
10,782
View table
The remaining contract liability of $8,086 (1/7 of the amount originally allocated to the points) will be recognized as revenue as the outstanding points are redeemed.

Question RR 7-1 addresses the accounting for a customer option that does not expire.
Question RR 7-1
When should a reporting entity recognize revenue allocated to a customer option that does not expire?
PwC response
Revenue allocated to a customer option is recognized when the future goods or services underlying the option are transferred, or when the option expires. In cases when a customer option does not expire, we believe revenue allocated to the option (which reflects an initial estimate of breakage) should be recognized when the likelihood of the customer exercising the option becomes remote.
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