Breakage Rules Finalized for Prepaid Cards For financial liabilities, Topic 405 would continue to apply; for nonfinancial liabilities, the less restrictive breakage guidance in Topic 606 would apply. Scope The original proposal’s scope was narrowly drawn, as FASB expressly didn’t want to include similar breakage issues related to airline points and rewards programs. Feedback favored broadening the scope, and the final standard reflects a more principle-based approach with specific scope exclusions. The ASU defines prepaid stored-value products in physical and digital forms with stored monetary values redeemable for goods, services or cash at the product issuer or third-party locations. This would include, among other items, prepaid gift cards, e-cards, phone calling cards and traveler’s checks.

Scope exclusions include products covered by escheatment laws, debit cards and products that can be redeemed only for cash. Examples of items redeemable only for cash and excluded from the standard include nonrecourse debt instruments, bearer bonds and trade payables. The ASU wouldn’t apply to customer loyalty programs or transactions within the scope of other guidance such as revenue recognition. Breakage Recognition The ASU addresses the current and potential diversity in practice related to breakage on prepaid products by clarifying that liabilities related to certain prepaid stored-value products are financial liabilities.

In addition, the update creates a scope exception within ASC 405-20 to require that breakage be accounted for in a manner consistent with the guidance in the revenue recognition standard: If an entity expects to be entitled to a breakage amount for a liability resulting from the sale of a prepaid stored-value product, the entity shall derecognize the amount related to the expected breakage in proportion to the pattern of rights expected to be exercised by the card holder only to the extent that it is probable that a significant reversal of the recognized breakage amount will not subsequently occur. If an entity does not expect to be entitled to a breakage amount for prepaid stored-value products, the entity shall derecognize the amount related to breakage when the likelihood of the customer exercising its remaining rights becomes remote. Entities would be required to disclose the methodology used and significant judgments made in calculating breakage. The prepaid liability would be subject to the disclosure requirements for financial liabilities in Topic 825, Financial Instruments, but entities are excluded from the fair value disclosure requirements. Transition & Effective Date The ASU can be applied on a modified retrospective or full retrospective basis.

For a modified retrospective transition, a cumulative catch-up adjustment would be made to retained earnings as of the beginning of the annual period of adoption. An entity applying a full retrospective transition also could take advantage of any practical expedients provided in the revenue standard. The ASU has the same effective dates as the revenue recognition standard. For public business entities, adoption is required for annual and interim reports beginning after December 15, 2017.

All other entities would apply the guidance to annual reporting periods beginning after December 15, 2018, and interim periods beginning after December 15, 2019. Early adoption is permitted, including adoption prior to the adoption of the revenue standard. For additional information, contact your BKD advisor. Contributor Anne Coughlan Director 317.383.4000 acoughlan@bkd.com 2 .