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I'm interested in the economics and law of when this is counted as income. The article says that in the general case, the company only counts the card as incom

by SamBam 7y ago

I'm interested in the economics and law of when this is counted as income. The article says that in the general case, the company only counts the card as income once it is redeemed. Until then it is counted as a liability. This makes a little sense, since they still owe you goods and services, but (1) aren't the goods/services they are offering worth less to them than the value on the card, and (2) aren't they generating interest off that? Next, it says that under a 2009 law, the companies can start counting it as income sooner (6-24 months), and the accompanying article suggests that this is good for the companies' bottom line. But wouldn't it really be the opposite? Before they counted it as income, surely they had all the benefits of the money and it's not even being taxed as income yet? Wouldn't they want to hold off on counting it as income as long as possible?

teej 7y ago
Cash that’s usable to invest in the business is different, and worth more, than cash that’s locked up due to liabilities. Interest rates are low, so earning < 2% on the float isn’t the best way to deploy capital.
638d127673 7y ago
From the point of view of financial reporting (i.e. accounting income that you see on the financial statements), holding the liability indefinitely is not a good thing as it negatively affects the leverage ratios and implies a future obligation. The new accounting requirement that allows companies to estimate the so called 'breakage' (i.e. anticipated unused balanced) and recognize that as income over time rather than keep it as an indefinitely liability. Legally, there's also the concept of escheatment, which depends on the country/state that tells a company what to do with the unused balance. In some cases, the government may claim this balance. To your question about paying income tax on income, most tax codes would require the companies to pay tax on the amounts when they receive the cash rather than when they satisfy the obligations. So it's likely that they've already paid tax on this amount.
AmericanChopper 7y ago
All outstanding gift (and loyalty) card balance is counted as liability because they represent good/services (and in some cases money) that the business currently owes to customers. I worked in the gift/loyalty industry, and the article gets most things right, but the specifics depend a lot on the jurisdiction and the nature of the program. In markets that don’t regulate otherwise, a typical program will count unused balance as breakage 12 months after issue. The typical balance on such a card would amount to unspent change from a purchase. In regulated markets, they’ll just follow whatever the regulation is, which sometimes requires charging an “account maintenance” fee, instead of just removing the balance. What happens to the money before it is either redeemed or taken as breakage depends again on the specifics of the program and the jurisdiction. Sometimes it will be required to be held in a trust, or in some other form of escrow. Often this will preclude the possibility of earning interest. Sometimes the gift card provider and the merchant are different parties. An example of this would be a mall that sells a gift card that you can use to redeem at any store in the mall, or a visa gift card. In this case, the program operator does not simply exchange the balance for stock, they have to settle cash with the merchant. Loyalty liability is different again, because that’s liability that you never received a direct payment for in the first place. The one huge mistake that this article makes is that it claims the breakage income is 100% profit. This ignores the costs of operating the program, which is usually millions of dollars. Small retailers would receive trivial breakage income, and would not necessarily even cover program costs with it. Medium size retailers may or may not generate a profit on breakage, large retailers likely do, but their program expenses are also enormous. The real value to the business is customer acquisition.

by SamBam 7y ago

teej 7y ago

Cash that’s usable to invest in the business is different, and worth more, than cash that’s locked up due to liabilities. Interest rates are low, so earning < 2% on the float isn’t the best way to deploy capital.

638d127673 7y ago

From the point of view of financial reporting (i.e. accounting income that you see on the financial statements), holding the liability indefinitely is not a good thing as it negatively affects the leverage ratios and implies a future obligation. The new accounting requirement that allows companies to estimate the so called 'breakage' (i.e. anticipated unused balanced) and recognize that as income over time rather than keep it as an indefinitely liability. Legally, there's also the concept of escheatment, which depends on the country/state that tells a company what to do with the unused balance. In some cases, the government may claim this balance. To your question about paying income tax on income, most tax codes would require the companies to pay tax on the amounts when they receive the cash rather than when they satisfy the obligations. So it's likely that they've already paid tax on this amount.

AmericanChopper 7y ago

All outstanding gift (and loyalty) card balance is counted as liability because they represent good/services (and in some cases money) that the business currently owes to customers. I worked in the gift/loyalty industry, and the article gets most things right, but the specifics depend a lot on the jurisdiction and the nature of the program. In markets that don’t regulate otherwise, a typical program will count unused balance as breakage 12 months after issue. The typical balance on such a card would amount to unspent change from a purchase. In regulated markets, they’ll just follow whatever the regulation is, which sometimes requires charging an “account maintenance” fee, instead of just removing the balance. What happens to the money before it is either redeemed or taken as breakage depends again on the specifics of the program and the jurisdiction. Sometimes it will be required to be held in a trust, or in some other form of escrow. Often this will preclude the possibility of earning interest. Sometimes the gift card provider and the merchant are different parties. An example of this would be a mall that sells a gift card that you can use to redeem at any store in the mall, or a visa gift card. In this case, the program operator does not simply exchange the balance for stock, they have to settle cash with the merchant. Loyalty liability is different again, because that’s liability that you never received a direct payment for in the first place. The one huge mistake that this article makes is that it claims the breakage income is 100% profit. This ignores the costs of operating the program, which is usually millions of dollars. Small retailers would receive trivial breakage income, and would not necessarily even cover program costs with it. Medium size retailers may or may not generate a profit on breakage, large retailers likely do, but their program expenses are also enormous. The real value to the business is customer acquisition.