What it means
When a customer buys a gift card, the business has not yet earned the money, because it still owes goods or services. The cash is recorded as a liability called deferred revenue or a contract liability.
Revenue is recognised only when the card is spent. In practice, some cards are never fully used.
Customers lose them, forget them or leave small balances. The unused portion is breakage, and for many retailers, airlines and subscription businesses it is a meaningful profit source.
Under modern revenue accounting standards, a company that expects to keep some of the unused amount can recognise breakage as revenue in proportion to the pattern in which customers redeem. This means it is recognised gradually as redemptions occur, not all at once at the start.
If the company cannot reasonably estimate breakage, it waits until the chance of redemption becomes remote. Estimating breakage takes historical data.
A business looks at how many cards of each age were redeemed in the past and builds a pattern. Estimates need regular updating, because customer behaviour changes.
The law adds a twist. In some places, unclaimed balances may need to be handed over to the government as unclaimed property after a set period, and some jurisdictions restrict expiry dates on gift cards.
Where this applies, the business may not be free to keep the unused amount. Breakage is a perfect example of why accounting matters to commercial teams.
A change in the redemption rate can lift or cut reported revenue without any change in sales.
In practice
Real-world examples
Example 1
A coffee shop chain sells gift cards over the holiday period and tracks redemption over several years. Past data show that about 5% of card value is never used. The accountant recognises that amount gradually as cards are spent. She reviews the rate each year to see whether customers are behaving differently.
Example 2
An airline sells tickets that go unused by passengers who miss their flight. Under the ticket terms the fare is not refundable, so the airline recognises revenue for the unused tickets once the flight date has passed. The finance team treats it as ordinary revenue and not as a gain.
Example 3
A fitness studio sells ten-class passes that expire after six months. Some customers use only seven classes, and the studio recognises the unused three in line with the expiry pattern. The studio's manager notes that the policy of expiry also encourages members to attend more often.
Think of it
Breakage is money from gift cards people never use-revenue from unredeemed stored value.
Formula
Calculation
Revenue recognised in a period = Redemptions in the period + (Redemptions in the period / Total expected redemptions) x Expected breakage
Suppose a retailer sells $500,000 of gift cards and expects 6% to go unused. Expected breakage = 500,000 x 0.06 = $30,000, and expected redemptions = 500,000 - 30,000 = $470,000.
In the first year customers redeem $235,000, which is half of expected redemptions. Breakage recognised = (235,000 / 470,000) x 30,000 = $15,000.
Revenue for the year = 235,000 + 15,000 = $250,000, and the remaining liability is 500,000 - 250,000 = $250,000.Case study
Seen in the real world
Maple and Oak Gifts is a fictional retail chain that sold $2,000,000 of gift cards in a year. The finance team had not estimated breakage and recorded nothing until cards were fully spent, so reported revenue lagged cash received. The liability on the balance sheet kept growing and no one could say how much of it would ever be claimed.
An external auditor suggested analysing five years of card data. The illustrative analysis showed that roughly 4% of value was never redeemed, and that most redemptions happened within eight months.
The company changed its policy to recognise expected breakage in proportion to redemptions. Reported revenue became smoother and better matched the true pattern of customer behaviour. The auditor reviewed the estimate and agreed that the method was reasonable. The finance team now refreshes the redemption curve every quarter using the latest card data. When a promotion changed customer habits and pushed redemption faster, the team lowered its breakage estimate and the change flowed through to revenue. Management also uses the data to decide how long to run holiday gift card campaigns.
Watch out
Common mistakes
- Recognising all breakage as revenue on the day the card is sold. It generally has to follow the pattern of redemption.
- Ignoring unclaimed property rules. In some places unused balances must be paid to the authorities instead of kept.
- Using an old estimate forever. Customer behaviour shifts, so the breakage rate needs regular review.
Questions
People also ask
Is breakage the same as a refund?
No, because a refund returns money to the customer, while breakage is value the customer never claims.
Does breakage affect cash?
Not at the point of recognition, because the cash was already received when the card was sold.
Why do auditors care about it?
The estimate involves judgement, and a small change in the rate can move reported revenue significantly.
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