FREQUENTLY ASKED QUESTIONS ABOUT
OUR DERECOGNITION REVENUE SERVICES

Derecognition is an accounting technique under which unused or stale liabilities are debited resulting in a credit to income or revenue. In is usual form, this technique applies to non-escheatable liabilities that are not subject to back-end fees or expiration dates. Some also believe the technique may be used to advance revenue recognition in the face of regulations delaying the use of back-end fees or expiration dates.

Card Compliant is an industry leader regarding the derecognition technique. Below are some frequently asked questions regarding our derecognition revenue services.

Q. What is derecognition?

Derecognition is an accounting technique under which unused or stale liabilities may be written down in a manner similar to writing down a stale receivable or bad debt. Under double entry accounting, the liabilities are debited with corresponding credits to income.

Q. What is the connection to gift card programs?

As a general rule, when gift cards are sold they represent future performance obligations so they are booked as liabilities on the financial statements of the card issuer. Because the cards are liabilities, derecognition techniques are available when they become unused or stale: debit liability and credit income.

Q. Is the recognition technique subject to regulation?

Yes. The Securities and Exchange Commission (“SEC”) has issued guidance on the subject including on the permissible methods of use. The Financial Accounting Standards Board (“FASB”) has set standards addressing the accounting technique. So has the International Accounting Standards Board (“IASB”). The technique cannot be applied to liabilities subject to escheat, so use of the technique also is subject to proper application of state unclaimed property laws.

Q. Where can I find the applicable regulations and standards?

You should visit our Compliance Libraries.

Q. What services does Card Compliant provide regarding the derecognition technique?

Card Compliant provides full and comprehensive services regarding the technique. Our services are supported by our proprietary processing platforms which implement the technique from start to stop, including management of its unclaimed property, breakage analysis, and earnings recognition components.

Q. Do your services address the applicable regulations and standards?

Yes. We address the SEC guidance, FASB standards, IASB standards, and state unclaimed property laws.

Q. You mentioned you are an industry leader on the subject. Can you give me some perspective?

Card Compliant was actively involved when the accounting standards were set, including invitations from both boards to speak directly to FASB and IASB on the subject. In addition, we have developed technology processing systems designed to process transaction data to operationally implement the technique per the applicable standards. And, some of our systems on the subject have been patented.

Q. What is the importance of the state unclaimed property laws?

If a card liability is subject to escheat under an unclaimed property law, it will be remitted to the applicable state per the escheat statute. If so, it will not be available for derecognition. Stated another way, If escheat applies it will bar derecognition.

Q. Do your derecogniton services address the state unclaimed property laws?

Yes. Card Compliant offers comprehensive services regarding unclaimed property. We leverage these capabilities when applying derecognition to identify and derecognize the liabilities not subject to escheat. For information about our unclaimed property capabilities, you should explore our unclaimed property & escheat services and visit Frequently Asked Questions Re Our Escheat Services.

Q. How come the unclaimed property laws do not bar derecognition for gift cards?

Many state unclaimed property statutes have exceptions, deductions or exemptions to the escheat of gift cards. The statutes in those states do not require escheat and, thus, permit derecogntion. The statutes in other states, however, require the escheat of gift cards and, thus, limit derecognition.

Q. Do your derecogniton services identify the gift cards that are not subject to escheat?

Yes. Our proprietary processing platforms identify each item, or portion thereof, that are not slated to escheat thereby positioning the item for the derecognition technique.

Q. What is the role of the SEC?

We view two related subjects as being in play. When stale card liabilities are not subjected to escheat, expiration dates, or back-end fees, the liabilities will build up over time and distort a company’s balance sheet. The derecognition technique corrects the distortion. In addition, when the method is used it results in earnings. The SEC guidance addresses a company’s ability to correct the reporting distortion while also appropriately recording and reporting earnings.

Q. Do your services address the SEC guidance?

Yes.

Q. What is the role of FASB and IASB?

The derecognition technique is an accounting technique. The FASB sets Generally Accepted Accounting Practices (”GAAP”) for U.S. companies and GAAP includes standards impacting derecognition. The IASB similarly sets International Financial Reporting Standards (”IFRS”).

Q. Do your services address accounting under GAAP?

Yes. Our services are designed to address GAAP – including the standards governing the technique in general along with specifics on the proportionate method, remote method, predictability and similarity standards, and required reporting period reviews.

Q. When is derecognition typically used?

The technique is usually applied to gift cards that do not have expiration dates or back-end fees. The technique removes the distortion in over-stated liabilities that can result from the absence of expirations or fees. The technique also replaces some income lost from not using expiration dates or back-end fees.

Some also believe the derecognition technique is usable in programs with expiration dates or back-end fees. When used in that way, the technique takes earnings for GAAP in advance of future expiration dates or back-end fees – subject to a true-up.

Q. Why are retail gift card issuers electing not to use expirations dates and back-end fees?

Several pressures exist against their use in a typical retailer gift card program. Expiration dates and back-end fees are subject to heavy regulation under consumer protection and unclaimed property laws. These regulations ban or limit their use making it impossible to use them in some settings and very difficult to manage in others. In addition, consumers and consumer groups often criticize expirations and back-end fees as being consumer unfriendly – raising public relations and customer service issues. Lastly, major retailers leveraged the issue by marketing expiration-free and fee-free products for competitive reasons.

These efforts have driven the market to discontinue expirations and back-end fees. The resultant silver lining, however, is a very consumer friendly card. Derecognition corrects the resultant distortion to booked liabilities and restores some of the lost income.

Q. You mentioned that some believe the derecognition technique is usable in programs with expiration dates or back-end fees. Can you explain?

Regulations force card issuers in some programs to delay the expiration dates as long as five years in some cases. They also force issuers to delay back-end fees for a year or more in some cases. These regulations separate program revenue in time from program costs causing cash flow problems. They also distort the economic realities of the expirations and fees. Some believe these problems may be addressed by using derecogntion techniques to advance income against future expirations and fees.

Q. Can your services be used to advance income or cash flow against future expirations and fees?

Yes. We also can use similar techniques to support the advancing of funds to program managers against future expirations or fees – correcting cash flow deficiencies.

Q. Is the derecogntion technique a required practice?

The technique is now addressed in GAAP. As a result, many believe the technique is required if the card issuer is applying GAAP. You should check with your accountants and auditors for their specific views.

Q. Does the derecognition technique only apply to publicly traded companies?

No; in our experience, the technique is used by companies which either use GAAP or have expectations of using GAAP in the future. Examples are publicly traded companies, companies with owners requiring GAAP, companies with bankers or financers requiring GAAP, and companies desiring GAAP in advance of going public or M&A transactions.

Q. Is the application of the derecognition technique limited to gift cards?

No; it applies to other liabilities including some liabilities that are redeemable for cash. We currently view the test as being whether the instrument is redeemable for goods and services – even if it also redeemable for cash. Of course, as explained above it does not apply to escheatable liabilities.

Q. How does the derecognition technique work?

We view the technique as being applied in steps. The unclaimed property laws must be addressed so that the card liabilities cleared of escheat before derecognition. The breakage amount of the non-escheatable liabilities must be statistically determined and quantified. The timing method for taking that breakage to earnings must be selected and implemented. The technique must then be operationally applied to large volumes of items via general ledgers entries. Lastly, various technique challenges must be addressed. When implemented, the technique takes the breakage on non-escheatable liabilities to earnings per a permissible timing method.

Q. How do you address the unclaimed property component of the techinque?

As explained above, we use our proprietary escheat processing platform to clear escheat on a per item basis and thereby identify the non-escheatable liabilities available for the derecognition technique.

Q. How do you determine the breakage amount?

Card Compliant has developed proprietary processing platforms to determine breakage amounts along with other breakage related metrics for applying the derecognition technique. You should explore our forecasting services and visit Frequently Asked Questions Regarding Breakage.

Q. What are the derecogniiton timing methods?

The SEC, FASB and IASB decided that breakage should not be taken to earnings at the point when the cards are sold. Instead, the standards recognize two timing methods. We refer to these two methods as being the proportionate method and the remote method. Under the proportionate method, the breakage is taken to earnings over time in proportionate to the redemption rates for the program. Under the remote method, the breakage typically is taken to earnings in a lump sum when the likelihood of redemption becomes remote.

Q. Do your services address the both timing methods?

Yes. Our proprietary forecasting platforms provide statistical support and metrics regarding redemption rates for application of the proportionate method. They also support determination of remote points. Our proprietary earnings platforms determine the amount of earnings to be taken via either method. Our platforms also support a combined method under which earnings are taken per the proportionate method until the remote point is reached at which time the remainder is taken lump sum.

Q. How do you address the large volumes of cards or items?

We leverage technology and let our proprietary computer systems do the work and, thus, take care of the volumes. These systems can apply derecognition at a bucket level or on per item basis.

Q. How does the actual revenue recognition and relating accounting work at an operational level?

Card Compliant has developed earnings platforms to take the breakage to earnings via the selected timing methods. These platforms calculate the applicable amounts per the timing methods and deliver information to clients on a monthly basis for the required general ledger entries; namely, debit liabilities and credit income. Forecasts of future earnings from the technique are also available.

Q. Can you handle irregular accounting periods?

Yes. Our experience includes non-calendar fiscal years and non-calendar month reporting periods.

Q. You mentioned some technique challenges that must be addressed. What are they?

We often encounter a variety of challenges. They include reconciling GAAP to tax; reconciling GAAP to the processors liabilities of record, managing recaptures when derecognized cards are used, addressing moving breakage rates, managing breakage influencers, understanding long range breakage, and managing for changed circumstances that may result in significant reversals. From a data standpoint challenges include selecting data pools, addressing difficult data, implementing new or young programs with little or no data, and using another program’s data via similarity or predictability standards. In addition, in international situations, fluctuating currencies may move the derecognized liability balances.

Q. Do Breakage Rates Move?

Yes. We see movement in both the breakage percentage and in breakage speed.

Q. What are Breakage Influencers?

“Breakage Influencers” is our phrase. The phrase refers to a variety of factors which we believe may cause the breakage percentage or breakage speeds for a gift card program to change.

Q. Can you provide some examples of breakage influencers?

A few examples: retailer brand – liquidity impacting features – card age – denomination amounts – geographic locations – monthly influences – distribution channel types – marketing pressures – consumer sentiment.

Q. Are breakage influences important?

Yes. Aside from their possible impact upon business plans, forecasts and budgets, movements in breakage metrics impact earnings when derecognition techniques are used.

Q. Do you manage breakage influences?

Yes.

Q. You mentioned that long range breakage needs to be understood. What is that?

Gift cards are relatively new. In our view, breakage can be over-stated using conventional techniques if long range actual use patterns are not understood. We are developing techniques to supplement current forecasting methods to adjust for long range patterns.

Q. What are recaptures?

We view recaptures as referring to the process of reversing derecognition for accounting purposes on cards that are actually used by the consumer after dercongition.

Q. Do you address recaptures?

Yes.

Q. Are there a difference between tax and GAAP?

Yes. There can be and often are in retail gift card programs. In some situations, GAAP can result in faster recognition of income than under the tax rules. That situation needs to be managed.

Q. Do you address the differences between tax and GAAP?

Yes. We address several approaches depending upon client decision.

Q. You mentioned reconciliation of GAAP to the transactions processor’s liabilities of record. What is that?

Each transaction processor maintains and tracks the outstanding card balances which, in turn, constitute the outstanding card liabilities on the street. Because the cards are not subject to expirations or back-end fees, the transaction processor liability cannot be reduced by derecongition. Instead, it remains the same in case the card is used. The derecognition technique is applied to the GAA{P books. This results in a difference between in liabilities in transaction processor’s records and the GAAP books.

Q. Do you address the differences GAAP and the transaction processor’s records?

Yes. Our systems perform and deliver monthly reconciliations.

Q. You mentioned the concept of managing changed circumstances. What is that?

Circumstances may change over time resulting in moving breakage rates and other metrics that may impact the earning taken via the derecognition technique. GAAP includes specific standards requiring a program to be reviewed each reporting period to watch for such changes to avoid significant accounting reversals. We also consider such reviews to be best practices for statistical work. Card Compliant has programs designed to addresses these review practices for our client’s gift cards.

Q. Are your proprietary systems audited?

Yes. Our systems are subject to annual PCI audits and SSAE 28 audits by third party auditors. The breakage and derecognition systems also are subjected to actuarial reviews and model validation reviews by third party reviewers.

Q. Why should we use your derecognition revenue services?

Unless you want to undertake all the challenges outlined above, derecogniton is a perfect target for outsourcing. Let us manage the challenges for you. Other reasons include the ability to leverage our audited system as opposed to internal controls and access to other data and benchmarks that are not available if you stay on an island.