Breakage

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Breakage

1. In accounting, an amount of money set aside to cover the cost of goods that break during transport. Because these goods cannot be sold, the company loses the revenue they would produce. A company may prevent this revenue loss from adversely affecting its finances by setting aside a breakage allowance. This exists due to fiscal conservatism and not because a company expects an unusual number of goods to break.

2. In retail, a gift card that is purchased but not used. The revenue a retailer generates from breakage is all profit, except for the minimal costs necessary to produce the cards.
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Best Buy reports the amount of breakage recognized in each fiscal year in its notes to the financial statements.
Does GAAP require firms to record any cost of goods sold as an expense when they record breakage as revenue?
Review Kile (2007) to identify the different choices that various firms made regarding how to report gift card breakage on their income statements.
Reporting breakage as other income and disclosing the amount of breakage in a footnote has the benefit of providing transparency and does not distort gross profit (or any ratios calculated using gross profit).
Recording breakage as net sales (the most frequent treatment in the sample) may distort gross profit because there is no related increase in cost of goods sold.
If a company reports significant breakage amounts as a reduction in selling, general, and administrative (SG&A), investors and creditors may be more likely to assume that the company has done a better job of controlling operating expenses than it actually has.
How might the accounting for and disclosure of gift card breakage affect the quality of earnings reported by a particular firm?