Gift cards have recently become very profitable for retailers because of the ease it can be purchased and the fact that 10% of the consumers don’t use the entire amount on their gift cards. The article discusses ways in which different retailers deal with gift-card reporting and disclosures in their financial statements and outlines issues associated with practicing self made guidelines.

Issues related to accounting and financial reporting for gift cards arise when consumers don’t use the entire amount on the gift card. When a gift card is sold, it is considered to be unearned revenue and thus a liability. If the entire amount on the gift card is not being utilized, there has to be a way to estimate the amount that is going to be forfeited by the consumer. There are no set guidelines by GAAP that address this issue so retailers are at their own will when it comes to reporting the liability and/or income generated through gift cards not being used.

If the gift card has monthly fees or expiration date, it is easy to report it because eventually the card will be of no value but as most companies don’t issue gift cards that carry monthly fees or expire, it is important to find out what is the revenue that should be recognized for the unused portion of the card, also known as breakage income.

Some retailers report breakage income in their financial statements and disclose the procedure by which they estimated the income, some just report liabilities and never disclose the breakage income or how they conclude that a gift card will never be utilized.

Most companies don’t want to invest in proper accounting methods for reporting income through gift card sales because of the costs associated with running a department especially dedicated to accounting for gift cards. If we use the revenue recognition principle, we fall short because we realize revenue when the gift card is sold but the earnings process is not virtually complete as the gift card hasn’t been redeemed or might never be redeemed for the entire amount that it carries.

Depending on the size of the business, accounting for this process will differ and the comparability of the financial statement is affected. If companies chose not to disclose the breakage income or properly disclose how the breakage income is estimated, financial statement users will be in dark as to how income was generated through gift card sales.

The best solution to this problem would be to estimate breakage income using historical patterns of customer experience. By this, businesses can “write off” unused portion of the cards which they are certain won’t be redeemed. It is not a complex task to estimate if or when a card is never going to be used because the longer it takes for the customer to completely redeem the card, chances are, he or she will never use the entire amount on the card. This process is even more feasible if the cards have expiration date.

FASB should soon decide on a legible course of action concerning accounting for gift cards and set general guidelines for companies so that one uniform method can be used. Guidelines should include how a company, no matter what size, should account for breakage income and how it should be disclosed in the notes to financial statements. Doing so will enhance the comparability and transparency which happens to be essential to the conceptual framework of financial statements.

This is a summary of “Gift Cards and Financial Reporting
Unwrapping the Uncertainties of Revenue-Recognition and Other Issues” article by Ronald E. Marden and Timothy B. Forsyth, The CPA Journal Online, November 2007

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