Mother’s Day is Sunday, which means the panic over what to get dear mom has officially set in. If your business routinely sells gift cards and gift certificates, you’ll likely see a bump in sales this week.
Gift cards are wildly popular, and becoming more so given the ease of purchase via mobile apps and near-instant delivery (hello, last minute shopper). Consumers love the flexibility of gift card giving (you don’t really have to decide on a gift), and businesses have embraced them as a means to increase sales. Gift card redeemers are not only spurred into making new purchases, but they often spend more than the gift card amount. Gift cards can be instrumental for retailers in improving cash flow and managing inventory.
But the challenge to businesses when it comes to gift cards is an accounting one. A sizable number of gift cards are simply never redeemed, and that’s a problem for businesses who issued the cards. Estimates of breakage, the percentage of gift card balances that remain unredeemed, range from 10 to 19 percent. Revenue typically can’t be recognized until a corresponding product or service is provided, and companies end up carrying a liability on their balance sheets without being able to record revenue that would clear it. Gift card breakage also has certain state escheat (where unclaimed property passes to the custody of the state) implications, since it affects income recognition, so these unredeemed dollars can have a significant influence on many companies’ bottom lines.
If you’re surprised by the need to list gift card revenue as a liability, you’re not alone. As an accountant, I see a lot of income statements, and I’m surprised how often I see gift card sales listed under revenue, where they don’t belong. In reality, gift card sales should be recorded as a liability on your balance sheet and shouldn’t show up on your income statement at all. Why? Because gift card revenue isn’t your money – it’s an indication that someone intends to do business with you in the future. When a recipient comes in and redeems a gift card, that gift card is just another payment method. When you list gift card sales as revenue, you’re actually spending money you don’t really have yet.
But back to breakage. How do we deal with it? Until recently, we didn’t have a definitive answer. But a new standard issued by the Financial Accounting Standards Board (FASB) on March 10 provides guidance on how entities that issue certain prepaid stored-value products should recognize breakage – again, the dollar value that is not redeemed by cardholders.
The updated standard allows companies to recognize an estimate of the amount of value on the card that is not expected to be redeemed currently in earnings, rather than waiting until it is legally released from the liability. This is the “breakage method”. Unless addressed by other guidance, a retailer can apply the breakage method and derecognize the liability, only if a significant reversal of the recognized breakage amount is unlikely to occur. Retailers must have sufficient evidence to support this assertion, and will likely find that their historical redemption trends are the best evidence of amounts not expected to be redeemed. So, in a nutshell, you can be released from the liability so long as you can provide sufficient evidence that the remaining gift card balance will not be redeemed. That’s a win for retailers.
This update is effective for fiscal years beginning after December 15, 2017 for public entities and is effective for all other entities for fiscal years beginning after December 15, 2018. Early adoption is permitted.
Is your head spinning? We can help you sort it out. And it’s all for your own good. All of this makes for more accurate balance sheets, which help you make smart business decisions on a day-to-day basis. In addition, should you ever want to sell your business, any potential buyer will be more able to match your assets and liabilities, and that boosts your overall value.
The bottom line is this: gift card sales are an important tool to bring in new clients at certain times of year, but they must be handled properly to keep your business financially healthy.
Happy Mother’s Day!
