Accounting for Gift Cards

Now accounting for breakage can be a little tricky as there are a few moving parts that need to be calculated. Our mission is to empower finance teams to do their best work and focus on driving their businesses forward with data driven decisions. These are just a few of the HR functions accounting firms must provide to stay competitive in the talent game. © 2023 GBQ Partners LLC All Rights ReservedGBQ is a tax, consulting and accounting firm operating out of Columbus, Cincinnati, Toledo and Indianapolis. © 2023 GBQ Partners LLC All Rights Reserved
GBQ is a tax, consulting and accounting firm operating out of Columbus, Cincinnati, Toledo and Indianapolis. While the CARD Act was born out of a federal law, it does mandate state statutes to define if and/or when unredeemed card funds get transferred to state reserves.

And, based on recent trends, they will continue to gain even greater traction. While accounting methodology treatments may vary, so do state definitions and statutes. As a result, the only way for businesses to ensure compliance and accuracy is to turn to a trusted business advisor with expertise and experience in the complexities of the consumer products sector.

Gift card liability and contra liability

Lastly, if a state does require an unused gift certificate or gift card to be remitted back to the state after a period of time, these gift cards should not be included in the above breakage calculation. Escheatment in its simplest form is unclaimed property that is remitted to the state after a certain period of time has passed. Each state has its own escheatment laws and depending on the state, gift cards may or may not be included in these laws. You can recognize breakage income in proportion to the value of actual gift card redemptions.

The revenue of 100 can now be recognized and this amount is transferred from the gift card liability account to the income statement revenue account. The business has received the cash of 1,500 however, the goods have not yet been provided to the customers and the revenue cannot be recognized. The amount is credited to the balance sheet gift cards liability account (deferred revenue). The company has to record revenue every time the customer redeems the gift card.

Business Benefits of Gift Cards

Without a standard means of recognition, this liability could otherwise remain on the balance sheet forever. For example, suppose on past experience, the business estimates that the breakage percentage is 20%. What this means is that a customer is expected to use only 80% of the gift cards value with the remaining 20% never utilized or redeemed. The journal entry is debiting https://online-accounting.net/ gift card liability and credit revenue. Though it is not an accounting transaction, one should also be aware of the delay in recognizing sales caused by gift cards. Card recipients may not use them for months, so the initial «sale» of the card only results in the recordation of a liability, which is eventually transformed into a sale when the card is used by the recipient.

• This trend is especially popular among millennials, who often reload coffee chain and lifestyle service-related cards.
• When a gift certificate is presented to the retailer, revenue will be recorded by the retailer for the amount of merchandise or services that were provided.
• The company will also do this same process for its prior year gift card sales except instead of using its first-year redemption ratio, it will use the second-year redemption ratio.
• The company will continue this process for each year of gift card sales in which 100% of breakage revenue has not been recognized.

The unique accounting challenges posed by gift cards and gift certificates evoke the debate over cash accounting versus accrual accounting (GAAP basis). In terms of cash accounting, some practitioners leave the sale on the income statement, which allows for easier determination of net sold versus redeemed revenue. While increased gift card sales can bode well for business owners in this modern era, swelling gift card sales also can translate into increased liability. For those gift cards where redemption appears to be unlikely, income is recognized as breakage income.

Accounting for Gift Cards

The transaction will increase the cash balance which receives from selling the gift card. At the same time, they need to record the gift card liability which represents the amount of liability that company needs to fulfill for customers when they redeem the card. When the company sale gift cards to customers, they will receive cash payments. They have the obligation to settle the gift card amount with the service or goods. When a gift card is not used, the funds must be remitted to the applicable state government; the company cannot retain the cash. This requirement is stated under local escheatment laws that cover unclaimed property.

They have to record the revenue and reverse the liability for the same amount. Gift cards can be physical cards or electronic which consist of serial numbers that can be redeemed for the amount of cash and used to purchase in a specific store. The 54-page eBook goes through how to manage your books, understand your financial position, and draw insights that help you make better decisions. The new guidance does not apply to those portions that are subject to escheatment laws.

Gift card revenue recognition and what complicates things: a primer

Hopefully, you were able to navigate through the changing accounting environment. Nevertheless, we will discuss applicable guidance with examples below as a reminder to seasoned owners or as a starting guide for new restauranteurs. Please keep in mind that the following discussion is related to US GAAP reporting. However, people often incorrectly assume that IRS rules on gift cards to employees are also covered under de minimis fringe benefit rules. The transaction will remove the liability as to the company already completed for customer.

A great fallback for hard-to-buy-for recipients, gift cards’ upward trajectory is directly linked to this modern era of online shopping. At the initial ‘sale’ of a gift card, a liability is recorded rather than an actual sale. For example, the account can be called the Gift Card Liability account, Gift Cards Outstanding account or even Shopify Gift Card account, as long as the account is a current liability account. By crediting the gift cards liability account, you increase the amount that you’ll have to fulfill when the gift card is used.

Furthermore, many companies will need to reclassify
their breakage income to be reported as part of sales revenue. Of course, in practice, most companies will record income from
gift card redemptions as they occur and will record breakage income as
an adjusting entry at the end of each accounting period. As with the breakage revenue mentioned above, it is encouraged to set up a contra liability account to record promotional expenses too for additional transparency. As the gift card is redeemed, this additional $20 promotion will be expensed at the ratio at which it was offered to marketing expense. As a restaurant matures it is possible to see an increase in its gift card redemption rates thus a change in estimate is likely going to need to be made. If you are a new restaurant and do not have historical redemption rates, a 5-10% breakage rate will likely be in the ballpark and can be adjusted as redemption rates become available.

• Setting up a system to track these specific data points is a worthy investment since it will save you a lot of headaches down the road.
• When the payment has been deposited, allocate it to the payment clearing account so it will post a DR to the cash account and a CR to the clearing account.
• Of course, in practice, most companies will record income from
  gift card redemptions as they occur and will record breakage income as
  an adjusting entry at the end of each accounting period.
• Financially speaking, a gift card is essentially an interest-free loan from the consumer to your company.
• The journal entry to record this transaction is $100 to cash, $120 to deferred revenue liability and $20 to gift card promotion liability (contra liability to gift card deferred revenue).
• As a result, an employee pays zero state or federal income tax for the de minimis benefits.

If the balance of the unredeemed cards is subject to full
escheatment, the company is precluded from recording any breakage
income. It must forward the cash received for the cards to the state
and remove the corresponding liability from its books. The
general rule in these situations is to first follow the escheatment
laws of the state what is cash coverage ratio where the purchaser lives, if that information is on
record. If the purchaser’s home state is unknown, or if that state
does not escheat gift cards, the state where the business is
incorporated can enforce its escheatment rules. If neither state
escheats gift cards, the state of sale may step in and exercise its
right of escheat.