Cards and Financial Reporting
Unwrapping the Uncertainties
of Revenue-Recognition and Other Issues
Ronald E. Marden and Timothy B. Forsyth
- Gift cards come in two basic types: those that are affiliated
with credit card companies such as Visa and MasterCard, and those
that are not. The nonbank cards, often purchased from retailers,
do not come under the jurisdiction of the federal banking laws,
and very little GAAP guidance addresses how to account for them.
There would appear to be a variety of ways that companies are accounting
for the revenues and disclosures associated with nonbank cards,
to the detriment of comparability. This article discusses differences
in gift-card financial reporting and disclosures, and the possible
issues with reporting transparency.
gift cards are frequently referred to as closed-system or closed-loop
cards because they are used only at the retailers that issue them.
(Besides retailing, other types of uses for closed-system cards
include telephone calls, restaurants, grocery stores, movie theaters,
coffee shops, vending, and even payroll.)
not much legal regulation of nonbank gift cards, leading to a
variety of conditions attached to the use of this plastic currency.
In some cases these cards carry monthly fees, carry activation
fees, and have an expiration date that can literally bring the
original value of the card down to zero if the card is not used
over time. For example, if the card had an original value of $20
and carried a monthly fee of $2, the $2 monthly fees would eventually
bring an unused card’s value to zero in less than a year.
Because these kinds of fees have been the basis of many consumer
complaints, many nonbank card issuers have stopped attaching monthly
fees or expiration dates. For consumers, another persistent negative
aspect of nonbank gift cards is that most issuers will not allow
the customer to redeem unused value for cash. Despite these limitations,
gift cards have become big business.
like gift cards because they are money-makers. According to estimates
from the National Retail Federation, 80% of all shoppers purchased
at least one gift card in 2006, with total annual gift card sales
estimated at around $53 billion. The 2006 end-of-year holiday
sales were some $27 billion, up almost 34%. During the 2006 holiday
season, the average consumer spent about $116 on gift cards, actually
overtaking clothing as the most popular of holiday gifts (Elizabeth
Wayke, “Someone’s Been Using My Gift Card,”
BusinessWeek, January 15, 2007). Additionally, companies
are keen on cards because gift recipients effectively extend the
retail holiday season for another month or two. Cards turn the
January and February clearance sales into one of the most important
nonholiday times of the year for retailers.
are fond of gift cards because they can be handy when one doesn’t
know what to give “that special someone” for a holiday
or other occasion. Gift cards can also be practical for relatives
at a distance, especially as an alternative to shipping presents.
And, in some cases, love may have nothing to do with it: Many
appreciative employers use gift cards as incentives and awards.
Either way, most everyone seems to like gift cards because they’re
convenient, easy to use, flat, lightweight, easily stored, virtually
unbreakable, and, perhaps most important, the recipient is saved
the predicament of having to return unwanted gifts.
Accounting for Gift Cards
One way a
company profits from gift cards is the phenomenon of people frequently
spending more than the actual amount on the card. According to
Providence College marketing professor Daniel R. Horne (in the
above-referenced BusinessWeek article), consumers, buoyed
by a sense of “found money,” spend an average of 1.4
times the amount on their cards. If applicable, issuers can profit
through monthly service or renewal fees (if the card has an expiration
date). In addition, some purchasers don’t use the entire
amount on the card, leaving a small balance that is forgotten
or disregarded. Some customers may even lose the card before using
it at all, and unused cards can add up to substantial amounts.
questions are raised for auditors, gift card issuers, and financial
statement users. If there are no fees or expiration dates, how
should a company account for the initial transaction and ultimate
disposition of the monies when a customer pays, say, $100 for
a gift card but never uses the card? Assume that the $100 is recorded
as cash and that the company now has a liability (unearned revenue)
in the same amount. If the card has no expiration date, will the
liability stay on the books indefinitely? At what point can the
company decide that the card will indeed never be used for the
amount recognized as income (referred to as breakage income)?
Keep in mind that while $100 may not seem material, it’s
been estimated that as much as 10% of the total value of gift
cards sold in the United States goes unused, totaling nearly $8
billion due to unredeemed value, expiration, or lost gift cards
(Cerise A. Valenzuela, “New Fraud Makes Rounds This Holiday
Season,” Copley News Service, The Alert Consumer,
December 11, 2006).
account for gift card sales in different ways. Moreover, not all
companies disclose their policies for recognizing breakage income.
A review of the notes to the 2006 10-Ks of four well-known retail
chains that offer gift cards reveals different accounting for
each. In all four cases, the cards are very popular because they
do not impose expiration dates or fees, they can be used online
and in stores, and they can be replaced if lost or stolen.
- In its
2006 10-K, Best Buy states that it recognizes breakage income
for unused cards that have been outstanding for 24 months, because
at that point, the “likelihood of redemption is deemed
to be remote.” In this case, breakage income is based
on the company’s “historical redemption pattern.”
Depot discusses its gift cards in the Management Discussion
and Analysis (MD&A) and footnotes of its 2006 10-K. Home
Depot discloses the amount of breakage income recognized, but
it does not provide details about the basis for recognition.
City’s only mention of gift cards in its 2006 10-K is
that the receipts are initially put into deferred revenue as
a liability. Circuit City makes no mention of breakage income.
states in its 2006 10-K that it recognizes revenue on gift cards
only when “the customer purchases merchandise by using
the shopping card.” Wal-Mart does not mention breakage
notes offer only a small sample of revenue recognition and disclosures,
they illustrate the variety in how gift cards are accounted for.
In addition, another interesting item noted in the Best Buy footnote
is the statement that the company does “not have a legal
obligation to remit the value of unredeemed gift cards to the
relevant jurisdictions.” In some states, after a certain
period of time, the unredeemed value of the cards reverts back
to the state as unclaimed property. For example, according to
Mary Lau, president of the Retail Association of Nevada, if a
card is not entirely used, the balance is usually turned over
by the issuer to the state where the card was purchased; under
Nevada law, it is unclaimed property (Valerie Miller, “Gift-Card
Purchases Expected to Jump, but Fees and Fraud Remain,”
Las Vegas Business Press, December 11, 2006). In North
Carolina, retailers must wait three years and then are allowed
to keep 40% of the money on cards that have an expiration date;
the other 60% goes to the state. If the card has no Expiration
date, the retailer is allowed to keep all the money. In South
Carolina, All gift cards are exempt from unclaimed property laws,
so retailers get to keep all of the unused money (Nichole Monroe
Bell, “And to All a Good Swipe,” Knight Ridder
Tribune Business News, December 23, 2006).
In New York
state, lawmakers have taken action on the gift card issue. Prior
to 2007, the process for handling gift cards and certificates
was something of an annoyance for retailers because the unredeemed
value of a gift card or gift certificate had to be escheated,
or turned over, to the state Treasury Department five years after
the date of issuance or two years after the expiration date, if
one was used. In January 2007, a new law went into effect that
gives businesses the opportunity to bypass the escheat process
by exempting “qualified” gift certificates and cards.
law defines a qualified card or certificate as one that does not
carry an expiration date and does not charge any fees to the certificate
or card holder. This provision allows businesses to avoid escheat
responsibility, but also permits businesses to continue using
expiration dates or fees if they so choose (Jessica Bair, “Law
Gives Businesses More Flexibility with Unredeemed Gift Cards,”
Central Penn Business Journal, May 18, 2007).
depending on the escheat and other laws of the state in which
a company does business, issuers of gift cards may incur additional
costs or not reclaim as much as expected in association with unused
cards. This, in turn, may influence how the cards are marketed
and accounted for.
Costs of Doing Business
for unused gift cards can be more costly and cumbersome than one
might think. According to the National Retailers Federation, a
Washington, D.C.–based trade organization, card programs
can have a cost for retailers, particularly when card balances
remain outstanding for several years. “It’s a matter
of accounting issues as well as practicality issues in operating
the card-issuing systems,” said Craig Shearman, a spokesman
for the federation, adding that the longer cards remain unused,
the longer an outstanding balance remains on the retailer’s
books. “The cost of paying for the program, i.e., the actual
outlays, employee time it takes to administer the program ...
retailers have to justify [operating] the program and how they
are going to pay without using money generated from fees”
(Sabra Ayres, “Alaska Legislature Considers Gift Card Fees:
Under New Law, They Couldn’t Expire or Arrive Harnessed
With Fees,” Knight Ridder Tribune Business News,
February 10, 2007).
expense is the cost associated with fraud. Any retail store that
uses gift cards can fall victim to fraud. The source of these
frauds can be categorized into two basic types: external threats
from nonemployees and internal threats from employees, with the
occasional collusion between the two.
threats. One of the easiest forms of fraud is to
simply shoplift the cards off the sales racks and try to swap
or sell them over the Internet at sites such as eBay.com, Plasticjungle.com,
Swapagift.com, or Cardavenue.com. Buyers believe they’re
getting a bargain that’s almost too good to be true, and
more often than not, conventional wisdom prevails. In fact, according
to Mark Albright, “An audit of 50,000 of one retailer’s
gift cards sold on auction sites revealed 35,000 were stolen,
had no balance or otherwise were bogus” (Knight Ridder
Business News, January 18, 2007).
scam is for a thief to take some cards from a store and use an
electronic device to copy the card’s authorization information
from the bar code or magnetic strip. The cards are then surreptitiously
returned to the sales rack. The thief will then periodically check
whether the card has been activated and what its balance is (usually
through a toll-free number or website). At this point, the thief
can use the stolen authorization codes to purchase items online
without needing the card itself.
threats. Fraud can also be perpetrated by individuals
within the organization. An employee could be involved in a “checkout”
scam, pretending a card is empty or deactivated, then persuading
the customer to hand over the “worthless” card. In
some cases a cashier can pull a sleight of hand and replace the
customer’s card with one that had no value on it. The cashier
tells the customer that the card must have already been used,
and the cashier keeps the card with value.
of scams may seem to be few and far between, but they represent
significant fraud. According to Richard Hollinger of the University
of Florida’s Center for Studies in Criminology and Law (see
the previously cited BusinessWeek article), the center’s
Annual National Retail Security Survey indicated that out of 150-plus
stores surveyed, respondents estimated gift card losses at more
than $120,000 a year. While 26% of the losses were attributed
to stolen or counterfeit cards, some 62% were attributed to dishonest
card fraud is really material to the bottom line may not address
the entire issue. When customers who give or receive these cards
are scammed, the store’s image can be tarnished even if
the store is not directly responsible. This can have a hidden
cost if these customers feel resentful and do not return.
for Gift Cards: A Recommendation
gift cards are becoming a large source of both revenue and costs,
obvious and hidden. The problem is that gift cards are a relatively
new type of significant revenue source for some companies, and
the accounting literature offers no specific authoritative guidance
for accounting for closed-system gift card revenue. The revenue-recognition
principle [Statement of Financial Accounting Concepts (SFAC) 5]
can provide some general guidance. SFAC 5, para. 83, states that
revenues should be identified whether they are “realized
or realizable” and earned; that is, “revenues are
considered to have been earned when the entity has substantially
accomplished what it must do to be entitled to the benefits represented
by the revenues.” The issue with gift cards is not realization,
but rather when the earnings process is actually completed.
will be different for each company, depending on its individual
experience with gift cards and the applicable state escheat laws.
When gift cards are issued, an unearned revenue account (liability)
is recorded. Revenues (and related expenses) are recognized as
the card is presented to the issuer in exchange for goods and
services. If the card has an expiration date, breakage income
should be recognized for the remaining balance of the gift card
at the expiration date, and that amount should be reduced by any
amounts accruing to the state in which the card was issued, based
on escheat laws.
if the gift card has no expiration date, the company should report
the unused portion on the balance sheet as a liability indefinitely.
Because most gift cards being issued currently are electronic,
companies can easily (and efficiently) track card usage in a manner
similar to aging accounts receivable. Many companies may find
that the longer a card is outstanding, the less likely the card
will be redeemed for merchandise. Similarly, companies may find
that cards that have been used but have relatively small remaining
balances are less likely to be redeemed than newer, high-balance
In such cases,
one solution could be to recognize breakage income when prior
experience provides substantial evidence that cards meeting certain
criteria will never be fully redeemed. If, in rare cases, some
of the “written off” cards are later redeemed for
merchandise, the company can recognize that expense at the date
of redemption. If the company has been conservative in determining
its breakage income, the subsequent expense recognition should
be immaterial. At the very least, companies with material gift-card
revenue should be required to disclose their revenue-recognition
policies related to their gift cards. Such disclosure would enhance
comparability and transparency in their financial reporting.
there is no standard way of accounting for or disclosing gift
card revenues, a large and growing segment of retail and other
industries. This presents an interesting situation for accountants.
If a given state does not have an unclaimed-property law, it could
be up to the company to decide when it believes the unused card
values are unredeemable and able to be recognized as income.
company’s financial statement footnotes disclose, as Best
Buy’s did, that “based on our historical information,
the likelihood of a gift card remaining unredeemed can be determined
24 months after the gift card is issued,” there’s
no telling what process is being used for this estimate. In this
case, at least Best Buy lets the financial statement reader know
when it has deemed the likelihood of redemption to be remote.
The other companies reviewed by the authors provided no indication
of when or how they will recognize their cards as breakage income
or as an offset to some expense.
to control when, where, and how a substantial amount of revenue
can be inserted into the financial statements can be beneficial
for management, but can be misleading for financial statement
readers and certainly deserves additional scrutiny. Given the
simplicity of the issue, FASB might place gift card accounting
on the Emerging Issues Task Force (EITF) agenda to enhance comparability
and transparency among gift card issuers.
E. Marden, PhD, is a professor, and Timothy B.
Forsyth, PhD, is an associate professor, both in the department
of accounting of the Walker College of Business of Appalachian State
University, Boone, N.C.