Accounting for Gift Card Sales

The arrival of summer yields many things – from dining out at that popular nearby café to buying a new wardrobe. What better time to put those holiday-season gift cards to good use? An even more important question is: what about those gift cards sold and received in December 2017 – more than 20 months ago?

Retailer, restaurant and lifestyle services gift card and gift certificate sales soared to an all-time high just nine months ago to surpass the prior year’s benchmark. The gift card phenomenon has been gaining traction for more than 35 years and is more popular than ever due to their convenience. Per Statista, during the 10-year period from 2008 to 2018, an increase from $91B to $160B has been reported in gift-card sales. A great fallback for hard-to-buy-for recipients, gift cards’ upward trajectory is directly linked to this modern era of online shopping.

In addition to gifting, self-buying rates also are up among more than half of consumers. This trend is especially popular among millennials, who often reload coffee chain and lifestyle service-related cards.

Not only are they convenient for gift givers and recipients, the benefits of gift cards and gift certificates are plentiful for issuing businesses. A significant source of cash, they are a catalyst for consumer “upspending” and reduced returns. According to a First Data 2018 Prepaid Consumer Insights Study, the average consumer spends $59 beyond the original value of gift cards, with supermarket gift cards averaging an astounding 94 percent above the original denomination. The most popular categories are fine dining, fast casual eateries and drugstores.

Getting back to those gift cards sold in 2017, more than a year ago. It has been reported that approximately 10 to 20 percent of gift cards remain dormant. MarketWatch estimates $1B in gift cards go unused each year. Reasons cited range from being misplaced or lost to forgotten. In addition to a financial loss for the gift-giver and the recipient, unused gift cards breed an array of accounting issues related to redemption – or lack thereof.

The regulation of gift cards is under the Federal Credit CARD Act of 2009, a federal law that regulates credit card issuers. Gift cards and gift certificates – not bank-issued debit cards – fall under the CARD Act umbrella. Its mission of consumer protection and empowerment, the Act requires disclosures for expiration dates and fees, limits inactivity and service fees, and establishes a five-year minimum expiration date for gift cards.

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.

Commonly known as escheatment, these statutes specify when unused funds must be remitted to the appropriate state government. Of course, each state has its own statute. For example, New Jersey, New York and Florida all offer a unique take on escheatment. Each has its own definitions of a gift card or gift certificate, as well as expiration dates, fee provision and escheat provision. Often considered unclaimed property, businesses must have a documentation system for tracking unused gift cards. In turn, this triggers remittance to the state once the dormancy period has been surpassed.

Accounting for gift cards and gift certificates is defined by Generally Accepted Accounting Principle (GAAP) Standards. The guideline emphasizes one very important fact: gift card revenue is not the seller’s money. It represents the intent to do business in the future. In short, gift cards and certificates are an alternative payment method rendered at the time services or products are provided.

Since gift card and certificate sales are not revenue, they are recorded as a liability on the balance sheet. All businesses issuing cards or certificates should maintain a matching bank account asset. The transaction is not recorded on the income statement at all. Rather, the cash goes to an escrow account, separate from the bank account, that can be drawn upon after the card or certificate is redeemed.

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. In turn, the business’ value diminishes. For those gift cards where redemption appears to be unlikely, income is recognized as breakage income. Companies typically use historical analysis and trends to estimate the breakage amount and recognize income.

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. In this case, owners do not view the sale as operating cash.

Tax treatment for gift card revenue is a bit complex. Income from the sale of gift cards is considered advanced payments for goods and services under Rev. Proc. 2004-34. For tax years beginning after January 1, 2018, taxpayers can elect to defer the income from gift cards to the end of the tax year following the tax year of receipt if that income has also been deferred for financial statement purposes. In other words, income recognized for tax purposes can’t be later than when it’s recognized for financial reporting purposes.

This differs from past treatment for tax years beginning before January 1, 2018, where there were two methods to account for advanced payments: the full inclusion method and the deferral method. Taxpayers who used the full inclusion method recognized receipts from gift cards and certificates in the tax year of receipt. When the payment was earned was irrelevant.

The deferral method recognized two different types of taxpayers: those with applicable financial statements and those without applicable financial statements. Taxpayers with applicable financial statements recognized income from gift cards as income in the tax year of receipt if that income was recognized in revenues in the applicable financial statement. Any remaining amount was included in gross income for the next succeeding tax year. If the taxpayer did not have an applicable financial statement, the taxpayer recognized gift card receipts in the tax year of receipt to the extent it was earned. Any amount not recognized as income in the tax year of receipt was recognized in the next subsequent year.

Taxpayers issuing gift cards in exchange for returned goods may treat the issuance of gift cards as a cash payment, with approval from the IRS.

There is no doubt gift cards and certificates – in their paper, plastic and digital forms – are here to stay. 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.