INTEGRATING GIFT CARDS INTO THE ACCOUNTING CURRICULUM
Ronald R. Rubenfield
Associate Professor of Accounting
Robert Morris University
(412 262-8301
rubenfield@rmu.edu
Accounting Track
(Refereed research paper)
INTRODUCTION
Gift cards have become an increasingly popular way of conducting business. Tower
Group estimated that $97 billion was spent on gift cards in 2007. [2] Although this figure
was expected to decline to about $88.5 in 2008 it still represents a sizeable portion of the
retail industry. [2] Since many students are familiar with these cards accounting
instructors have a unique opportunity to enhance students’ comprehension of both
business and accounting concepts. This paper will discuss the two types of gift cards,
review gift cards in comparison to other ways of transacting business and explain the
accounting for these cards. The paper concludes by offering suggestions for the effective
use of these and for establishing a more consistent accounting for them.
Types of Cards: Retail v. Bank
Perhaps the best introduction to gift cards is to first discuss the ubiquitous debit card
that most students are very familiar with. The debit card, although misnamed, is really the
same as paying cash or issuing a check. Money is in the user’s account and withdrawn
immediately upon authorization. The user authorizes a deduction either by signature or
by identification number (PIN). The business is assessed a fee so it does not collect the
full proceeds of the transaction but does have immediate access to the cash. Of course,
from an accounting point of view, the user’s cash account is reduced, or credited, thus
giving rise to the inaccurate term for the transaction.
With this context established the instructor can move to a discussion of the more
complicated and contentious gift cards. There are two popular types of gift cards, retail
and bankcards. Both are pre-loaded with cash thus their similarity to debit cards, Retail,
or close-looped, cards are by far the most popular but bankcards are catching up. Retail
cards are purchased from a specific retailer and can be used only at that establishment
thus giving rise to their closed-looped or limited nature. Bankcards, on the other hand,
have greater flexibility and can be used virtually anywhere like a bank credit card. In
2008 it was estimated that $60 billion was spent on retail cards which represented a
14.4% decline from the previous year. [2] Bankcard use for the same period was
estimated at $28.5 billion representing a 5.6% increase from 2007. [2] Obviously the
recession has taken its toll on all businesses but has hit retail cards particularly hard.
Perhaps consumers are concerned about the potential bankruptcy of certain retailers and
have curtailed their purchases of these cards thus exacerbating the decline. How does
using gift cards stack up with other ways of doing business?
Transacting Business
Merchants can engage in business transactions for cash, charge cards or, the
increasingly prevalent, gift cards. A cash transaction provides an immediate exchange of
assets and except for the possibility of a return the business cycle is complete. The
merchant has the cash and the customer the goods or services. It is a business neutral
transaction. If the customer uses a charge card the goods or services are received before
payment is made. The consumer gains an advantage (float) if the liability is paid in a
timely fashion. If cash is not paid when due interest accrues at a high rate and the
merchant (or bank) benefits if the cash is ultimately collected. Of course, there is the
possibility of incurring a bad debt if the merchant provides the financing or being
assessed a service charge if a bank credit card, such as VISA, is used. The retail gift card
transaction is the most advantageous transaction for the merchant. The merchant receives
cash prior to earning it and the possibility exists that the card may never be fully
redeemed (breakage) making it a seemingly ideal way to conduct business. In addition
the money is immediately available to earn interest. With a bankcard the user initiates a
transaction, similar to using a debit card, and the money is withdrawn from the available
cash and transferred to the merchant. Unlike a retail card there is typically an up-front
service charge to the purchaser of a bankcard. We now look at how gift card transactions
are accounted for.
Gift Card Accounting
A brief review of the revenue recognition principle would be helpful before the
discussion of gift card accounting is undertaken. Revenue recognition, of course, occurs
when a transaction is complete and the collection of an asset is reasonably assured.
Normally this occurs when a product is delivered or a service rendered and a charge card
or cash is given in consideration. The revenue is typically recorded at the point of
exchange whether or not cash is received at that time. With a retail gift card the merchant
receives the cash before delivering a product or rendering a service. This transaction
establishes a liability (unearned revenue) for the merchant. When the obligation is “paid”
with the delivery of a product or rendering of a service the liability is reduced and
revenue is recorded. With a bankcard, when a card is used, the merchant treats it as a
cash transaction similar to a debit card accounting and the bank reduces its liability. The
above transactions are routine and non-controversial. However it is the non-use of these
cards and related service fees that can be problematic for their users.
Breakage and Service Fees
It is impossible to accurately gauge how much gift card breakage occurs. It is up to the
business to self-report breakage in its annual report if one is required. Private companies,
of course, have no requirement to provide any financial activity to the public.
TowerGroup estimated that unredeemed gift cards totaled almost $8 billion in 2006. [1]
In its survey for 2006 Consumer Reports found that 27% of recipients had not used at
least one card, up from 19% in 2005. [1] Whatever the actual amount, suffice it to say,
breakage is large and growing with increased gift card use.
Related to the potential for breakage are service charges and expiration dates.
Bankcards, unlike retail cards, almost always carry up front service charges to the
purchaser. A common charge might be $3 for any card with a value of $10-$1000. For
example a $50 card would be purchased for $53. In addition most bankcards will assess
another fee for non-usage after a certain period of time typically six months. This, of
course, de facto establishes a time limit on usage, as eventually unused cash will be
exhausted. So the sponsoring bank can derive revenue in three ways: from interest by
investing the money before payouts are authorized, from up-front charges and from nonuse fees. While these revenue opportunities seem to be somewhat exploitative for a no
risk, low-cost service that the bank is providing all must pass the scrutiny of bank
regulators.
Retail cards can also assess non-use charges and establish time limits on usage but
the practice has become less common. Perhaps pressure from state governments,
including applying escheat law, has discouraged these practices. Indeed in a survey of
fifteen large retailers, the author did not find one that still maintained a service charge or
expiration date. [4] Several had recently eliminated one or both of these practices.
Accounting for Breakage
As mentioned above there is little controversy involving the sale and redemption of
the retail gift card. The contentious issue is when to book the expected breakage and an
appropriate amount. No specific Generally Accepted Accounting Principle (GAAP) has
been issued to clarify the issue. The only general guidance comes from the Securities and
Exchange Commission’s (SEC) Pamela Schlosser who indicated, at an American
Institute of Certified Public Accountants’ conference in 2005, that income recognition at
the time the card is sold is not appropriate [5]. She went on to add that it was her staff’s
previous view that it would be appropriate to recognize revenue when “the vendor is
legally released from its obligation” to deliver the goods or services or “at the point
redemption becomes remote” [5]. No further guidance is given and no specific
accounting standard has been issued regarding breakage. The author did find that eight
of the fifteen companies surveyed used “remote” to describe the threshold for
recognizing breakage income. [4] When mentioned, the “remote” period varied up to 60
months from the purchase of the card. [4] Clearly the accountant, in determining the
recognition threshold, must use professional judgment. Historical evidence should be
prioritized. Accounting instructors can relate this adjustment to the one involving bad
debts. The accountant uses an aging analysis or a historical percentage to determine the
appropriate write-off for bad debts. Similarly with breakage, accountants would use past
experience regarding the non-use of retail cards in determining the amount of breakage to
record. If this amount is material the opportunity for earnings management exists. A
class discussion of the materiality concept might be appropriate at this point. For
example, in 2005, Home Depot opted to record $43 million from estimated breakage in
previous years [3]. Since this was the first year of recognizing any breakage Home Depot
recorded the accumulated amount for all prior periods that the retail card was available. It
added another $9 million for estimated 2005 breakage. [3] Are these amounts material
enough to warrant skepticism on the part of the auditor or investor? Could income have
been manipulated by overestimating breakage? How much did this adjustment affect this
period’s earnings per share? Also, Home Depot disclosed these amounts not as
additional revenue but as a reduction in selling, general and administrative (SGA)
expense [3]. Obviously, this accounting treatment was conveyed in its annual report.
Since no GAAP exists for gift card accounting other companies may not be as
forthcoming as Home Depot. Indeed Kile’s research indicated that only 39 companies
(23%) disclosed any gift card revenue on the income statement [3]. So how should
breakage be disclosed? And what might a standard for gift card accounting look like?
This presents the instructor an opportunity to discuss the need for a possible standard for
gift card accounting. The following points could be the basis for this discussion.
Toward Consistent Breakage Accounting
The amount of the earnings recognition for previous years’ breakage and for the
current year, if material, should be disclosed and explained in the footnotes. If a
separate account is not provided for breakage revenue the footnote should explain what
account is used. The best conceptual approach would be to show it as an operating
income item as part of sales. In essence, breakage is the additional charge for goods that
were redeemed with the gift card. It certainly is not related to SGA expense as recorded
by Home Depot or to cost of goods sold since nothing was sold. Furthermore it does not
meet the criteria for an extraordinary item (unusual and infrequent) or an unusual item
(unusual or infrequent) so it should not be disclosed as such. As far as the time period to
wait to recognize breakage revenue a reasonable period would seem to be two years. The
de facto breakage period (when the probability for redemption becomes remote) is likely
less than two years so this would be a conservative approach and is consistent with
current tax law. If an amount is redeemed in a later period it could be reversed out much
like occurs when a bad debt previously written off is ultimately collected.
SUMMARY AND CONCLUSION
Instructors have a unique opportunity to integrate gift cards into the accounting
curriculum to enhance students’ understanding of business and accounting concepts. The
most important financial issue for businesses and consumers is that some of the cards’
value will likely go unused thus giving rise to the concept of breakage. The business thus
has extra income potential everytime a gift card is purchased. And virtually the only cost
to the business would be for the purchase of a card reader which typically sells for around
$500. Recipients of gift cards should therefore use these cards promptly to avoid
breakage or service fees for non-use. As for the accounting for gift cards, instructors
have an opportunity to reinforce the important revenue recognition rule. In addition the
instructor can discuss the potential need for a standard involving the recording of the
estimated breakage revenue because the accounting for gift cards varies widely. A
comparison with the accounting for bad debts can be used to establish the context for
establishing or applying an appropriate standard. In conjunction with this discussion
concepts such as materiality and extraordinary items can also be reviewed.
With gift cards playing an increasingly large part of business transactions some
discussion of this concept is appropriate in the introductory or intermediate accounting
courses. The students already have the personal experience with these transactions. It
would seem routine to add it as a component to the accounting curriculum to both stay
current with modern business practices and to comprehend how to account for gift card
transactions.
REFERENCES
1. Anonymous. Consumer Reports Takes on Gift Cards in Second Annual Public
Education Campaign [online].
www.consumersunion.org/pub/core_financial_services/ous188.html.
2. Anonymous. TowerGroup Press release [online].
www.towergroup.com/research/news/news.htm?newsId=4940
3. Kile Jr., C. O. (2007). Accounting for Gift Cards. Journal of Accountancy, November:
38-43.
4. Rubenfield, R. (2008). Survey of fifteen public companies.
5. U.S. Securities and Exchange Commission Statement by SEC Staff: Remarks Before
the 2005 AICPA National Conference [online].
www.sec.gov/news/speech/spch120505ps.htm.