Gift cards or gift certificates are sold by a business to customers to allow them to purchase products at some future date. The cards are sold for cash and, in effect, the customer is prepaying for the goods.
There are three significant stages in the life of gift cards which need to be considered when processing transactions as follows:
- Sale: The gift cards are sold to the customer and the business has an obligation to supply goods in the future.
- Redemption: Customers redeem the gift card in return for products.
- Breakage: Some gift cards are not redeemed and ‘expire’ (referred to as breakage).
Gift Cards Sale
Gift cards are sold to the customers (usually in return for cash), and the business must establish the liability for its obligation to supply the customers with goods in the future.
Suppose the business sells gift cards for the amount of 1,500, the deferred revenue journal entries to record the sale are as follows:
|Gift card liability||1,500|
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 gift cards account represents the value of gift cards outstanding on which the business has an obligation to supply goods at a future date. The account is included in the balance sheet as a current liability under the heading of deferred revenue.
Gift Card Redemption
When a gift card is redeemed by a customer, the business satisfies its obligation to supply the goods and the liability is extinguished. The revenue can now be recognized and matched to the corresponding cost of goods sold.
Suppose a customer redeems a gift card for the amount of 400, the journal to record the gift card redemption is as follows:
|Gift card liability||400|
The business has supplied the goods to the customer and the revenue can now be recognized. The amount of 400 is transferred from the gift cards liability account (deferred revenue) in the balance sheet, to the revenue account in the income statement.
Gift Card Breakage
Gift cards can be issued with an expiration date and the revenue associated with them can be recognized when they are either used or on expiration of the card. Most cards however, are issued without an expiration date and considerations need to be given as to when revenue from unredeemed cards can be recognized.
It is normal for a certain percentage of the gift cards not to be redeemed by customers, this is referred to as breakage. If this breakage is not dealt with, the gift cards would remain as a balance sheet liability of the business indefinitely. In order to prevent this, the business can estimate the expected breakage, and release this amount to the income statement as revenue.
Gift Cards Breakage Example
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.
In the example above, the customer redeemed the amount of 400. This 400 reflects the 80% of the gift card value the business expects customers to redeem and therefore the total gift card value is estimated at 400/80% = 500. The remaining balance of 500-400 = 100 is the breakage (100/500 = 20%), which the business expects the customer not to redeem.
The business is now able to estimate the breakage revenue to be released proportionately as other gift card balances are redeemed by customers.
The bookkeeping journal to reflect this is as follows:
|Gift card liability||100|
In the above example, 400 was redeemed and the estimated breakage revenue, based on this redemption is 100. 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.
If the business is unable to estimate the breakage amount, the revenue for the unused portion of the gift card is recognized when the likelihood of the customer redeeming the gift card becomes remote.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.