Though December numbers for retail performance will probably turn out to be discouraging, if not downright depressing, a popular form of gift-giving seems to have endured through 2008 – gift cards.
Gift cards come in two basic forms; either a Mastercard/Visa/Amex “prepaid” credit type of card (which GAAP guidance does very little to address) and every other variety of gift card, whether it be retailer-specific, used for telephone calls, or a vending machine card. The latter, called closed-system or closed-loop cards, can cause serious financial reporting headaches for retailers.
When the card is purchased by a gift-giver, it is recorded as a liability for the amount of the card, meaning $100 of merchandise (or any combination of merchandise and cash, depending on whether or not the retailer allows the recipient to “cash in” the remainder after a purchase) is owed to the customer.
Reporting is complicated due to “breakage” or gift cards that remained unused in the system. Because some cards do not have expiration dates, retailers must decide when the gift card amount is effectively “lost” on the books. Historical estimates of breakage by consumer research groups estimate that between 10-19% of gift cards are never redeemed. With $27.8 billion in gift card purchases reported in 2006, one can easily see the impact these unredeemed cards can have on a retailer’s statements.
Cards have a positive effect on the retail sector, of course, because they essentially extend the holiday season shopping frenzy through at least February and help keep excess holiday inventory to a lower level.
Few retailers even acknowledge breakage in their statements. In 2006, Best Buy reported that 24 months is a reasonable point at which the company can assume a gift card of that age will not be redeemed. Other retailers like Circuit City and Wal-Mart bypassed the breakage issue and stated simply that they recognize gift card sales as liabilities under deferred revenue.
Revenue-recognition under SFAC 5 can help to define the issues inherent to gift cards that GAAP does not, but some issues will always remain. Because of their nature, cards are often sent from one state to another, unredeemed, and even subject to fraud (both internal and external) like theft, misrepresentation, and retail employee scams.
So when you’re at the store cashing in that $100 gift card your grandma was nice enough to send for the holidays, take a moment to consider the complicated accounting of gift cards!