Accounting For Gift Cards - A Demonstration of The Need For A New
Accounting For Gift Cards - A Demonstration of The Need For A New
Accounting For Gift Cards - A Demonstration of The Need For A New
eGrove
2009
Recommended Citation
Van Landuyt, Ben Wilson, "Accounting for Gift Cards: A Demonstration of the Need for a New Accounting
Standard" (2009). Honors Theses. 2141.
https://egrove.olemiss.edu/hon_thesis/2141
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accounting for gift CARDS:
A DEMONSTRATION OF THE NEED FOR A NEW ACCOUNTING STANDARD
Oxford
May 2009
improved by
©2009
Ben W. Van Landuyt
ALL RIGHTS RESERVED
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ACKNOWLEDGEMENTS
Thank you to Dr. Dave Nichols and Dean Mark Wilder for ser\dng on my thesis
committee and helping me think through the topic of accounting for gift cards.
Thank you, especially, to Dr. Rick Elam for serving as my thesis advisor. Without your
insight, help, and deadlines, this project would not have been completed.
Ill
ABSTRACT
BEN W. VAN LANDUYT: Accounting for Gift Cards: A Demonstration of the Need for
a New Accounting Standard
(Under the direction of Dr. Rick Elam)
This thesis concerns the current accounting environment and methodology related
to gift cards, and proposes a new accounting standard. The lack of authoritative guidance
for companies that issue gift cards has led to disparities in gift card financial treatment
unredeemed gift cards. Companies generally adhere to one oftwo basic methods of
calculating said revenue. The first method calculates revenue from unredeemed gift cards
as an annual percent reduction of the gift card liability. An alternative method recognizes
revenue from unredeemed gift cards with the passage of time. Thesis research included
analysis of Form 10-Ks, testing of data from companies who issue gift cards, and
simulated models to determine various ways in which revenue from unredeemed gift
considered in relation to gift card accounting methodology. It was concluded that a new,
authoritative standard is needed. This standard should require revenue from unredeemed
gift cards be recognized based on the passage of time, and mandate complete financial
iv
TABLE OF CONTENTS
LIST OF FIGURES VI
INTRODUCTION 1
CONCLUSION 56
BIBLIOGRAPHY 62
APPENDICES 65
LIST OF FIGURES
Figure 1 11
Breakage Reporting Companies
Figure 5 First Year Loading of Breakage (Effect on Income before Taxes) ,39
Figure 7 Gift Card Liability and Breakage using the Percent Reduction Method,
Increasing Gift Card Sales 49
Figure 8 Gift Card Liability and Breakage using the Percent Reduction Method,
Erratic Gift Card Sales 49
Figure 9 Percent Reduction of One Year’s Unredeemed Gift Card Liability.... ,50
Figure 10 Gift Card Liability and Breakage using the Passage of Time Method,
Increasing Gift Card Sales 51
Figure 11 Gift Card Liability and Breakage using the Passage ofTime Method,
Erratic Gift Card Sales 52
Figure 12 Comparison of Gift Card Liability for Passage of Time and Percent
Reduction Methods given equal Gift Card Sales and Redemption
Patterns 53
VI
Accounting for Gift Cards:
A Demonstration of the Need for a New Accounting Standard
Introduction
The sale of gift cards is a common marketplace transaction. Stored value cards
and certificates redeemable from the retailers and restaurants that sell them are
appreciated by consumers for their convenience and gift giving potential. Issuing
companies enjoy several tangible and intangible benefits from offering gift cards. One
benefit, revenue associated with gift cards that are never redeemed, raises some
interesting accounting questions. Consumer Reports found at the end of 2007, that 27%
of those who received a gift card in 2006 had not used it(Consumer Reports). The
material amount of unredeemed gift cards are a boon for companies as they represent
revenue with no associated good that must be transferred or service that must be
rendered. Lack of accounting standards on the topic has led to financial reporting that
resulted in practices divergent with accounting principles. The following study will
illustrate the current problems with accounting for gift cards, test alternative standards,
setting authorities have issued very little procedural guidance on the issue. As a result,
companies’ gift card accounting practices vary to a large extent. The revenue that results
from gift cards going unredeemed, also known as “breakage” revenue, has the potential
to impact companies’ financial statements in ways that are to the detriment of financial
statement users. Investors, creditors, government entities, and other external users cannot
make satisfactory decisions based on financial statements that are not comparable.
Gift cards sold by retailers and restaurants are recorded as a liability until their
redemption. Limited guidance on how to deal with revenue resulting from unredeemed
gift cards, breakage, has led to a variety of accounting approaches by gift card issuing
theoretical flaws incumbent to the current gift card accounting environment limit the
To date, there has been only one significant research study devoted to gift card
accounting. That study examined 167 gift card issuing companies to evaluate how
companies treat gift cards and breakage revenue. The study found that of the 167
statements, and only eight provided the specific amount of breakage revenue they
recognized from unredeemed gift cards. This indicates that the majority of companies
either did not recognize any breakage revenue or buried the amount in an account like
breakage computation have emerged among gift card issuing companies. Some
companies compute revenue from unredeemed gift cards by annually reducing their gift
card liability by a fixed percent. Others estimate breakage based on the passage of time,
conservatism are concepts that must be reconciled with and satisfied by any new standard
accounting for breakage revenue is often contrary to the revenue recognition and
matching principles; fourth, gift card accounting practices create divergences between the
The validity of these assertions will be established through testing of data from
companies that report an amount for breakage revenue. The results will indicate if a new
before tax tests the materiality of breakage. Analysis of current gift card related Forni 10-
of common gift card accounting practices will reveal other violations of accounting
principles.
Having established the need for a new standard this study will test which of two
alternatives may best satisfy relevant accounting concepts and principles. The
3
examination of current reporting practices identified two approaches to computing and
annual percent reduction of the gift card liability; the other is based on recognizing
breakage after a gift card has gone unredeemed for a certain length of time. A new'
standard will likely require that only one of these approaches be used by all companies
that issue gift cards. This study will test through simulation whether mandating the
percent reduction method or the passage of time method would best satisfy the pertinent
accounting principles.
promote financial statement integrity, a new standard must meet certain requirements.
Even if the new standard is based in principle, rather than rule, it should provide
breakage. Such a standard should ensure that financial statement reporting practices are
unifonn among and within companies and in accordance with proper accounting theory.
It should be mandated that financial statement disclosures related to gift cards present
sufficient information to convey the financial effects of gift cards. These considerations
in a new accounting standard would help make certain that the effects of gift cards and
associated breakage revenue clearly and consistently meet the objectives of financial
statement users.
4
Section I. Background and Previous Research
In recent years, consumers have become infatuated with the giving of gift cards.
In 2006, United States’ November and December holiday sales of gift cards alone totaled
an estimated $75 billion (Kile). Gift cards are popular with consumers for their
convenience as gifts, but are especially popular with retailers for numerous reasons. The
sale of gift cards are typically accompanied by “increased sales, marketing opportunities,
improved cash flow and inventory management and a stronger bottom line as the result of
The ambiguities of financial accounting for gift cards, coupled with their
widespread use, has raised some interesting accounting questions. Companies have
difficulties determining when the earnings process for gift cards is complete. That makes
economic effects of gift card sales in their financial statements. What’s more, the
Securities and Exchange Commission has offered minimal guidance on the subject, and
particular, the problem of dealing with unredeemed gift cards, called breakage, especially
There are two types of gift cards. The first type is usually backed by a credit card
company such as Visa or MasterCard. These are referred to as bank cards, are prepaid,
5
have a preset spending limit, can be used anywhere that accepts credit cards, and fall
The second type of gift card is issued by, and purchased from, individual retailers.
This variety of gift card causes financial reporting and disclosure difficulties, and is the
focus of this study. Referred to as non-bank, closed system, or closed loop cards, these
types of cards have applications beyond retail gift giving including “telephone calls,
restaurants, grocery stores, movie theaters, coffee shops, vending, and even payroll”
(Marden). Many colleges and universities also use this type ofsystem for meal plans and
student expenses.
The basic bookkeeping procedure for the sale of a gift card is to debit an asset
(usually cash) and credit a liability. Upon redemption of a gift card, a company debits the
gift card liability, and credits a revenue account. Unless a gift card is redeemed, the
liability would theoretically stay on the books indefinitely. A material portion of gift
cards go unredeemed, and it is certainly reasonable for companies to write off a portion
of their gift card liability and recognize breakage as revenue. How and when to recognize
revenue from unredeemed gift cards, breakage revenue, is not clear-cut because there is
no transaction or event which signals that the card will never be redeemed. This
circumstance is at the heart of the difficulties present when accounting for gift cards.
The only current guidance for the accounting treatment of retail gift cards,
especially with regard to gift card breakage, comes from the Securities and Exchange
Commission’s Staff Accounting Bulletins numbers 101 and 104, issued on 3 December
6
Conference for current SEC and PCAOB developments, the SEC’s accounting for gift
cards guidelines are not specific or authoritative enough to allow for the appropriate level
In that statement, the SEC explained their stance on, what is chiefly, the question
of when the liability associated with the selling of gift cards can be derecognized. That is,
the liability removed and recognized as revenue. The SEC’s position is that it is
inappropriate to recognize revenue immediately upon the sale of a gift card based on a
may not record 10% of all gift card sales as revenue if they estimate that 10% of gift
Revenue may be recognized when the gift card vendor is legally released from
their obligation. That occurs upon redemption or expiration of the gift card. To account
for breakage, the SEC allows companies to recognize revenue at a point when the
redemption of gift cards becomes remote. They offer no guidance or commentary on the
recognize breakage revenue in proportion to gift card redemption. Gift cards sold over a
certain period of time would be considered on a homogenous pool basis. The value of gift
cards expected to go unused would then be recognized over the period of performance,
that is, as the remaining gift card values are redeemed.” This requires companies to
“reasonably and objectively” determine both the amount of gift cards to go unredeemed
and the time period in which gift cards that are to be redeemed are actually redeemed. For
example, if a company estimates that 10% of gift cards will go unredeemed and that the
7
remainder will be redeemed, proportionally, over the next twelve months, then 10% of
gift card sales may be recognized ratably as revenue over the twelve month period.
Again, the SEC offers no guidance, commentary, or standard method of making the
determinations and estimations. Further, the SEC is open to other options for gift card
accounting standard. In the wake ofthe major corporate accounting scandals of the early
21“' century, which resulted in the Sarbanes-Oxley Act, there has been a push by many in
the accounting community for a shift from the rules-based accounting system currently
Reporting Standards, and the SEC has outlined a timetable for convergence of US GAAP
to some
reporting and then provides guidance explaining the objective and relating it
common examples. While rules are sometimes unavoidable, the intent is not to try to
“bright lines”. Given the current accounting environment in the United States, it is
8
The U.S. Financial Accounting Standards Board, the institution with the authority
for issuing the most authoritative accounting guidance and standards, has issued no
statement regarding the proper treatment of gift cards, and revenue related to breakage.
Additionally, the Emerging Issues Task Force, a subsidiary ofthe FASB, has no
announced plans to investigate the issue. The EITF is the first step for accounting
problems to be resolved through the issuance of new standards. Foreign authorities have
Some general guidance can be gleaned fi-om the revenue recognition principle, as
it is realized or realizable. “Revenues are considered to have been earned when the entity
by the revenues”(SFAC 5). The issue with breakage revenue from gift cards is not
detemiining if revenue has been realized, it is detennining when the earnings process has
been actually completed. That is, when the gift card actually goes unredeemed.
The lack of Generally Accepted Accounting Principles guidance for gift cards
poses several problems. What little guidance has been offered is not nearly specific nor
in gift card related financial reporting. The significant amount of gray area in current
how to account for gift cards and related revenue. At best, it is likely that companies
associated with gift cards. At worst, the potential exists that companies could use this
freedom to manage their earnings, alter their bottom line, issue misleading financial
9
statements, and, ultimately, inequitably influence decisions made by investors, creditors,
Generally Accepted Accounting Principles, or the lack thereof, are not the only
factors that influence how gift cards are, or should be, accounted for. State laws also
dictate how companies report financial information related to gift cards. Many states
escheat, turn over, the value of unredeemed gift cards to the state Treasury Department.
In Pennsylvania, for example, the value of unredeemed gift cards are escheated five years
after the card’s sale, or two years after expiration, if applicable. A law passed in January
2007 allows businesses to avoid the escheating process if gift card proceeds are from
qualified gift cards. A qualified gift card is defined as one that has no expiration date and
does not charge any fees to tlie cardholder. Other states have similar escheat laws. Unique
situations like this, as well as the many states that have legislation banning gift card
expiration dates and fees, may cause issuers of gift cards [to] 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. (Marden)
The abundance of state consumer protection laws restricting gift card expiration
dates has effectually eliminated their use by companies that operate in at least one state
with such laws. While cards with declining balances or expiration dates would eliminate
the problem of calculating and dealing with breakage revenue, such rules are not an
Given the context created by ambiguous guidance and varying state laws, actual,
current, gift card accounting and reporting is far from uniform, though some patterns
seem to be emerging. One thing that the SEC has made clear tlirough Staff Bulletins 101
10
and 104 is that immediate recognition of revenue related to gift cards is inappropriate.
Gift card sales are always recorded as an unearned or deferred revenue liability until they
accounting, it does pose a couple of interesting issues for the companies that sell the gift
cards, and for industry analysts. First, the gift card liability(and lack of any immediate
revenue recognition) incurred upon the initial sale of the card fails to reflect any ofthe
several, albeit somewhat intangible, economic benefits that gift card sales afford retailers
(i.e. increased sales, marketing opportunities, cash flow and inventory benefits, etc.).
Secondly, the unpredictability and inherent delay of gift card redemption defers
reporting the financial benefit of gift card sales, revenue, to future periods, while the
tangible benefit of gift card sales, the receipt of cash, occurs when the cards are initially
sold. This tends to cause financial statements to understate the actual effects and benefits
of, for example, the holiday selling season. In 2006, gift card sales caused industry
analysts to “misgauge 2006 holiday sales as being weaker than expected.” When January
sales, which were stronger than expected due to gift card redemptions, were counted
toward the 2006 holiday season, 2006 actually became “a strong year for most retailers”
(Kile), A situation like this could potentially have significant economic implications,
stamps. Trading stamps are a central component of a practice that began in the 1890s.
Trading stamp companies would sell stamps to merchants, who would them give them to
customers to incite repeat business. Consumers could then redeem the stamps with the
Trading stamps are similar to gift cards in that there is the likelihood for a
adjusting entry. For example, if a trading stamp company sold $100,000 worth of trading
stamps in the current year, and experience indicates that 95% of outstanding stamps will
be redeemed, they would recognize $5,000 in revenue from unredeemed trading stamps.
Unlike gift card breakage revenue, all revenue from unredeemed trading stamps is
recognized in the year of sale. This provides some support for the notion the same
treatment should be applied to the recognition of gift card breakage (Schroeder). Current
SEC guidelines, however, prohibit recognizing revenue from unredeemed gift cards at the
point of sale. The focus of this study will be to examine methods currently in use by
companies, and reconcile those methods with the SEC guidance and accounting
Previous Research
Dr. Charles Kile, of Middle Tennessee State University, analyzed the 2006 Form
10-Ks from 167 companies who sell gift cards to determine any trends, or lack thereof, in
gift card recording and reporting. Approximately two-thirds of the companies analyzed
provided at least some level of gift card relevant information. Of those that did not, most
were “Mom and Pop” or, as the researcher tenned it, “over-the-counter ’ operations. Most
of the companies reported their revenue recognition policies and the amount of their gift
12
card liability. Many companies disclosed where the liability appears on the balance sheet,
usually lumped into “accrued expense or other liabilities” or “deferred revenue”. Only
nine companies afforded the gift card liability its own separate line item on the balance
sheet, and only one company, Ruth’s Chris Steakliouse, disclosed the total amount of gift
related to unredeemed gift cards. Technology associated with the issue of most gift cards
makes it easy and efficient for companies to track gift card use. It has been demonstrated
an
that the more time that elapses, the less likely redemption becomes. Methods similar to
aging of accounts receivable or the use of historical trends to compute a weighted average
gift card breakage estimate allow companies to establish a basis for recognizing
unredeemed gift card revenue. The lack of a standard creates difficulties in evaluating the
Once some amount of breakage revenue has been determined, companies are
faced with the option of how to report it in their financial statements. Kile found that only
fifty-three ofthe 167 companies disclosed their breakage revenue recognition policies,
and only thirty-nine identified where that revenue appeared in the income statement.
Revenue was most commonly included in “net sales”, but “other income was also used.
The researcher concluded that “while an increasing number of companies are providing
gift card information, useful quantitative disclosures indicating amounts of annual gift
gift cards is recognized and included in net sales (or as a reduction of cost of goods sold)
it tends to overstate various investor sensitive financial trends and ratios related to sales
and gross margin. One suggested alternative is to reduce selling, general, and
administrative expenses when writing off unredeemed gift cards. This practice, however,
is “conceptually flawed and potentially misleading, since the economic benefit does not
originate from expense reduction measures”(Kile). Reporting gift card breakage as Other
There also exists the problem of how to treat gift cards that have previously been
written off but are subsequently redeemed, or (depending on the method used to
recognize breakage revenue) gift cards redeemed in excess of the reported gift card
liability. The most likely treatment would be to offset gift card revenue at redemption.
This contingency, coupled with the lack ofrequired gift card related disclosures, further
Given such a lack of restrictions and requirements, companies are not likely to
revenue
employ methodology, or disclose information related to gift cards and breakage
that would harm their financial standing. In 2007, Ruth’s Chris Steakhouses said that they
expected to “gain an added $2.2 million in operating income this year thanks to
Steakhouses’ 2007 Operating Income. Because the point at which breakage revenue can
be recognized is so subjective, some companies issue gift cards with the hope of creating
14
an additional revenue cushion. A Deloitte and Touche department head commented that,
“Some companies depend that people will not use their cards”(Rappeport).
regulation opens the door for companies to possibly manage earnings to various degrees.
problem under the current discloser conditions, the materiality of gift card sales,
redemption, breakage, and revenue make for potentially serious, even unethical, reporting
deficiencies.
Because of the need for financial accounting and reporting to be relevant and
reliable to financial statement users, the Financial Accounting Standards Board has
defined a conceptual fi*amework to serve as the basis for setting new standards. The
fundamentals that can lead to consistent standards and that prescribes the nature,
function, and limits offinancial accounting and financial statements (Kieso 28). In other
words, the FASB has fonnally defined the basic objectives, concepts, elements,
definitions as a basis and guide for dealing with specific or emerging accounting
problems. The FASB began developing their conceptual framework in 1976 and
Six principles from the FASB’s conceptual framework are of particular concern to
the discussion of accounting for gift cards. First are the two qualitative characteristics of
15
accounting information, comparability and consistency. The FASB has declared that
different companies and consistent from period to period within a single company.
Likewise, two basic principles of accounting, the revenue recognition principle and the
matching principle, are integral to the problems presented by gift card accounting.
Comparability
Comparability requires that all companies follow the same rules when performing
a particular accounting function. When this is achieved, financial transactions will have
comparison of companies to be relevant. Based on this concept the FASB has created
standards, setting rules for a multitude of accounting issues from calculating depreciation
to recording pension costs. While many standards are not totally rigid, and may afford
some flexibility in approach to an accounting issue, the rule must assure that the
comparable.
Consistency
situations with similar accounting practices and methods from period to period. This
ensures that certain financial transactions will have equivalent and consistent etfects on
to change accounting methods, it must disclose the specifics, justification, and effects of
16
the change in the period of the change. Based on this concept, the FASB must create
standards that ensure mandated accounting methodology will have equivalent and
Revenue Recognition
When a company should recognize revenue is not always clear cut. Generally,
Revenue is realized or realizable when a company exchanges goods or services for assets
or claims to assets. The most common example is when merchandise is sold for cash. If
an asset other than cash is accepted as payment, revenue is only realizable if the asset can
be easily converted to cash and has a determinable value. Further, revenue must be
the revenues”(SFAC 5). Determining the point at which revenue from unredeemed gift
cards is realizable and earned is at the heart of the conceptual problems related to gift
card accounting.
Matching
like material, labor, and overheard, can be associated with a particular product and are
not recognized as expenses until revenue is realized from the sale of the associated
product. Some costs, such as executives’ salaries and administrative expenses, cannot be
as easily linked with sources of revenue and must be expensed during the periods in
17
There are some conceptual flaws with the matching principle. Companies can
often end up deferring costs that may have no future benefit, and recognizing expenses in
periods during which they received no associated revenue. It is interesting to note that
with regard to gift card accounting, when revenue is recognized from unredeemed gift
Materiality
reporting would influence the judgment of a reasonable person, then that item is material.
Therefore, the materiality of a financial factor varies from company to company based of
the factor’s relative size and importance. “Companies and their auditors generally adopt
the rule of thumb that anything under 5% of net income is considered immaterial.
However, the SEC indicates that a company may use this percentage for an initial
assessment of materiality, but it must also consider other factors.” Both qualitative and
Conseiwatism
Finally, the FASB values the convention that when in doubt, the solution to an
accounting issue that is least likely to overstate assets and income is the best. That is, if
faced with a difficult decision, the alternative that avoids the overstatement of a
company’s bottom line is the preferred solution. This constraint and guide is known as
conservatism. Conservatism does not aim to understate assets or income, only prevent
18
Tlie elements of accounting’s conceptual framework are important, but not
completely rigid. The FASB tries to apply the conceptual framework when setting
standards but often ends up with standards that contain loopholes or contradict some
framework in every situation. When setting standards there is some give and take as
elements and principles are reconciled and practically applied to real world situations.
19
Section II. Gift Card Accounting Inconsistencies: Data and Analysis
Since breakage revenue often does and certainly has potential to significantly
reconciled with accounting principles. Adequate and clear gift card disclosures should be
representation of effects from gift cards. The following sections of this study will include
Hi) Lack of accounting standards for gift cards is to the detriment of financial
H4) Current gift card accounting practices create divergences between the
The implications of these conditions denote the problems incumbent to gift card
accounting and indicate the need for a clear and definitive standard. Like most standards,
but the issues above must be considered and gift card accounting practices must be
20
standardized and proper disclosures mandated, to ensure that financial statements
Data
Testing the foregoing hypotheses requires gathering financial statement data from
companies that have actually reported gift card breakage. That is, somewhere in their
financial statements, the company has disclosed a specific number for revenue recognized
were
due to unredeemed gift cards. Using Dr. Kile’s data, twenty-one companies
identified as candidates for reporting a dollar amount specifically identified as gift card
breakage revenue. For those twenty-one companies, Form 10-K filings for fiscal year
ended 2007 and 2006 were retrieved from the SEC’s EdgarOnline service. If either of the
two year’s 10-Ks reported a dollar amount for breakage, prior years’ 10-Ks were
retrieved until a report that did not include breakage was encountered. Using this method,
fifteen companies were identified as having presented a specific breakage dollar amount.
One additional company that did not disclose a breakage amount in 2007 or 2006 was
identified because of a reference made in Kile’s article. Figure A shows these sixteen
companies.
21
Figure 1
For each company and each fiscal year in which breakage was reported, the
1. Breakage Recognized
4. Income Statement
5. Balance Sheet
Footnote Disclosures
A company’s practices and policies concerning gift card accounting are almost
9')
Fonn 10-K. The only place gift card information shows up in the actual financial
statements as a separate line item is the gift card liability on the balance sheet. For fiscal
year 2006, only nine of 167 companies actually show gift card liability on their balance
sheet (Kile).
separate “gift card” heading within this footnote, but usually gift cards are discussed as a
component within the “revenue recognition” heading. For companies that actually
disclose their calculated amount of breakage, the information presented and language
used follows a similar format, but even within this sample, gift card accounting
Because the SEC has stated that it is inappropriate to recognize any breakage
revenue at the time gift cards are sold, companies must initially recognize all gift card
sales as a liability. According to the SEC,companies cannot recognize revenue fi-om gift
cards until legally released from the liability or the likelihood ofredemption becomes
remote. As gift cards are redeemed, companies are legally released fi'om their liability,
and the liability is converted to revenue. Determining the point at which the likelihood of
determine. Based on data gathered for this study, two alternative breakage computation
methods have emerged: breakage computed based on an annual percent reduction of the
gift card liability, and breakage computed based on the passage of time.
23
To recognize revenue from unredeemed gift cards, some companies elect to
determine a particular rate at which to annually, arbitrarily, reduce their gift card liability.
The journal entry would debit a liability and credit a revenue account. The rate is constant
from year to year. For example, The Sports Chalet recognizes breakage revenue by
“periodically decreasing the carrying value of the Gift Card liability by approximately
or periods of inactivity. For example. The Gap recognizes the balances of unredeemed
gift cards as income after three years have elapsed since the sale ot the card (2007 10-K).
The specifics of either method are decided upon by company management based on an
some point since 2004, exhibit the two prevailing trends for the estimation ofbreakage.
Some companies estimate breakage based on a gift card breakage rate, other companies
recognize breakage based on the passage of time, periods ofinactivity, or some other
estimate breakage under both methods. The following information from the footnotes of
the sixteen companies shows how even within the few companies that do make fairly
transparent gift card disclosures, there exists a significant lack of comparability and
It is interesting to note that only one company has ever disclosed the discrete
dollar amount of gift card sales for the year (Kile). In fiscal year 2006 Ruth’s Chris
24
reported total gift card sales for the year, but did not report breakage revenue, and in 2007
Of the sixteen companies studied, five use a gift card breakage rate to determine
breakage: Sport Chalet, Stage Stores, Hot Topic, The Casual Male, and The Texas Road
House.
Sport Chalet
Sport Chalet began recognizing breakage in 2005 at the time of the issuance of
gift cards. This method is disallowed by the SEC, and the company began recognizing
breakage at the time of redemption in following periods. Per their 2007 10-K,“breakage
is recognized as revenue by periodically decreasing the carrying value of the Gift Card
into how they determined to use 5% as the amount by which they reduce their gift card
liability.
Stage Stores
Stage Stores combines their gift card liability with their merchandise credit
liability, and likewise recognizes breakage for both. From their 2007 10-K, “the
Company’s gift cards and merchandise credits are considered to be a large pool of
homogeneous transactions.” They recognized breakage for the first time in 2006 and
“included the breakage income related to gift cards sold and merchandise credits issued
The footnote related to breakage irom Stage Stores’ 2006 10-K begins with the
25
are recorded as a liability.” This is a violation of SEC guidelines if the associated revenue
was recognized at the time the liability was recorded. For 2006, the first time they
recognized breakage, revenue w'as recognized in the fourth quarter by reducing the
In their 2007 10-K, Stage Stores states that “breakage income is recognized based
on usage or actual redemptions as the cards are used.” This statement does not clearly
convey to the reader when exactly revenue is recognized, but it seems to indicate that
breakage is not recognized at the time the liability is incurred. Also in 2007, the company
In their 2005 10-K, Stage Stores reported that their gift card liability at year end
2005 and 2004 was $ 12.2 million and $10.3 million, respectively. There is no mention of
merchandise credits or the liability being recorded net of estimated breakage. They did
Hot Topic
According to their 2007 10-K, Hot Topic uses a gift card breakage rate of 5-6% to
recognize breakage. They recognized $1.2 million in 2007 and 2006 which indicates that
the balance of their gift card liability was nearly identical at year end 2007 and 2006. As
with most companies that use a gift card breakage rate, when they recognized breakage
for the first time in 2005, it included revenue from unredeemed gift cards issued since the
The Casual Male first recognized breakage revenue in 2005 based on a gift card
breakage rate of 7-8%. 2005 revenue included revenue from unredeemed gift cards issued
26
since the inception of the gift card program. Their 2006 10-K was the last to include any
infonnation about gift cards in its footnotes. Their 2007 10-K has no mention whatsoever
The Texas Road House recognized breakage for the first time in 2004. According
over 3 years, should be recorded for each gift card that is sold, based on historical
redemption trends.” Rather then recording revenue, they reduce operating expenses by
$1.7 million (increasing income before taxes by 6.2% and decreasing their gift card
liability by 10.4%). Presumably, this number includes breakage from unredeemed gift
Texas Road House reported in their 2007,2006, and 2005 10-Ks that they were
using the same policy to recognize breakage, or rather, to adjust expenses. They did not,
however, disclose the amount of adjustments to expenses for any year except 2004.
Eleven of the sixteen companies use a passage of time basis for recognizing
breakage revenue: Abercrombie and Fitch, Best Buy,The Children’s Place, Golfsmith
International Holdings, The Home Depot, J. Alexander, Limited Brands, Starbucks, The
consolidated financial statements along with other revenue recognition information. Their
2005 10-K was the first to report specific breakage and gift card liability numbers and did
27
so for the fiscal years 2005 and 2004. The footnote states that Abercrombie and Fitch
recognized no revenue from breakage in 2003. It is unclear whether or not 2004 was the
first year they recognized breakage, but it appears unlikely that Abercrombie recognized
According to their 2005 10-K,“The Company considers the probability of the gift
card being redeemed to be remote for 50% of the balance of gift cards at 24 months after
the date of issuance and remote for the remaining balance at 36 months after the date of
issuance and at that time recognizes the remaining balance as other operating income.”
Their method of detennining breakage, according to their 2007 10-K, has been amended
as follows, “The Company detemiines the probability of the gift card being redeemed to
be remote based on historical redemption patterns, and recognizes the remaining balance
as other operating income.” The latter method provides a considerable amount more
flexibility for Abercrombie, and breakage caused a 1.5% change in income before taxes
Best Buv
Best Buy first recognized breakage in fiscal year 2006, and discloses gift card
recognize breakage based on the passage of time. They consider the possibility of
redemption remote at twenty-four months after the gift card is issued. Best Buy s income
was increased $46 million in 2007 and $43 million in 2006 by gift card breakage. It can
be imputed that their total gift card liability was reduced by 8.5% and 8.4% in 2007 and
2006, respectively.
28
The Children's Place
The Children's Place recognized breakage for the first time in 2005. Their 2005
10-K states that of the “of the SI.3 million adjustment, the Company estimates that
approximately $1.0 million relates to fiscal 2004 and prior. The Company did not restate
prior years’ financial statements since the impact was immaterial.” In their 2006 10-K,
the company disclosed portions of the $1.3 million applicable to 2005 and 2004 as if
those portions had been recognized discretely in those periods. That is, per the 2006 10-
K breakage revenue for 2005 and 2004 was $300,000 and $400,000, respectively,
accounting for a .3% and .6% increase in those years respective income before tax. In
reality, however, 2005 income was increased by 1.4% through the recognition of the $1.3
gift cards and returns credit for the first time in 2005. From their 2007 10-K, estimated
breakage is calculated and recognized as revenue over a 48-month period following the
card or credit issuance, in amounts based on the historical redemption patterns of the used
cards or credits. Amounts in excess of the total estimated breakage, if any, are recognized
as revenue at the end of the 48 months following the issuance of the card or credit.
The Home Depot reports gift card breakage numbers in a footnote to their
consolidated financial statements. They state that they use historical redemption patterns
as a basis for determining an amount for which the likelihood of redemption is remote
29
and recognizes that amount as income. The 2007 10-K reports that “Fiscal 2005 was the
first year in which the Company recognized gift card breakage income, and therefore, the
amount recognized includes the gift card breakage income related to gift cards sold since
the inception of the gift card program.” In comparison with the other companies from the
sample, The Home Depot recognizes exceptionally large dollar amounts for breakage
revenue. In years 2005, 2006, and 2007 they recognized S52, S33, and $36 million,
respectively. Each of these amounts, however, had a less than 1% impact on net income
before tax.
J. Alexander Corporation
When J. Alexander Corporation began issuing gift cards in 2000, they charged the
cards (and reduced their liability) with a $2 monthly service charge after twelve months
of inactivity. The service charges were recorded as revenue. They discontinued this
practice in 2005, likely due to consumer protection laws, and began estimating according
considers the probability of redemption of a gift card to be remote when it has been
outstanding for 24 months.” Further, “in 2005, the Company recorded breakage of
$168,000 in connection with gift cards that were more than 24 months old and $366,000
in connection with the remaining balance of gift certificates issued prior to 2001.”
Limited Brands
amounts in their footnotes. In 2005 the company recognized breakage for two subsidiary
companies. They recognized $30 million of breakage over thirty-six months based on a
gift card breakage rate determined from historical redemption patterns. Limited disclosed
30
the intention to recognize more breakage related to other subsidiaries when adequate
Starbucks
deteiTnine the likelihood of redemption to be remote for certain card and certificate
balances due to, among otlier things, long periods of inactivity”, and recognize breakage
revenue. Starbucks is the only company from this sample that differentiates between
stored value gift cards, and gift certificates. Their gift cards and gift certificates have the
same characteristics (with the exception that the card balances can be replenished) and
provide exactly the same function. In fiscal year 2007, the company recognized breakage
revenue related to both gift cards and certificates. In 2006, which was presumably their
first year to recognize breakage, Starbucks recognized only gift card related breakage.
The Gap
The Gap records revenue from unredeemed gift cards after an interval of time has
elapsed. In their 2007 10-K they reported that in 2006 they changed their policy from
recognizing breakage after five years to three years. They recognized $31 million in fiscal
year 2006, causing a 2.5% increase in income before taxes. They do not disclose any
breakage information in the 2006 10-K, and it is unclear from the 2007 10-K footnote
what exactly the $31 million is. It could be additional breakage recorded in 2006 due to
the change accounting policy, or total breakage for that year. No other numbers, or even
confirmation breakage was recognized, related to 2007 or any other fiscal year are
31
The Wet Seal
The Wet Seal recognized breakage for the first time in 2007. $3.7 million of
breakage revenue, which included revenue from prior periods, increased their income
before taxes by 18.6% and reduced their gift card liability by 37%.
The Buckle
The Buckle includes breakage revenue in Other Income, and disclosed the
amounts recognized since 2004 in their 2006 10-K. This was their first disclosure of
specific breakage amounts. They do not specifically disclose how they determine
breakage but, according to their 2006 10-K,“the amount of the gift certificate liability is
determined using the outstanding balances from the prior three years of issuance and the
gift card liability is determined using the outstanding balances from the prior four years
three years old gift certificates and over four years old gift cards.
demonstrates that gift card disclosure is far from uniform. As a result, the effects of gift
statements. This situation raises interesting problems, some of which have not yet been
addressed by researchers.
given time period when gift card accounting practices vary to the extent illustrated above,
its not apples to apples. Financial information from one company for a given time period
32
cannot be accurately compared to other periods when gift card accounting practices
within a company are not consistent for all time periods. Further, some trends in gift card
principles, and may cause conflict between the constraints of materiality and
conservatism.
breakage produce the same percent change in income before taxes for every company,
every period. Some companies might truly realize a greater economic benefit from
unredeemed gift cards than other companies, and (for smaller companies especially) it
might have a greater effect on their bottom line. However, when the use of different
company and within individual companies, comparability and consistency have been
compromised.
Given the extent and effects ofthese issues, specific standards for the
to ensure financial
computation and disclosure of breakage revenue is necessary
Materiality of Breakage
Despite any potential conflicts with accounting principles incumbent to gift card
accounting practices, these issues would be of little concern as long as breakage revenue
has a negligible effect on company’s bottom line. For time, effort, and resources to be
exerted in shaping a new standard and enforcing more diligent gift card accounting
33
practices, it must be demonstrated that revenue from unredeemed gift cards has, or has
For the sixteen companies that reported breakage, analyzing the percent change in
income before taxes caused by recognized breakage revenue shows the magnitude of
breakage’s effect on the companies’ bottom line. Over a combined 40 fiscal years (the
number of individual reporting periods, not span of time) in which those sixteen
ranged from less than 1% to more than 36% with an average of approximately 4%. Figure
2 shows that the effects of breakage fall in somewhat of an inverse bell cure. The two
tails are less than a 1% increase in income before taxes, and greater then a 5% increase.
Five percent is a reasonable tlireshold at which breakage can be said to have a material
Using this criterion, breakage has a material effect almost as often as it causes a
less than 1% increase in income: 11 of40 periods over 5% versus 14 of40 periods less
than 1 %. Further, eight of the sixteen companies have experienced at least one fiscal
period since 2004 in which breakage increased income before taxes by 5% or more. This
exhibits that while breakage is sometimes immaterial, and its effect depends not only
upon the magnitude of breakage but also the company’s income, it certainly has the
potential to and often does have substantial effects on companies’ financial statements.
34
Figure 2
15
(A
T3
.2 10
0)
CL
° 5
o
z
:-l.:
0
0-.9 1-1.9 2-2.9 3-3.9 4-4.9 5-5.9 6+
Percent Increase in Inc. b/f Taxes
Analysis of specific companies gives further compelling evidence for the potential
effects of revenue from unredeemed gift cards. The most significant change to income
before tax caused by breakage revenue recognition took place for Golfsmith International
caused a 36.6% increase in their income before tax. The next year, the company reported
a loss before taxes which was reduced by 15.0% when they recognized $1,400,000 in
breakage revenue.
In 2006, Sport Chalet, Inc. reported taxes in excess of income before taxes.
Assuming their revenue from breakage of$397,000 was taxed at a 35% marginal tax rate,
then it would have decreased their net loss by 74.7%. Ignoring tax consequences.
J. Alexander Corp saw their income before taxes increase by 13.7% from
unredeemed gift card revenue in fiscal year 2005. Sport Chalet had an over 10% bump
35
from breakage in fiscal 2006. The Wet Seal recognized breakage in fiscal 2007 causing
an 18.6% increase in income before taxes. Hot Topic, in fiscal 2005, saw a 9.4% jump,
and also in 2005, the Casual Male experienced a 17.6% increase in income before taxes
from breakage. Conversely, six companies over fifteen periods experienced a less than
1% increase in income before taxes from recognizing revenue from unredeemed gift
cards.
These specific examples, as well as general observations from the sample group
of companies clearly indicate that breakage has the potential to, and often does,
materially effect companies’ financial statements. For this reason, the concerns raised by
the variety of accounting methodology used by issuers of gift cards are worthy of analysis
accounting maneuver by including revenue attributable to past periods during their first
period to recognize breakage. In other words, when these companies first recogmzed
breakage revenue, they lumped in revenue that they estimated could have been
recognized during past periods. This practice violates the revenue recognition and
the magnitude of breakage revenue recognized. Figure 3 shows total breakage revenue
recognized in fiscal years 2005, 2006, and 2007. In 2005, The Home Depot recognized
37% more revenue than in 2006, and 31% more than in 2007. Breakage related to prior
36
periods has inflated the effect of breakage revenue on the year in which it is first
recognized.
Figure 3
60,000,000
●a
Q>
N 50,000,000
C
g 40,000,000
I 30,000,000 i
o)
(0
20.000,000
2 10,000,000
GO
0
The Home The Home The Home
Depot 2005 Depot 2006 Depot 2007
Figure 4 shows the same effect from this “first year loading” of breakage on the
remaining six companies. Breakage revenue for the first year J. Alexander Corp
recognized breakage is 50% and 43% higher than the subsequent two years. Stage Stores
recognized 70% more breakage tlieir first year than the next. The Wet Seal has only had
one period in which they have recognized breakage, but did include revenue attributable
to prior years. Hot Topic’s breakage revenue in their first year to recognize was 61%
higher than the subsequent year. The Children’s Place saw breakage decrease by 69% and
54% after their first year to recognize. The Casual Male recorded 33% more breakage
37
Figure 4
On the surface first year loading of breakage seems reasonable. When companies
first decide they can recognize revenue from unredeemed gift cards, using either a
breakage recognition rate or the passage of time method, their balance of gift cards likely
to go unredeemed is significantly higher than it would have been had they been
recognizing breakage all along. Therefore, they reduce their liability and recognize
revenue in greater amounts than they will in subsequent periods to account for breakage
While this does contradict the revenue recognition and matching principles, it
would not be a large concern if the additional breakage revenue had an immaterial effect
on companies’ bottom line. Figure 5, however, shows that this is not the case. For five of
the seven companies, first year loading produced a material effect on reported income
before taxes. Breakage revenue’s effect on income before taxes was at least double the
subsequent periods’ (or normal periods’) effects for all but one of the seven companies.
38
For some companies, first year loading caused breakage revenue to increase income
before taxes in the first year by three or four times as much as in the following years.
Figure 5
(A 20
First Year Loading of Breakage
O
X 18
h- 16
n 14 T
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c
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CD 8
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cf tf"
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First year loading is an aspect of current gift card accounting practice that
highlights the overall problems breakage revenue causes with regard to the revenue
recognition and matching principles. As stated earlier, detemiining the point at which
revenue from unredeemed gift cards is realizable and earned is what makes a reliable
estimation of breakage so difficult. Companies that use a gift card breakage recognition
rate do so under the assumption that some annual percentage of their liability is a fair
estimation of the amount of gift cards to go unredeemed. Other companies estimate the
probability of redemption is remote after a certain amount of time has passed. While both
of these methods might prove to be valid means to estimate breakage revenue, neither can
explicitly determine when revenue is realizable or earned, i.e. when a gift card actually
39
goes unredeemed. Because this is something that really cannot be determined, standard
setters are charged with the task of determining the best way to estimate breakage.
When companies first year load, they clearly breach the matching principle by
showing an economic benefit in a period that is different from the period that actually
benefited from gift cards going unredeemed. The matching principle says that revenues
should be matched with their associated product costs, like material, labor, or overhead.
A peculiarity with the recognition of any breakage revenue, not just first year loading, is
that there are no associated product costs to unredeemed gift cards. Breakage revenue,
then, can almost be thought of as “period revenue”, in that it cannot be linked with costs
and is recognized in the period in which it is estimated to occur. With this in mind, a new
standard should attempt to confine reporting of the economic benefits to periods in which
individual companies over multiple periods when one period has a disproportionate
amount of breakage revenue caused by first year loading. Financial statements for a given
year are not comparable across several companies when some companies have
Because the current practice of first year loading has a material and significant
this problem is to deal with revenue attributable to prior periods retrospectively with an
40
adjustment to beginning retained earnings, sufficient footnote disclosures, and possible
When a business sells a gift card, they receive cash and establish a liability. When
any portion of that gift card is redeemed, the liability is reduced and revenue is
recognized. The foregoing has established that revenue from unredeemed gift cards is
usually estimated and applied based on one oftwo basic methods: a reduction of the gift
based on the passage of time since the initial sale of the gift card. The SEC prohibits
recognizing a percentage of each gift card sale as revenue at the time of the sale based on
fundamental conflict between matching and conservatism. Because a gift card going
revenue is
unredeemed is a nonevent, it can never be precisely determined when breakage
the amount of revenue that is appropriate to recognize for a given period. Contrasting the
two general methods for the estimation of breakage exhibits a tradeoff between the
When companies use a set rate by which to reduce their gift card liability annually
they seem to more closely match revenue with the period benefited than when companies
recognize breakage based on the passage of time. Using a gift card breakage recognition
rate, however, appears to be a less conservative estimate of when the revenue fi-om
41
unredeemed gift cards is actually earned. That is, revenue recognition based on the
passage of time is a better conceptual measure of when gift card redemption becomes
remote.
Additionally, the data examined here suggests the percent reduction being the less
conservative method, or at least the method most likely to have a significant effect of
companies’ bottom line. Of the sample of sixteen companies that reported breakage, six
estimated it using an annual rate. Ofthose six, all had at least one period since 2004 in
w hich breakage has had a significant effect(5% or greater increase) on their income
before taxes. All six companies experienced at least a 1.8% increase in income before
time, only tliree of the ten companies experienced at least one period in which breakage
income before tax due to breakage of less than 1%. This shows that for companies who
reduce their gift card liability using an annual rate, breakage revenue has had a more
substantial effect on income, possibly indicating that breakage estimations based on the
passage of time are a more conservative measure of revenue from unredeemed gift cards.
The trend among the sample companies is that over time the gift card liability
increases. Therefore, the breakage recognition rate approach best matches revenue from
unredeemed gift cards with the tangible economic benefit of the original sale of those gift
cards: the receipt of cash. As gift card sales increase and the company receives more
cash, using an annual rate will cause the amount of breakage revenue to proportionally
increase with the increased sales. This matches revenue recognition with the period that
42
actually receives the economic benefit, the receipt of cash. Calculating breakage using
this method, however, may not be the most accurate or conservative measure of the
conservative amount for unredeemed gift card revenue. Estimating breakage based on the
passage of time defers increasing economic benefits from breakage due to increasing
sales of gift cards to future years. It provides a more realistic estimation of the point in
time when the company can reasonably claim that a gift card has gone unredeemed.
Therefore, it allows for a more reliable estimate of unredeemed gift cards attributable to
the current period. That is, the period in which the gift cards actually go unredeemed.
However, it does not match revenues with the receipt of cash: the period which receives
conservative and accurate estimate of the amount of gift cards to actually go unredeemed
for a period.
financial statement numbers that are important to investors, creditors, and other users of
financial statements. What’s more, these companies actually disclosed, albeit somewhat
buried in the footnotes, the extent to which their income was magnified or loss was
43
whether or not the breakage revenue for those respective periods is reasonable or
Companies that actually have reported specific gift card infomiation, including
breakage revenue, would seem to be the most responsible and conservative in their
estimates, accounting, and disclosures of gift card data. Even among and within these
companies there exist immense discrepancies and lack of comparability and consistency.
There is no way to know if companies that disclose far less information related to their
gift card accounting policies are using breakage to have an even more material effect on
While acknowledging that breakage does not always have a material effect on a
company’s bottom line, there is potential for it to have an immense effect. At worst, the
lack of standardized treatment for and disclosure ofbreakage revenue and gift card
accounting opens the door for the possibility of earnings management,income smoothing
and other unscrupulous behavior that can cause misleading financial statements that
inequitably influence decisions made by investors and creditors beyond the limitations
Analysis ofthe data collected from the sixteen companies studied shows that
comparability and consistency in the current reporting environment, and that gift card
accounting practices violate important accounting principles. For all these reasons, a new,
44
Section III. Testing Potential Standards
Aside from reconciling gift card accounting practices to accounting principles, the
most immediate and important benefit from a new standard is improvement in the
comparability and consistency of financial statements for companies that sell gift cards.
Wlien companies use the same method to compute, apply, and disclose breakage, gift
are
cards’ fiscal effects will be relative and equivalent when financial statements
A strong case can be made that the preferred method of dealing with breakage
revenue would be to recognize it, based on a reliable estimation, at the point of sale. It is
not conceptually flawed to argue that estimated breakage revenue is earned and realizable
when the gift cards are sold. The remainder ofthe revenue is earned when the cards are
later redeemed. The critical event for the recognition of breakage revenue is the purchase
of the card, not the passage of time. The SEC, however, disallows any recognition of
revenue from unredeemed gift cards at the point ofsale. Therefore, a new standard must
detennine an alternative approach to dealing with breakage that fits within the constraints
the liability and passage of time, some variation of either should be adopted as the
45
standard. To measure which method best achieves the desired objectives of a new
standard, real world data should be uniformly applied to each method and the results
analyzed. Because of limitations in the availability of disclosed gift card data, a proposed
standard using either method cannot be applied to the sixteen companies to analyze the
effects of the standard. Therefore, proposed standards were tested in this study by
Regardless of which method is used as a basis for the standard, adequate gift card
related information disclosures must be compulsory for companies that issue gift cards.
Based on data gathered from the sixteen companies, breakage revenue does not have a
significant enough effect to be required as a separate line item on the income statement,
and could be included as a component of an account like Other Income. Bieakage does,
Policies should be dedicated to gift card disclosure. This section should at least include
the dollar amount of breakage recognized and where breakage is included on the income
statement. Likewise, while the gift card liability does not warrant its own line on the
The criteria used to recognize breakage revenue under both computation methods
is when the seller can determine the point at which they are legally released from the gift
card liability. Each method offers a different approach to computing how much of the
liability can be written off. The percent reduction method assumes that a certain
percentage of gift cards outstanding go unredeemed every period. The passage ot time
method assumes that all gift cards over a certain age will go unredeemed.
46
Percent Reduction Method
Figure 6 shows the distribution of actual disclosed and imputed gift card breakage
recognition rates from the sample of companies over the periods in which breakage was
companies based on historical analysis of gift card redemption trends. Theoretically, they
should all be accurate and appropriate for each company, but the lack of standard
methodology and the ambiguity of the SEC’s requirements for the historical analysis do
maximum percent by which the gift card liability can be reduced, even ifsome
companies might legitimately calculate that they experience more breakage. Likewise,
few companies who would have computed a lower rate would likely complain about a
Figure 6
7
(A 6
1 5—
o 4 —jk
2: 3 -
● 2 ~
Z 1 -T-
0
Q) q> O)
/ W <D- <b- A- 93- q>-
<o' A." 9)'
47
For the purposes of this paper, the reduction of the gift card liability due to
revenue recognized from unredeemed gift cards will be set at 8%,as this number falls in
the middle of reported and imputed rates from the sample companies and seems
● Eighty percent of gift cards sold are redeemed within the year in which
● Fifty percent of unredeemed gift cards are redeemed in their second year
outstanding.
● Twenty percent of unredeemed gift cards are redeemed in their third year
outstanding.
● The company has gift card sales of$100,000 during their first year of
operations.
If gift card sales increase by $10,000 each period, the gift card liability and
amount of breakage recognized will grow every period (Figure 7, Appendix A).
Additionally, the incremental increase to breakage revenue and the gift card liability will
grow each period. Because the company reduces the liability by a percentage,
unredeemed gift cards are never completely removed from the books.
48
Figure 1
350,000
300,000
250,000 t GC Sales!
</) 200,000
n Breakage
150,000
O GCL
Q 100,000
50,000
0
1 3 5 7 9 11 13 15 17 19
Year
Figure 8(Appendix B)shows the effects of erratic gift card sales. In this example,
despite increases and decreases in gift card sales, the gift card liability and breakage
Figure 8
200,000 -r
150,000
GC Sales
ns 100,000 Breakage
o GCL
O
50,000
0 . . . . . . . '. . . .=^
1 3 5 7 9 11 13 15 17 19
Year
Figure 9(Appendix E)shows how reducing the gift card liability by a certain
annual percent does not allow for the full recognition of the desired amount of breakage.
49
and leaves unredeemed gift cards on the books for a prolonged period of time, never
completely eliminating the liability. The forgoing data suggests that, the metliod of
computing breakage based on a percent reduction of the gift card liability does not fulfill
Figure 9
I w
CO 10,000
o
Q
5,000
0
1 10 19 28 37 46 55 64 73 82 91 100
Year
historical data to determine the number of periods subsequent to the sale of gift cards at
which their redemption becomes remote. Like above, for the purposes of ensuring
comparability and consistency a discrete number of years after which companies can
recognize breakage is desirable in a standard, even if it might exceed or fall short of some
individual companies’ estimates. For this hypothetical application, three years falls in the
middle of the reported time periods from the sample of companies, and seems reasonable.
50
● Breakage is computed by writing off the remaining balance of the gift card
liability at the end of the third year from the year in which the liability was
incurred.
● Eighty percent of gift cards sold are redeemed within the year the in which
● Fifty percent of unredeemed gift cards are redeemed in their second year
outstanding.
● Twenty percent of unredeemed gift cards are redeemed in their third year
outstanding.
If a company sells $100,000 in gift cards their first year, and sales increase by
$10,000 each period (Figure 10, Appendix C), their gift card liability will increase by
$12,000 in year two,$11,000 in year three, and $3,800 in all subsequent years. Breakage
Figure 10
350,000
300,000
250,000 GC Sales
2 200,000
Breakage
= 150,000
Total GCL
Q 100,000
50,000 -
0
1 3 5 7 9 11 13 15 17 19
Year
51
Figure 11 (Appendix D)shows the effects of the same erratic gift card sales
experienced in the previous example. In this example, from year four on, the gift card
by more than $8,000 in a single year. Likewise, from year four on, breakage fluctuates by
approximately $5,000, never increasing or decreasing during a single period by more than
$4,000 and $2,400 respectively. The gift card liability reached its highest point in year
nine at $59,800. The highest amount of breakage revenue, $13,600, occurred in year
fourteen, year twelve had the highest amount of gift card sales.
Figure 11
200,000 -
_ 150,000
GC Sales
ra 100,000 Breakage
o Total GCL
° 50.000
0
1 3 5 7 9 11 13 15 17 19
Year
Computing breakage based of the passage oftime causes the subsequent revenue
and changes to the gift card liability to mirror actual changes in gift card sales. However,
effects are deferred by the three years companies must wait to recognize revenue matched
with gift card sales made in the current period. By completely writing off the outstanding
liability after three years, this method ensures that the gift card liability does not
continually increase over time as it does under the percent reduction method.
52
Comparison
breakage recognized based on the passage oftime is the more desirable alternative.
Breakage computed using the passage oftime method produces financial data with less
fluctuation, and more closely correlated (although three years deferred) to changes in
sales volume. Most importantly, it completely eliminates the unredeemed liability, and
does so at once, not over the course of several periods. This allows for breakage revenue
recognition that is more completely correlated with the periods benefited and prevents
Figure 12
200,000
150,000 GC Sales
2 100,000 GCL(POT)
ra
o GCL(PR)
Q 50,000
0
1 3 5 7 9 11 13 15 17 19
Year
If the two methods were combined, allowing for an annual percent reduction of
the liability with the balance of unredeemed gift cards written off after three years, it
would result in the same total breakage but would somewhat smooth the deferral effect
caused by the passage of time method. Analyses of the foregoing hypothetical situations
53
indicate that the passage of time computation method should be the basis of any new
standard.
Despite the need for conformity of practice, different companies observe different
gift card redemption patterns and therefore have the potential to legitimately determine
the point of remote gift card redemption at different intervals. For example, if one
company has justifiable evidence that all outstanding gift card balances over two years
old will go unredeemed, while another company rightfully recognizes breakage after
three years, then the breakage revenue recognized in both cases is equally valid.
Comparability and consistency of financial statements has not been impaired. In this
sense, a standard including a rigid mandate of when redemption becomes remote (three
company.
address the issues of breakage recognition. The big problem is ensuring that companies
fairly, comparably, and consistently estimate when breakage can be recognized. If this
cannot be guaranteed, then any standard, either based in principle or rule, cannot be
successful as it will not solve the problems caused by a lack of comparability and
consistency in financial statements. This is an important topic for future research, and is
an issue incumbent to more broad and overreaching accounting dilemmas as the United
States’ rules-based accounting community begins to move towards convergence with the
54
The current SEC guidance for breakage recognition is an effectual principles-
based standard, and the forgoing study has illustrated its failures in ensuring proper gift
card accounting practices. Unless proven otherwise, some “bright line” is needed to
ensure that the standard solves the problems that have been demonstrated to accompany
successful standard:
sooner.
the point at which gift card redemption becomes remote occurs
and the amount of breakage revenue recognized in the current fiscal period
When computing breakage under the above constraints for the first time,
any revenue fi-om unredeemed gift cards attributable to prior periods (i.e.
55
Summary and Conclusion
The preceding study demonstrates the need for a new accounting standard for gift
cards. Resulting changes to accounting for gift cards and breakage revenue will reconcile
practice with theory, uphold important financial accounting concepts and principles, and
ensure that financial statements best serve the needs of their users.
increasing importance. While it is essential for companies to reflect the financial benefits
of unredeemed gift cards in their financial statements, the current regulatory enviromuent
affords companies too much financial reporting leeway and results in financial statements
The only current guidance for recognition of breakage revenue, contained in two
Securities and Exchange Commission Staff Bulletins, does not provide companies with
Emerging Issues Task Force, to date, has failed to address the issue.
presentations when recognizing breakage revenue on their financial statements, and that
very few companies provide any specific information that is useful to financial statement
users. Previous research stopped short of analyzing any explicit financial effects, or
substantially considering how current practices related to accounting theory and concepts.
56
The research reported here demonstrates the need for a new accounting standard
amount for many companies, 3)current practices violate the basic accounting principles
of revenue recognition and matching, and 4) practices create divergence between the
Analysis of Form 10-Ks since 2004 from sixteen breakage reporting companies
illustrated the lack of comparability and consistency caused by gift card accounting in
unredeemed gift cards in income before taxes for companies that report breakage showed
that breakage has the potential to be and often is a material component of a company’s
bottom line. The common practice of“first year loading” of breakage revenue was found
to be in conflict with revenue recognition and matching. And the matching principle and
To determine how the problems created by current gift card accounting practices
could be solved tlirough a new standard, extensive testing of hypothetical situations was
used. The two currently used alternative methods of breakage computation (one based on
an annual percent reduction of the gift card liability, the other based on the length of time
a gift card goes unredeemed) were applied to theoretical companies. The findings
indicated that the passage oftime method is the more desirable alternative for
recognizing breakage.
57
The overail results of this research indicate that the Financial Accounting
Standards Board needs to take action to standardize the accounting for and disclosure of
gift cards. The preceding demonstrated that when companies take advantage of SEC
allowances to reduce gift card liabilities and recognize revenue, they do so without
disclosing the specifics of their methodology. It has been shown how companies’
practices impair the integrity of their financial statements, and potentially mislead the
users of those statements. Authoritative and specific guidance for the treatment ofthe
various issues related to the use of gift cards, their financial effects, and disclosure is
This study shows that such a standard would achieve those objectives and
prerequisites. First, it must be based on the method of computing breakage based of the
passage of time, not a percent reduction of the gift card liability. Second, it must mandate
that companies provide complete gift card disclosures that fully inform the financial
statement user of pertinent and specific gift card and breakage revenue related
information.
The unique characteristics of gift cards and revenue from unredeemed gift cards
create some interesting accounting dilemmas. Because breakage revenue can and does
si
rignificantly affect companies’ financial statements, it important that it be computed and
clear that to ensure this, and protect those who rely upon applicable financial statements.
58
a sufficient, definitive, and authoritative standard must be promulgated by the appropriate
accounting authorities.
59
r
LIST OF REFERENCES
60
“Avoid Gift Card Pitfalls.” Consumer Reports. Dec 2007. Consumer Reports.
<http://vvw\v.consumerreports.org/cro/money/shopping/shopping-tips/gift-card-
pitfalls-12-07/over\'iew/gift-card-pitfalls-ov.htm>.
Rieso, Donald, et.al. Intermediate Accounting. Hoboken: Wiley and Sons, 2007.
Rile Jr., Charles. “Accounting for Gift Journal ofAccountancy 204.5 (2007): 38.
Marden, Ronald, and Timothy Forsyth. “Gift Cards and Financial Reporting.” The CPA
Journal 11.\ \ (2007): 28.
Rappepoit, Alan. “Re-Gifting: Unused Gift Cards Can Boost Company Income.
CFO.com 21 Nov 2007. 5 Nov 2008
<http://www.cfo.eom/article.cfm/l0167303/c_l0170769?f=home_todayinfinance
>.
Schroeder, Richard G, et al. Financial Accounting Theory and Analysis. New York:
Wiley and Sons, 2001.
Securities and Exchange Commission. 1999. Staff Accounting Bulletin No. 99. <
http://www.sec.gov/interps/account/sab99.htm>.
61
BIBLIOGRAPHY
62
1
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63
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1
APPENDICES
65
Appendix A. Percent Reduction Method, Increasing Gift Card Sales
GC GC Incremental Incremental
Year Sales Redemptions Breakage GCL Breakage GCL
1 100,000 80,000 1,600 18,400
2 110,000 98,000 2.432 27,968 832 9,568
3 120,000 110,000 3,037 34,931 605 6,963
4 130,000 119,300 3,650 41,980 613 7,050
5 140,000 128,600 4,270 49,110 620 7,130
6 150,000 137,900 4,897 56,313 626 7,203
7 160,000 147,200 5,529 63,584 632 7,271
8 170,000 156,500 6,167 70,917 638 7,333
9 180,000 165,800 6,809 78,308 643 7,391
10 190,000 175,100 7,457 85,751 647 7,443
11 200,000 184,400 8,108 93,243 651 7,492
12 210,000 193,700 8,763 100,780 655 7,537
13 220,000 203,000 9,422 108,357 659 7,578
14 230,000 212,300 10,085 115,973 662 7,615
15 240,000 221,600 10,750 123,623 665 7,650
16 250,000 230,900 11,418 131,305 668 7,682
17 260,000 240,200 12,088 139,017 671 7,712
18 270,000 249,500 12,761 146,755 673 7,739
19 280,000 258.800 13,436 154,519 675 7,764
20 290,000 268,100 14,114 162,305 677 7,786
GC GC Incremental Incremental
Year Sales Redemptions Breakage GCL Breakage GCL
1 100,000 80,000 1,600 18,400
2 110,000 98.000 2,432 27,968 832 9,568
3 120,000 110,000 3,037 34,931 605 6,963
4 130,000 119,300 3,650 41,980 613 7,050
5 130,000 120,600 4,110 47,270 460 5,290
6 110,000 104,900 4,190 79 910
48,180
7 160,000 142.900 5,222 60,058 1,033 11,878
8 150,000 139,300 5,661 65,097 438 5,039
9 160,000 147,800 6.184 71,113 523 6,016
10 140,000 132,500 6,289 72,324 105 1,211
11 120,000 114,800 6,202 71,322 -87 -1,002
12 170,000 152,200 7,130 81,993 928 10,670
13 150,000 140,600 7,311 84,081 182 2,089
66
14 150,000 140,100 7,518 86,463 207 2,382
15 120,000 115,500 7,277 83,686 -241 -2,777
16 130,000 120,500 7,455 85,731 178 2,045
17 120,000 112,600 7,450 85,680 -4 -50
18 110,000 103,900 7,342 84,438 -108 -1,242
19 150,000 134,600 7,987 91,851 645 7,413
20 140,000 130,300 8,124 93,427 137 1,576
GC GC Incremental Incremental
Sales Redemptions Breakage GCL Breakage GCL
Year
1 100.000 80,000 20,000
2 110.000 98,000 32,000 12,000
3 120.000 109,000 8,000 43,000 11,000
4 130.000 118,200 8,800 46,800 800 3,800
5 140.000 127,400 9,600 50,600 800 3,800
6 136,600 10,400 54,400 800 3.800
150.000
7 160,000 145,800 11,200 58,200 800 3.800
8 170.000 155,000 12,000 62,000 800 3,800
9 180.000 164,200 12,800 65,800 800 3,800
10 190.000 173,400 13,600 69,600 800 3,800
11 200.000 182,600 14,400 73,400 800 3.800
12 210,000 191,800 15,200 77.200 800 3,800
13 220,000 201,000 16,000 81,000 800 3,800
14 230,000 210,200 16,800 84,800 800 3.800
15 240.000 219,400 17,600 88,600 800 3,800
250,000 228,600 18,400 92,400 800 3,800
16
260.000 237,800 19,200 96,200 800 3.800
17
270.000 247,000 20,000 100,000 800 3.800
18
280.000 256,200 20,800 103.800 800 3,800
19
20 290.000 265,400 21,600 107,600 800 3.800
GC GC Incremental Incremental
Sales Redemptions GCL Breakage GCL
Year Breakage
1 100,000 80,000 20,000
2 110,000 98.000 32,000 12,000
3 120.000 109.000 8,000 43,000 11,000
4 130,000 118.200 8,800 46,800 800 3,800
5 130,000 119,400 9,600 48.600 800 1,800
6 110,000 103.600 10,400 45,400 800 -3.200
7 160,000 141,600 0 8,000
10,400 53,400
67
8 150,000 138,200 8,800 54,800 -1,600 1,400
9 160,000 146,200 12,800 59,800 4,000 5,000
10 140,000 131,000 12,000 56,000 -800 -3,800
11 120,000 113,200 12,800 50,800 800 -5,200
12 170,000 150,800 11,200 57,200 -1,600 6,400
13 150,000 139.400 9,600 56,600 -1,600 -600
14 150,000 138,400 13,600 58,600 4,000 2,000
15 120,000 114,000 12,000 51,000 -1,600 -7,600
16 130,000 119,000 12,000 50,000 0 -1,000
17 120,000 111,400 9,600 46,600 -2,400 -3,400
18 110,000 102,600 10,400 44,400 800 -2,200
19 150,000 133,400 9,600 50,600 -800 6,200
20 140,000 129,200 8,800 51,800 -800 1,200
GC GC GCL b/f
Year Sales Redemptions Breakage Breakage GCL
1 100,000 80,000 20,000 1,600 18,400
2 0 10,000 8,400 672 7,728
3 0 2,000 5,728 458 5,270
4 0 0 5,270 422 4,848
5 0 0 4,848 388 4.460
6 0 0 4,460 357 4,103
7 0 0 4,103 328 3,775
8 0 0 3,775 302 3,473
9 0 0 3,473 278 3,195
10 0 0 3,195 256 2,940
11 0 0 2,940 235 2.705
12 0 0 2,705 216 2,488
13 0 0 2,488 199 2.289
14 0 0 2,289 183 2,106
15 0 0 2,106 168 1,938
16 0 0 1,938 155 1,783
17 0 0 1,783 143 1,640
18 0 0 1,640 131 1,509
19 0 0 1,509 121 1.388
20 0 0 1,388 111 1,277
100 0 0 2 0 2
68