University of Mississippi

eGrove

Honors College (Sally McDonnell Barksdale

Honors Theses Honors College)

2009

Accounting for Gift Cards: A Demonstration of the Need for a New

Accounting Standard
Ben Wilson Van Landuyt

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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

Ben W. Van Landuyt

A thesis submitted to the faculty ofThe University of Mississippi in partial fulfillment of

the requirements of the Sally McDonnell Barksdale Honors College

Oxford
May 2009

improved by

Advisor: Professor Rick Elam

Reader; Professor Dave Nichols

Reader: Dean Mark Wilder

I

©2009
Ben W. Van Landuyt
ALL RIGHTS RESERVED
}

II

L
 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

and disclosure. Of particular concern is the treatment of revenue resulting from

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

cards can effect financial reporting. The accounting concepts of comparability,

consistency, revenue recognition, matching, materiality, and conservatism were

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

reporting of pertinent gift card information.

iv
 TABLE OF CONTENTS

LIST OF FIGURES VI

INTRODUCTION 1

SECTION I: Background and Previous Research 5

SECTION II: Gift Card Accounting Inconsistencies: Data and Analysis 20

SECTION III: Testing Potential Standards ,45

CONCLUSION 56

LIST OF REFERENCES ,60

BIBLIOGRAPHY 62

APPENDICES 65
 LIST OF FIGURES

Figure 1 11
Breakage Reporting Companies

Figure 2 Percent Increase in Income Before Taxes Caused by Breakage ,35

Recognition

Figure 3 First Year Loading of Breakage(The Home Depot) 37

Figure 4 First Year Loading of Breakage ,38

Figure 5 First Year Loading of Breakage (Effect on Income before Taxes) ,39

Figure 6 Gift Card Breakage Recognition Rate .47

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

Ben Van Landuyt

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

lacks consistency, comparability, and transparency offinancial statements, and has

resulted in practices divergent with accounting principles. The following study will

illustrate the current problems with accounting for gift cards, test alternative standards,

and propose a new standard.

Reliably quantifying for accounting purposes the benefits to a company of a gift

card going unredeemed, a “non-event ’, is a difficult proposition. Accounting 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.

consistent, transparent, and reliable.

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

companies, resulting in varying effects to financial statements. Accounting variations and

theoretical flaws incumbent to the current gift card accounting environment limit the

usefulness of effected financial statements, and should therefore be addressed by new,

authoritative, and comprehensive accounting standards.

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

companies, fifty-three disclosed their breakage policy in a footnote to their financial

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

Other Revenue with no explanation in footnotes (Kile).

Despite numerous discrepancies in accounting practices, two general methods of

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,

or the age of the liability.

When assessing current accounting practices and considering a potential

accounting standard, it is important to address the accounting conceptual framework. In

particular, comparability, consistency, revenue recognition, matching, materiality, and

conservatism are concepts that must be reconciled with and satisfied by any new standard

for gift card accounting.

The hypothesis that a new accounting standard is needed is supported if the

following can be demonstrated. First, the lack of accounting standards undennine

financial statement comparability and consistency; second, that breakage revenue is a

material component ofinformation reported in financial statements; third, current

accounting for breakage revenue is often contrary to the revenue recognition and

matching principles; fourth, gift card accounting practices create divergences between the

matching principle and conservatism.

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

accounting standard is needed. Computation of the percent change in companies’ income

before tax tests the materiality of breakage. Analysis of current gift card related Forni 10-

K footnote disclosures will illustrate a lack of comparability and consistency. Exploration

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

recognizing breakage revenue being employed currently. One approach is based on an

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.

To successfully ensure reconciliation with financial accounting concepts and

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

comprehensive guidance to ensure reasonable treatment of gift cards and estimation of

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

History of Accounting for Gift Cards

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

unredeemed gift cards”(Kile).

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

it problematic for companies to accurately, consistently, and transparently reflect the

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

the Financial Accounting Standards Board has taken no position whatsoever. In

particular, the problem of dealing with unredeemed gift cards, called breakage, especially

complicates financial reporting.

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

under the jurisdiction of federal banking laws.

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

1999, and 17 December 2003. As summarized in a statement by SEC Staff representative.

Pamela R. Schlosser at the 2005 American Institute of Certified Public Accountants

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

of confidence in financial reporting.

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

predetermined, estimated percentage of unredeemed gift cards. For example, companies

may not record 10% of all gift card sales as revenue if they estimate that 10% of gift

cards will go unredeemed.(Schlosser)

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

determination of that point, however.

Another allowable method of revenue recognition for gift card breakage is to

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

treatment as unique circumstances might dictate.(Schlosser)

The SEC’s stance on computing and recognizing breakage revenue provides

somewhat of a loose framework for what could eventually become a principles-based

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

required for United States based companies,known as Generally Accepted Accounting

Principles, to more of a principles-based system. The International Accounting Standards

Committee promotes the use of a principles-based system called International Financial

Reporting Standards, and the SEC has outlined a timetable for convergence of US GAAP

with that system.

The principles-based approach focuses on establishing the “objectives of good

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

provide specific guidance or rules for every possible situation”(Shortridge). GAAP is

based on rules that include specific mandates and specifications,commonly known as

“bright lines”. Given the current accounting environment in the United States, it is

reasonable to expect that if accounting authorities issued a comprehensive gift card

accounting standard, it would be rules-based in conformity with GAAP.

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

issued no guidance on accounting for gift cards.

Some general guidance can be gleaned fi-om the revenue recognition principle, as

outlined in Statement of Financial Accounting Concepts 5. Revenue is recognized when

it is realized or realizable. “Revenues are considered to have been earned when the entity

has substantially accomplished what it must do to be entitled to the benefits represented

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

authoritative enough to have any meaningful impact on methods employed by companies

in gift card related financial reporting. The significant amount of gray area in current

standards allows individual companies a remarkable amount of discretion in determining

how to account for gift cards and related revenue. At best, it is likely that companies

would recognize a slightly disproportionate amount of benefits relative to earnings

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,

and other users of financial statements.

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

option for most companies.

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

are redeemed for merchandise or service.

Though this approach certainly conforms to the basic principles of financial

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,

especially as related to the stock market or economic forecasting.

An area somewhat analogous to gift card accounting is accounting for trading

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 stamp company for merchandise.

Trading stamps are similar to gift cards in that there is the likelihood for a

significant portion of outstanding stamps to go unredeemed. Revenue fi-om unredeemed

trading stamps, roughly equivalent to gift card breakage, is recognized in a year-end

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

principles to propose a new accounting standard.

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

card sales for the year.(Kile)

Because in many cases the amount of gift card breakage is material, it is

reasonable and necessary for companies to develop a method of recognizing revenue

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

reasonableness of these estimates.

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

card sales and breakage are rarely provided”(Kile).

 Because there are no associated inventory costs, when revenue from unredeemed

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

Revenue would at least segregate it from Sales Revenue.

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

muddles financial reporting.

Significance of Gift Card Accounting Environment

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

unredeemed gift cards”(Rappeport). That amounts to almost 7% of Ruth’s Chris

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).

As mentioned previously, the amount of gray in current gift card accounting

regulation opens the door for companies to possibly manage earnings to various degrees.

Wliile lack of comparability and transparency in financial reporting is undoubtedly a

problem under the current discloser conditions, the materiality of gift card sales,

redemption, breakage, and revenue make for potentially serious, even unethical, reporting

deficiencies.

Conceptual Framework of Accounting

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

FASB’s conceptual tfamework is “a coherent system of interrelated objectives and

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,

assumptions, principles, and constraints of financial accounting, and uses these

definitions as a basis and guide for dealing with specific or emerging accounting

problems. The FASB began developing their conceptual framework in 1976 and

subsequently issued a series of Statements of Financial Accounting Concepts.

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

financial accounting should strive to produce information that is comparable amongst

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.

Additionally, the accounting constraints of materiality and conservatism apply to an

analysis of gift card issues.

Comparability

Comparability requires that all companies follow the same rules when performing

a particular accounting function. When this is achieved, financial transactions will have

equivalent or consistent effects on different companies’ financial statements, allowing a

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

information produced by all companies following that standard is equivalent and

comparable.

Consistency

Consistency requires that individual companies deal with similar accounting

situations with similar accounting practices and methods from period to period. This

ensures that certain financial transactions will have equivalent and consistent etfects on

an individual company’s financial statements from period to period. If a company decides

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

consistent effects on a company’s financial reporting every period.

Revenue Recognition

When a company should recognize revenue is not always clear cut. Generally,

revenue should be recognized when it is realized or realizable, and when it is earned.

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

earned to be recognized. “Revenues are considered earned when the company

substantially accomplishes what it must do to be entitled to the benefits represented by

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

The matching principle is related to the revenue recognition principle in that

expenses related to revenue should be matched, or recognized together. Product costs,

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

which they occur.

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

cards it is difficult to determine associated costs to match with revenue.

Materiality

The FASB has declared that if an item’s inclusion or omission in financial

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

quantitative factors must be considered when detennining the materiality of an item.

(SEC SAB No. 99)

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

them from being overstated.

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

principles. It is impossible to completely uphold all the tenets ot accounting’s conceptual

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

Hypothesis: A Standard is Needed

Since breakage revenue often does and certainly has potential to significantly

affect companies’ financial statements, gift card accounting practices need to be

reconciled with accounting principles. Adequate and clear gift card disclosures should be

required by authoritative standards to ensure that financial statements contain a fair

representation of effects from gift cards. The following sections of this study will include

analysis of actual gift card accounting practices and examine whether:

Hi) Lack of accounting standards for gift cards is to the detriment of financial

statement comparability and consistency.

H2) Breakage revenue materially impacts financial statements.

H3) Current accounting for breakage revenue is often contrary to revenue

recognition and matching principles.

H4) Current gift card accounting practices create divergences between the

principles of matching and conservatism.

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,

it might be impossible to completely reconcile accepted practice to accounting principles,

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

reasonably reflect the economic effects of gift cards.

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

Breakage Reporting Companies

Abercrombie and Fitch Best Buy

The Children’s Place Golfsmith International Holdings

The Home Depot J. Alexander Corp.

Limited Brands, Inc. Sport Chalet, Inc.

Starbucks The Gap

Stage Stores, Inc. The Wet Seal Inc.

Hot Topic The Buckle

Casual Male Texas Road House

For each company and each fiscal year in which breakage was reported, the

following items of information, if available, were gathered:

1. Breakage Recognized

2. Income Before Taxes

3. Gift Card Liability

4. Income Statement

5. Balance Sheet

6. Footnote disclosure regarding revenue recognition and gift cards

Footnote Disclosures

A company’s practices and policies concerning gift card accounting are almost

exclusively disclosed in the footnotes to their consolidated financial statements in their

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).

Gift card information is generally included in companies’ Footnote 1: “Nature of

Business and Summary of Significant Accounting Policies.” Sometimes there is a

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

methodology is far from uniform.

Variations in Breakage Computation

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

redemption becomes remote is an ambiguous target for companies to subjectively

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

5% of the aggregate amount”(2007 10-K).

Alternatively, some companies recognize breakage based on the passage of time,

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

analysis of historic gift card redemption trends for that company.

The sixteen companies identified as disclosing a gift card breakage number at

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

factors. It is common for companies to use an analysis of historical redemption trends to

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

consistency, and other undesirable accounting ramifications.

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

disclosed no numbers related to gift card sales, liability, or revenue.

Breakage Rate Examples

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

liability by approximately 5% of the aggregate amount.” Sport Chalet provides no insight

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

since the inception of the various programs”

The footnote related to breakage irom Stage Stores’ 2006 10-K begins with the

statement,“Unredeemed gift cards and merchandise credits, net of estimated breakage.

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

combined gift card and merchandise credit liability by 4%.

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

no longer recorded the liability net of estimated breakage.

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

not disclose their gift card liability in 2006 and beyond.

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

inception of their gift card program.

The Casual Male

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

of gift cards or breakage revenue in the financial statements or footnotes.

Texas Road House

The Texas Road House recognized breakage for the first time in 2004. According

to their 2004 10-K,“the Company determined that a 5% breakage estimate, amortized

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

cards issued since the inception oftheir gift card program.

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.

Passage of Time Examples

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

Gap, The Wet Seal, and The Buckle.

Abercrombie and Fitch

Abercrombie and Fitch discloses gift card information in a footnote to their

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

multiple past periods’ breakage in 2004.

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

in 2007 compared to a .8% change in 2006.

Best Buv

Best Buy first recognized breakage in fiscal year 2006, and discloses gift card

related information in a footnote to their consolidated financial statements. They

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

million in breakage revenue.

Golfsmith International Holdings

Golfsmith International Holdings recognized breakage revenue from outstanding

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

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

to the following policy,“Based on the Company’s historical experience, management

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

Limited Brands, which has several subsidiaries, discloses breakage revenue

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

historical data existed.

Starbucks

According to the footnote in their 2007 10-K, Starbucks’ “management may

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

disclosed in either the 2007 or 2006 10-K.

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

of issuance.” Breakage, then, appears to be calculated as the unredeemed balance of over

three years old gift certificates and over four years old gift cards.

Summary of the Significance of Footnote Disclosures

Analysis of the preceding discussion offootnote disclosure practices clearly

demonstrates that gift card disclosure is far from uniform. As a result, the effects of gift

card breakage revenue on companies’ financial statements carmot be satisfactorily

measured and compared by potential investors, creditors, or other users of financial

statements. This situation raises interesting problems, some of which have not yet been

addressed by researchers.

Financial information cannot be accurately compared across all companies for a

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

accounting violate aspects of the matching and revenue recognition accounting

principles, and may cause conflict between the constraints of materiality and

conservatism.

Certainly, it should not be expected that a realistic and conservative estimate of

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

methodology produces striking disparities in breakage’s effects from company to

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

statements that are comparable, consistent, and conform to established accounting

principles and practices.

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

the potential to have, a significant effect on companies’ financial statements.

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

income before taxes

companies have reported breakage, breakage revenue’s impact on

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

effect on companies’ financial statements.

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

Percent Increase in Income Before Taxes Caused by

Breakage Recognition

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

Holdings in fiscal year 2005. Nine-Hundred-Thousand dollars of breakage revenue

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.

breakage revenue increased income before taxes by 10.3%.

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

and should be reconciled by a future standard.

First Year Loading of Breakage - Revenue Recognition and Matching Concerns

Seven of the sixteen companies reporting breakage employed an interesting

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

matching principles and impairs comparability and consistency.

The Home Depot is an especially interesting example of this practice because of

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

Rrst Year Loading of Breakage

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

revenue in their first year, than the next.

37
Figure 4

First Year Loading of Breakage

●D
0)
N 5.000,000 -
c 4,500,000 ]
O) 4,000,000
o 3,500,000
u
0) 3,000,000
2,500,000
<0 2,000,000
O)
(TS
1,500.000
1,000,000
(a 500,000 l D
<i) 0
m
^ ^^ <§‘ <# ^5? ^s?'
// / //
xP ^ J'
A^ A^ <«*●
///
Si Si 4
& ^cf
v'^v^v^

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

that could have been recognized previously.

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

o 12
c
c 10
CD 8
(A
c 6-
CO
0>
4
o
c 2
6^ 0 n
/// /
^0°\o»\oO'
^
/ / /// ^ ^^
///
/// is®- ^ /y
//
4</ .0
^<5^® .<^>®

cf tf"
cf cf

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

they are estimated to have occurred.

Additionally, first year loading further impairs comparability and consistency of

financial statements. Financial statements cannot be considered consistent within

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

disproportionate amounts of breakage revenue caused by first year loading.

Because the current practice of first year loading has a material and significant

effect on companies’ financial statements, and it violates or impairs important accounting

principles and concerns, it should be remedied by a new standard. A possible solution to

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

restatement of prior year financial statements.

Computation Methods- Conflict between Matching and Conservatism

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

card liability based on an annual percentage of that liability, or an estimation of breakage

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

an estimation of future breakage.

In comparing the two basic methods of breakage estimation, there appears to be a

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

actually realized. Companies, then, have no way to be completely accurate in calculating

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

principles of matching and conservatism.

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

taxes from breakage in 100%(13/13) of the companies’ reported periods.

By contrast, of the companies that recognized breakage based on the passage of

time, only tliree of the ten companies experienced at least one period in which breakage

had a material effect. Further, 58%(15/26) of reported periods showed an increase in

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

amount of gift cards that actually go unredeemed during that period.

An estimation of breakage based on the passage of time produces a more

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

the tangible economic benefit of unredeemed gift cards.

When crafting a standard, it must be decided how best to reconcile a reasonable

more
matching of revenue with the period benefited by the receipt of cash and the

conservative and accurate estimate of the amount of gift cards to actually go unredeemed

for a period.

Summary and Statement of the Need for a New Standard

In foregoing cases, breakage revenue was shown to have material effects on

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

reduced by breakage. Lack of a standard methodology leaves unanswered the question of

43
whether or not the breakage revenue for those respective periods is reasonable or

comparable enough to have such a profound effect on reported earnings.

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

their bottom line.

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

caused by the failure of financial statements to satisfy accounting principles.

Analysis ofthe data collected from the sixteen companies studied shows that

breakage revenue is a material concern, that there is an unacceptable lack of

comparability and consistency in the current reporting environment, and that gift card

accounting practices violate important accounting principles. For all these reasons, a new,

comprehensive, and authoritative standard must be created and implemented.

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

compared. As time progresses, individual companies’ financial statements will more

consistently reflect the effects ofrevenue from unredeemed gift cards.

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

of accounting’s Conceptual Framework.

Of the two methods currently used to compute breakage, percentage reduction of

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

application to extensive hypothetical data.

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,

however, have sufficient enough effect on financial statements that a section of

companies’ Footnote 1: Nature of Business and Summary of Significant Accounting

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

balance sheet, it should be disclosed in the footnote.

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

recognized. These rates, according to the SEC,should be computed by the individual

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

not lend sufficient credibility to these numbers.

Clearly, there is not a definitive, one-size-fits-all, rate. Regardless, in the interest

of better meeting the requirements of accounting concepts, it is reasonable to set a

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

higher standard rate.

Figure 6

Gift Card Breakage Recognition Rate

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)'

Percent Reduction of Gift Card Liability

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

reasonable (Figure 6).

A hypothetical company illustrates the effects of this standard. Calculations were

made based upon the following assumptions:

● Breakage is computed as an 8% annual reduction of the gift card liability.

● Eighty percent of gift cards sold are redeemed within the year in which

they are sold.

● 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 remaining outstanding gift cards go unredeemed.

● 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

Gift Card Liability and Breakage using the Percent Redution

Method, Inceasing Gift Card Sales

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

follow a clear increasing trend.

Figure 8

Gift Card Liability and Breakage using the Percent

Reduction Method, Erratic Gift Card Sales

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

desired objectives of a potential accounting standard.

Figure 9

Percent Reduction of One Year’s Unredeemed Gift Card

Liability
20,000 7
Breakage
GCL
15,000

I w
CO 10,000
o
Q
5,000

0
1 10 19 28 37 46 55 64 73 82 91 100
Year

Passage of Time Method

To recognize revenue based on the passage of time, companies should use

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.

A hypothetical company illustrates the effects of this standard. Calculations were

made based upon the following assumptions:

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

they are sold.

● 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

will increase by $800 each period.

Figure 10

Gift Card Liability and Breakage using the Passage of Time

Method, Increasing Gift Card Sales

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

liability remains within approximately a $13,000 window, never increasing or decreasing

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

Gift Card Liability and Breakage using the Passage of Time

Method, Erratic Gift Card Sales

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

A comparison of these two models for breakage computation indicates that

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

perpetual growth of the gift card liability (Figure 12).

Figure 12

Comparison of Gift Card Liability for Passage of Time and

Percent Reduction Methods given equal Gift Card Sales and
Redemption Patterns

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

years, for example)seems inappropriate, as redemption patterns vary from company to

company.

Because of the variability of different companies’ natural business cycles, a

principles-based standard, as opposed to a rules-based standard, might seem best suited to

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

principles-based international community.

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

accounting for gift cards and breakage revenue.

Based on these considerations, the following are proposed elements for a

successful standard:

Breakage revenue may be recognized at thirty-six months after the liability

was incurred unless a company can demonstrate compelling evidence that

sooner.
the point at which gift card redemption becomes remote occurs

Gift card issuing companies must disclose in the footnotes to their

consolidated financial statements the amount of their gift card liability,

and the amount of breakage revenue recognized in the current fiscal period

and where it appears on the income statement.

When computing breakage under the above constraints for the first time,

any revenue fi-om unredeemed gift cards attributable to prior periods (i.e.

liabilities over thirty-six months old) must be treated retrospectively with

an adjustment to beginning retained earnings.

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.

As gift cards grow in popularity, accounting for breakage revenue is an issue of

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

that do not fulfill the needs oftheir users.

The only current guidance for recognition of breakage revenue, contained in two

Securities and Exchange Commission Staff Bulletins, does not provide companies with

specific or authoritative direction. The Financial Accounting Standards Board, or its

Emerging Issues Task Force, to date, has failed to address the issue.

Previous research has established that companies use a variety of accounting

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

by examining four h\^otheses: 1)financial statements for companies with breakage

revenue are currently not comparable or consistent, 2)breakage revenue is a material

amount for many companies, 3)current practices violate the basic accounting principles

of revenue recognition and matching, and 4) practices create divergence between the

principles of matching and conservatism.

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

financial statements. Computation of the percent change caused by revenue from

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

conservatism constraint were not consistently upheld in practice because of varying

methods of breakage computation.

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

necessary to ensure the consistency, comparability, transparency, and integrity of the

financial accounting for relevant entities.

This study shows that such a standard would achieve those objectives and

reconcile accounting practice to accounting principle if it included the following

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

stated as fairly as possible and in accordance with established accounting principles. It is

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
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Financial Accounting Standards Board. 1976. FASB Discussion Memorandum.

Financial Accounting Standards Board. 2004. Statement of Financial Accounting

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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
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Rappepoit, Alan. “Re-Gifting: Unused Gift Cards Can Boost Company Income.
CFO.com 21 Nov 2007. 5 Nov 2008
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>.

Schlosser, Pamela R. Securities and Exchange Commission. 2005. Statement by SEC

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Schroeder, Richard G, et al. Financial Accounting Theory and Analysis. New York:
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Securities and Exchange Commission. 1999. Staff Accounting Bulletin No. 99. <
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Shortridge, Rebecca and Mark Myring. “Defining Principles Based Accounting

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61
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62

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64
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

Appendix B. Percent Reduction Method, Erratic 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
5 130,000 120,600 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

Appendix C. Passage of Time Method, Increasing Gift Card Sales

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

Appendix D. Passage of Time Method, Erratic Gift Card Sales

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

Appendix E. Percent Reduction of One Year’s Unredeemed Liability

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

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