Gift cards – the gift that keeps on giving…
My gift to you for the holidays, here is a discussion on gift card accounting from one of my guest bloggers, Paul Unger.
Are your gift cards leaving money on the table?
By Paul Unger
Gift cards sold for cash or on a credit card are accounted for as a liability until they are redeemed. But there are gift cards that will never be redeemed; guests will lose them, forget about them, etc., and it doesn’t make sense to keep a liability on your books forever. Fortunately, U.S. GAAP recognizes this reality, and lets you “pick up” the amount left behind on the table as revenue — “breakage.”
Before reviewing how unredeemed gift card values are recognized as revenue, you will have to consider whether any unclaimed property laws apply. This can be complex since unclaimed property laws will vary state to state. It’s recommended you consult your general counsel or attorney.
Breakage with a redemption pattern
Assuming unclaimed property laws do not apply, GAAP prefers recognizing breakage revenue “in proportion to the pattern” of redemption. This means recognizing breakage based on how much of a gift card’s value is used (redeemed), against how much is not. This can be done with a two-step process.
First, figure out your historical forfeiture, and redemption rates. Having a reliable method, or gift card service partner, to track gift card usage is key; for the time being, assume the tracking results show that over a normal year, guests typically leave 20% of their cards’ value unredeemed and use the remaining 80%. Divide the forfeiture rate by the redemption rate to get your proportionate recognition rate. In this case, 20% ÷ 80% = 25%.
Second, recognize breakage revenue using your proportionate recognition rate, as guests use their gifts cards. With the 25% proportionate recognition rate, if a guest redeems $50 of gift cards, you will recognize $12.50 of breakage with the following entry;
In other words, you would recognize breakage revenue at 25% of the value of gift cards used.
Gift Card Liability 62.50
Sales Revenue 50.00
Breakage Revenue ($50 × 25%) 12.50
Check with your POS provider to see if this can be done automatically; if not, a journal entry each period is sufficient.
Since the idea behind breakage revenue is to account for the portion of gift cards expected to be forfeited, a common source of confusion is why the historical forfeiture rate isn’t used to recognize breakage. This is because breakage is calculated off the value of gift cards used, rather than the value sold.
For example, if your restaurant sells $100,000 of gift cards during the year, using the 20% historical forfeiture rate above, you will need to recognize breakage revenue of $20,000 based on the $80,000 of gift cards used. $80,000 × 25% proportionate recognition rate = $20,000.
Breakage without a redemption pattern
It may be your restaurant has such a high redemption rate for gift cards you cannot reasonably expect any forfeitures (more common in fine dining). In such situations, GAAP directs breakage to be recognized when the chance of redemption becomes remote. While “remote” is not defined, two years of non-use is generally seen as a fair period in the restaurant industry, unless your own data indicates a different period is more appropriate. When the appropriate period has lapsed, you don’t need to wait for another gift card to be used; simply debit the gift card’s liability, and credit breakage revenue, typically through a journal entry.
Closing the check
Accounting for breakage may seem complicated, but it’s worth the effort (not to mention required under GAAP). While your historical forfeiture and redemption rates may vary, a simple analysis of public restaurant companies shows breakage can bring the equivalent of an extra 1–2 days’ worth of average sales to your top line. Considering there are no associated COGS, you could see all of it flow through to your bottom line.
Check out this earlier blog post on promo cards…
Are your restaurant’s promo cards being accounted for properly?
Karen is a Principal in the CLA Bizops practice specializing in serving restaurant clients as a CFO. She has 25 years of experience in the retail and restaurant industry with senior management positions at Wilsons Leather, Famous Dave's, and a division of Hallmark Cards. She is based out of Minneapolis, MN
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