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Accounting for Gift Cards...

... Can mess up the books.

by CLN Subscribers (January 15, 2006)

(Note: In the 1/1/07 edition of CLN, the commentary said, "Would someone please explain to me why retailers can only count gift card revenue when the cards are redeemed? Retailers received the money when the card was purchased, why not count it then? Early reports say the Christmas season was disappointing, up only 4.3% instead of the predicted 5%. But the estimated $25 billion in gift cards can't be counted yet." CLN readers responded.)

1. "Let's start with what a sale is: You give me merchandise in exchange for payment, and we're done (at least, once the return period expires). As a retailer, you have no further obligation to me, and as a customer, I have no claim on you.

"When I 'buy' a gift card, on the other hand, you're selling me a PROMISE that some time in the future I can make a purchase for the value of the gift card. A promise of exchange of value in the future isn't like a sale, it's like (drum roll, please)... A LOAN!

"And in fact, that's pretty much how the accounting works � the retailer books in cash (asset) and a future redemption obligation (liability). The purchaser is, in practical fact, a CREDITOR of the retailer (as those stuck with unredeemable cards when a retailer goes bankrupt discover).

"For those following the health of the industry and of individual retailers, gift card sales do muddy the water this time of year. If more retailers reported their gift card sales and redemptions in addition to their same-store sales, we'd get a clearer picture. Fortunately for retail analysts, most gift cards are redeemed within a couple of weeks of receipt, so by the end of January, all's right with the world again.

"As an aside, the growth of gift cards implies that retailers should probably be less aggressive with markdowns post-Christmas. If retailers have the guts to hold prices for a few weeks, they can probably get more margin due to the built-up spending pressure from gift cards. Plus, though I have no research to back this up, I'd wager that recipients spending gift card money are less price-sensitive in their shopping than the average customer.

"As a shopper, I'm seeing less aggressive post-Christmas promotions so far. In fact, at a number of stores, they're the same as pre-Christmas (e.g. only 50% off on gloves, scarves, and sweaters, same as before Christmas, vs. the usual 60%-75% by now).

"So, it looks like some retailers 'get it', which should bode well for profits. � Mark Temares

2. "In simple terms, gift card revenue is counted when they are redeemed in order to match the revenue with the cost of the item being removed from stock." � Ed Cooke, Blumenthal Lansing Co.

3. "It�s been years since I wore my accountant�s hat, but my guess is if you recognize the income when the card is sold, there is no offsetting expense (cost of goods sold), so it overstates income for that month. Conversely, when the card is redeemed, you have overstated the cost of good sold (items taken out of inventory), so it understates income for that month. By recognizing the income in the month it is redeemed, you get the income and expense in the same month, and it does not distort your financials. � Bonnie Benjamin, StenSource Int'l. Inc.

4. "As explained by my accountant, the money received from the sale of a gift certificate is considered then a liability. You owe something to the person who purchased it (or who holds the gift card). It is almost like a loan. They are loaning you money in advance, and then when they want it back, they come 'purchase' products with the gift card. Therefore, if a store closed, you would owe all the gift card holders product or their money back. That is why it is not considered sales until it is redeemed." � Sue Lech, Thanks for the Memories

5. "Not an accounting professional, but I can give you two assumptions: 1. If you pick up the sale of the gift card when it is made, you have to pick up 100% profit at the time of sale since there is no Cost associated with the merchandise. Then, when the card is redeemed, you have 100% loss, because you have to remove the item from inventory with no offsetting proceeds. The gift card is a payment, and is handled the same way as cash or a credit card � e.g., a $30 item with a cost of $15.00 will be handled as follows at the time of the transaction: $15 removed from inventory and $15 gross profit. However, if you have already picked up the gift card as revenue, then you have to tally that sale as a loss of $30. 2. Not all gift cards are redeemed � a nice way to pick up extra revenue "off the books." 3. Pushing actual revenues into the following year while picking up costs in the current year can be a good thing accounting-wise." � Dave Riba, Kandi Corp.

6. "Many systems are really 'charges' and the way many of these programs work, the retailer does not get the money until the card is used. It is still in the account of Visa/MC/Disc or whomever; they get to enjoy a wonderful float, then it counts as revenue at the location where it is used - because that is when an actual sale is made." � Wheat Carr, Wandering Wolf

7. "I'm no accounting professional and would like to know the official answer, but would offer these thoughts: Gift cards can be purchased everywhere, including grocery stores. Were a chain like Kroger or Publix to report them as sales, they would have to pay sales taxes on items that might be purchased at a Best Buy or Bed Bath and Beyond. Then, as the consumer purchases with the gift card, sales taxes would be collected and paid again. Yes, Kroger could separate the sales out and report them as a separate item for sales tax elusions. Probably why they don't report the sales.

"From an operating standpoint, as a former retailer, I would want to know which stores were actually making merchandise and product sales. Gift card revenue masks the true measures of sales without extensive analysis. The other fact is that not all cards are redeemed to their full value. Sounds like a good deal for the company selling the gift cards, but it's a pain to track." � John Caldera, Just Nan, Inc.

8. "The answer is quite simple. The retailers would have to pay taxes on the income if they reported the income when they received the money. In addition, revenues and expenses would not match up until they knew what products were being purchased with the gift card. A prudent business person always strives to postpone taxes as long as possible. � Bob Keesan, Scott Publications

9. "It�s a liability on the books of the retailer because they owe that much in product to someone. It�s like putting a deposit down on an item." � Kathleen Caldwell, Jack Dempsey Needle Art

10. "I believe that the reason the Gift Card revenue is not counted at the time of the sale is because the costs associated with that card are not counted. Example: You have revenue from the sale of the card but no cost of goods associated with it. So I believe the revenue is accrued until the card is used. Bob Jennings, Decorator & Craft Corp.

11. "I'm not an accountant but I did do my own accounting as a small business owner for several years so I do have a basic understanding of business accounting. The reason that businesses cannot claim gift cards as income the moment they are purchased is because doing so could result in profits being overstated for the period the card was sold, and understated for a future period.

Take this example: If I buy my husband a gift card for $50 in December and the store records that $50 sale in December, that sale is almost entirely profit for them. It makes it look like they had a really profitable month!

Then in January he goes back and spends that gift card on a sweater. Suddenly the store has $25 (or whatever the sweater cost THEM) in merchandise expenses with no reportable income to balance it. It looks like they lost money that month!

So to prevent the accounting numbers from being warped by transactions like that, the company records the incoming cash from the gift card sale BUT then records an offsetting debt in their accounts as well, for the value of the cards that still have to be redeemed. At the time of the card's redemption, they then record the $50 income and the merchandise expense, just like with any other transaction. It is just that in this particular case, they've already had the cash sitting for some time waiting to be counted.

It is easy to understand why companies do not like having unredeemed gift cards held for very long by customers when they must be accounted as debt for the company, and when gift card sales can make a period's sales numbers look artificially low. But correct accounting practices require handling the numbers in this way, and it is for this reason that despite the fact that you have essentially given businesses an interest free loan when you buy a gift card, they do everything possible to encourage rapid redemption of the cards. This includes everything from major post-holiday sales to fees deducted from cards that stagnate too long.

Gift cards can be great for retailers and consumers if they are chosen wisely and rapidly redeemed by the recipient. But there can also be some downsides to their widespread use, which are becoming more apparent as their use becomes more and more common. � Nancy A. Nally

(Note: To read previous "Kate's Collage" articles, click on the titles in the right-hand column.)

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