How FASB aims to address this issue
But people tend to forget about their gift cards, and it sometimes takes years before they’re redeemed. At that point, the value to the business’s bottom line is probably close to zero, driving the “gift card accountants” nuts.
So, how do you account for all of those unused gift cards?
Typically, when a gift card is purchased, cash is received, and a liability is booked for the future services to be performed or goods to be received. Once a gift card is redeemed, the liability is reduced, and revenue is recognized.
Many consumers who forget to use these gift cards cause unexercised customer rights, also known as breakage and stale liabilities. Unexercised customer rights can cause significant obligations on a company’s financial statements.
In order to manage this, the Financial Accounting Standards Board (FASB) has proposed a standard that considers the recognition of breakage, or unused customer rights, into revenue.
Therefore, if a company is reasonably assured of the breakage amount based on trends and internal forecasting systems, the proportionate method of accounting is recommended.
How the FASB method works
Under the new FASB method, each redemption results in revenue from:
- The sale of goods and services
- Income from the proportionate share of breakage
In other words, if a company is experienced with the trends of gift card redemptions and has identified that 20% of gift cards are redeemed after six months, 10% after one year, etc., revenue can be recognized based on the proportionate share reasonably estimated to be redeemed.
However, if a company is unable to determine the proportionate trend of gift cards, they would recognize the breakage when it is remote that the gift cards will be redeemed.
As such, revenue recognition is slower and often recognized in lump-sum after a certain number of years determined by the company’s policy.
What about expiration dates?
The important thing to note is that a company may only recognize these two methods mentioned above if there is no expiration date on the gift card.
If there is an expiration date, the gift card is considered abandoned on the date of expiration, and at that point, the company may not reduce the liability nor can they recognize revenue.
The liability will then be owed to the state under unclaimed property law.
For more information regarding gift card revenue recognition, reference FASB Topic 606.