Now that the holidays have passed, it’s time for everyone to start spending the gift cards they received. Companies all over, from Best Buy to Walmart make a killing during the holiday season from the sale of gift cards. Gift cards have become such a big money maker for companies that many of them now sell in local grocery stores and warehouse clubs. There are several reasons why companies enjoy the benefits of selling gift cards:
- They are a good source of cash. It’s estimated that about 10-20% of all gift cards purchased are not used.
- Companies see an increase in sales. Several gift card recipients spend much more than just the value of their gift card.
Many think that once a company sells a gift card that the money from that sale is automatically recognized as revenue. While most companies wish this were the case, it’s just not that simple. After all, in the accounting world, nothing is ever “that simple.”
In reality, companies are not allowed to recognize revenue from the sale of a gift card until the gift card is used. Companies initially record the sale of gift cards as a liability (a future obligation), and then as the gift cards are used, revenue is recognized. For example, when a company sells a $50 gift card, the company posts the following journal entry. Notice the credit is shown as a liability and not revenue.
Debit: Cash $50
Credit: Gift cards liability $50
Then as that gift card is used the revenue gets recognized with the following journal entry. The debit is now shown as the liability and the credit is received as revenue.
Debit: Gift cards liability $50
Credit: Revenue $50
One exception to this is known as “breakage.” Breakage is when customers do not redeem their gift cards. Companies are allowed to estimate expected breakage from gift card sales and recognize this as revenue. An example of how breakage is recorded as revenue is, if a company sells a $100 gift card and estimates that 20% will be breakage (will not be used), the following journal entry is made.
Debit: Gift cards liability $20
Credit: Revenue $20
So, the next time you purchase a gift card, don’t think you are contributing to the revenue of that company just yet. Only once that gift card is used can the recognition of revenue occur.