Free Custom «Accounting for Gift Cards» Essay Paper

Gifts cards are available in the market in two forms; the ones affiliated with company’s credit card like MasterCard and Visa and the other type that is not affiliated. The latter type which is in most cases purchased from retailers, does not fall under the federal banking laws jurisdiction and has very few GAAP guidance that are meant to guide on how they should be accounted. Companies have adopted a variety of ways of accounting for the disclosures and revenues linked with this nonbank type gift cards. Despite the many ways set aside to account for the gift card, in most occasions, a situation referred to as gift card breakage occurs. Breakage of the gift card refers to an event where the gift cards are purchased but are not put into any application. Gift breakage has it good and bad impacts in a business (Owen 2).

It is advantageous to the company as the merchant is left to pocket the money yet he or she is not expected to provide any services or goods. Accounting regulation prohibit money earned from gift cards from being declared as state property in form of revenue as that is the case in some states unless the cards either expire or are sold. Statistics has it that more than ten percent of the all the gift cards dollars end up never being spent, leaving merchants to enjoy float until the money is redeemed. The downside of gift cards is that breakages will imply that a company lacks the opportunities to make use of gift card services in order to build a strong customer base. This issue is reflected in the accounting books of such a company giving it a hard time to account for it (Owen 4).

 

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In most cases, a large percentage of the value of gift cards which end up not being used result in additional accounting complication. Taking 2005 as a reference year, it was estimated that approximately 19% of the companies which had acquired gift cards never used them. Such a situation mostly occurs when one fails to redeem a gift card. This is because, some gift cards have their expiration dates serving as events to do away with any amount that has not been used from the liability of the lingering gift card. To deal with such a situation, consumer advocacy efforts have ensured that gift cards do not bare any expiration date in a situation where they are not redeemed. When such occurs, the previous trends of the gift cards sold help retailers to come up with future breakage estimate. As time goes, the chances of redemption declines considering past redemption patterns. Such patterns help retailers to calculate the gift cards weighted average estimate(Owen 4).

This approach of estimating patterns assumed by gift card breakage poses a major challenge to the retailers. This is mostly to do with the initial adjustments and the breakage adjustments. The initial adjustment, in some cases has a lot of dangers as it may result in a nonrecurring trend that is not normal in the process of reporting. Also, this adjustment timing can be easily manipulated as well as have its amount substantiated. This is in consideration of the fact that the stated amount is an accumulation of many breakage years and not just one. A good example of such a scenario was experienced by Home Depot in 2005 when the company estimated a $43 million gift card breakage adjustment for all the preceding period. However, it came out that estimate adjustments for gift card breakage for the remainder of that year were $9 million, relatively small compared to the initial one time adjustment (Owen 5).

The complexity of the gift card breakage has proved to be a difficult accounting issue in most of the companies. The difficult is experienced in the placement of the gift card breakage in any organization’s financial statement leading to additional variation and uncertainty in financial reporting. This situation was witnessed in Best Buy Inc. financial statement in February 2006 when $43 million was added to gift cards that were unredeemed directly to the company’s sales revenue. This was inclusive of $27 million carried forward from the prior period. After the incident, the company declined to give an explanation for its gift card accounting. The research conducted indicate that of any 53 companies having a breakage policy statement, only approximately 39 happen to locate where the breakage is or offer gift card information. Vital quantitative disclosures showing annual gift card sales amounts and breakage are in most cases not provided (Owen5).

The inclusion of amounts from unredeemed gift card in the organization sales or considering it as a goods sold cost results to gross margins that are overstated and misleading. Consequently, proceeds from unredeemed gift cards lack accompanying inventory costs. In other situations, a gift card breakage that is recurring may be considered as other revenues thus the amount disclosed separately in a footnote. A good example of this is the situation where Best Buy had initially misread the sales from investor-sensitive and the gross margin trends. In this case, a reduction in the SG&A expenses as the gift card was written off represented an approach that was more conservative. However, this seemed to be a potential misleading and conceptually flawed as the economic benefit did not originate from the measures meant to reduce expenses. Moreover, gift cards breakage that is not recurring especially from a long period results to an unattainable operation element. This calls for companies to at least disclose how they are treating breakage and gift card transactions when they put them on offer. The MD&A companies requirement expects the companies to disclose if they offer gift card breakage programs and in such a case they should go ahead to disclose the unredeemed balances and amount earned from gift cards processes(Owen 4)..

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The main accounting issue while refereeing to gift card breakage arises in the placement of such gift cards in the financial statement due to the complexity of its estimations. Such placements result in additional variation and uncertainty in the financial reporting. This issue has not yet been resolved by the SEC as it has not taken any public position regarding gift card accounting. This makes the situation even more difficult as companies are not certain on which accounting position to assume. The best SEC has done is to advice staffs of affected companies to refrain from viewing any immediate recognition amount in terms of revenue at the sale point as being consistent with the GAAP staff views(Owen 4).