Use It or Lose It

Gift cards simplify shopping for consumers but complicate accounting for retailers. In a perfect world, gift-card recipients would dash to the store and spend the card’s full amount, or even more.

Although almost half of the shoppers who redeem gift cards do spend more than the value of the card (see related story on page 33), a surprising number of recipients never redeem their gift. A survey conducted from Dec. 31, 2007 to Jan. 7, 2008 by Findlay, Ohio-based Corporate Research International found more than 32% of individuals who received gift cards in the 2006 holiday season had not redeemed them a full year later. Therein is the rub for retail balance sheets.

The problem is that the money a retailer has collected for the gift card cannot be considered revenue until the gift card is redeemed—and that wreaks havoc on accounting systems and corporate taxes.

“A retailer collects money when the gift card is sold and becomes obligated to fulfill that gift card on a future date, which means the retailer has set up a liability,” explained Ravi Raghunathan, audit senior manager at Roseland, N.J.-based J.H. Cohn.

When a gift card is redeemed, the retailer can count the amount spent as revenue. If a $100 gift card is redeemed in full, it is $100 in revenue. If only $75 of the gift card is spent, then only $75 counts as revenue. Simple math—except the accounting implications for tracking spent vs. unspent gift-card amounts presents a huge challenge.

There are exceptions. For instance, if the gift card has an expiration date then the retailer can, in some cases, claim it as revenue after that date has expired even if the card has not been redeemed.

Similarly, Raghunathan suggested that when retailers can prove historical precedence, they might argue successfully to count the unredeemed cards as revenue. For example, if a retailer had data supporting a trend that indicated 15% of its gift cards were not redeemed after three years, the unredeemed amounts potentially could be allowed as revenue.

Accounting for unredeemed gift cards becomes even trickier in states that have escheat rules that require companies to remit liabilities to the state. Escheat rules apply for the state where a company has incorporated.

“If a company has a liability on its books, such as an unredeemed gift card, at some point in time the company may be required to pay that money to the state,” acknowledged Raghunathan. “In the state of Delaware where many companies have registered their corporations, so much escheat monies have been collected that the state may discontinue its income tax. Ohio and Virginia are two states that do not enforce escheat rules, so we have been working with several retailers to set up gift-card companies in those states.”

Catherine Fox-Simpson, a partner in the Retail and Consumer Product Practice at accounting and consulting firm BDO Seidman, Dallas, echoed the advice that retailers should establish gift-card companies in states with favorable terms.

“The key for retailers,” she said, “is to limit the ability of the states to lay a claim or right to this property. The existence of personal data on gift-card purchasers is key to a state’s ability to claim revenue. Therefore, limiting the personal data collected is important.”

Both Fox-Simpson and Raghunathan recommended that retailers should watch for guidance from the Financial Accounting Standards Board (FASB), the Securities and Exchange Commission (SEC) and the Internal Revenue Service (IRS).

However, Raghunathan advised, “When the SEC and FASB keep silent, we have to look to general accounting rules. Public companies should certainly disclose the liabilities carried from gift cards.”

Whenever retailers conduct business with gift cards, it impacts the accounting process. For instance, when a retailer uses gift cards as a promotional incentive, revenue calculations have to be adjusted accordingly.

“If a retailer provides a $100 gift card for a $1,000 purchase, then the sale should be recorded as $900 with a $100 liability on the books until the gift card is redeemed,” noted Raghunathan.

Similarly, there are implications when gift cards are donated to charities and when gift cards are reloaded with additional cash value.

Visit www.chainstoreage.com and click on Web Exclusives for expanded coverage of the auditing and tax implications for unredeemed gift cards.