Gift cards and gift certificates are not only popular gifts but can be a great source of income for your restaurant. However, accounting for gift cards can be confusing. Becoming familiar with a few of the basic rules and best practices can go a long way in simplifying the accounting process.
Gift card purchases are generally classified as a deferred revenue liability. The cash received from the sale is paid upfront but does not qualify for revenue recognition as no goods or services have been exchanged.
Gift card purchases are recorded as deferred revenue and subsequently recognized as revenue as the gift card is redeemed in the future.
Company A sells a $50 gift card today. Company A will then record $50 cash and $50 of deferred revenue. Fast forward one week and the gift card recipient buys lunch for $20. With this gift card redemption, Company A has met the requirements for revenue recognition under ASC 606, Revenue Recognition and Company A debits deferred revenue for $20 and records $20 in revenue.
With all rules come exceptions and gift card revenue recognition is no different. As stated above, gift cards are deferred revenue until the gift card is redeemed.
This begs an obvious question, what if the gift card is never redeemed?
This is called breakage, which in essence is the portion of gift card sales that will never be redeemed. This will require Company A to make an estimate of what it believes is the gift card value of sales that will never be redeemed.
Usually, a company can use historical redemptions over the last five to ten years to come up with pretty accurate breakage rate. The breakage rate can also change depending on redemption rates.
As a restaurant matures it is possible to see an increase in its gift card redemption rates thus a change in estimate is likely going to need to be made. If you are a new restaurant and do not have historical redemption rates, a 5-10% breakage rate will likely be in the ballpark and can be adjusted as redemption rates become available. The change in breakage rate is a change in accounting estimate, thus will be recorded on a prospective basis.
Now accounting for breakage can be a little tricky as there are a few moving parts that need to be calculated.
ASC 606 requires breakage revenue to be recognized ratably over the life of the gift card. This requires a company to track gift card sales and redemption rates and calculate the ratio of gift cards recognized each year.
For example, if Company A sold $100,000 in gift cards five years ago it would be able to look back and see the number of redemptions five years ago (first year), four years ago (second year) and so on. This will allow the company to calculate the redemption ratio for each period and will show that redemptions typically peak in the first or second year subsequent to the gift card sale and as time goes on these rates will decrease significantly with each passing year.
This data will also help the company estimate a gift card breakage rate as redemption rates will start to approach 0% as time passes. To calculate breakage revenue, the company will multiply the total annual gift card sales for the year with the breakage rate and the average first year redemption rate for its current year gift card sales.
The company will also do this same process for its prior year gift card sales except instead of using its first-year redemption ratio, it will use the second-year redemption ratio. The company will continue this process for each year of gift card sales in which 100% of breakage revenue has not been recognized. Generally, this process is done for five to seven years of gift card sales.
The journal entry to record gift card breakage revenue is to debit deferred revenue and credit breakage revenue. A best practice is to create a contra liability account and to use this account to offset the gift card deferred revenue liability so that gift card breakage revenue taken can be tracked independent of gift card deferred revenues.
When evaluating a gift card service provider, reviewing the different reporting options available under the platform prior to engaging with a provider is recommended.
Some companies offer valuable insight into gift cards, including sales, location, redemptions, etc., while others do not. Having insufficient access to key data can make the breakage calculation and overall recording of gift card transactions a headache. Therefore, researching different gift cards systems available prior to entering a contract is wise.
The restaurant industry is a competitive business; most restaurant operators will never turn away an opportunity to retain or gain a new customer. Very rarely will restaurant gift cards include expiration dates or maintenance fees, but if you do, be aware of both state and federal laws governing limitations.
Federal law states gift cards cannot expire before five years from the date of purchase and reloadable gift cards should be valid for five years from the date of the most recent reload.
If a restaurant’s gift card includes fees, those fees should be clearly stated on the card or the packaging in which the gift card is sold. The fees cannot kick in until one year of inactivity has passed and you can only charge one fee per month.
If your restaurant is going to assess any fees or expiration dates, it is recommended that team members disclose these terms verbally in addition to written documentation on the card when selling gift cards to consumers.
Escheatment in its simplest form is unclaimed property that is remitted to the state after a certain period of time has passed. Each state has its own escheatment laws and depending on the state, gift cards may or may not be included in these laws.
If a restaurant is operating in more than one state it is important to be aware of gift card escheatment laws to remain compliant with laws and regulations in the markets in which your restaurant operates.
It is important to keep track of the state in which a gift card is sold. That is the state in which the escheatment laws will apply.
Lastly, if a state does require an unused gift certificate or gift card to be remitted back to the state after a period of time, these gift cards should not be included in the above breakage calculation.
Holiday seasons are great times to offer promotions on gift cards. Typically, the fourth quarter of the year is when the highest sales of gift cards occur and adding an extra incentive to customers can go a long way to increasing gift card sales. This is yet one more facet in gift card accounting as any promotional value added is a deferred expense associated with the gift card.
For example, Company A runs a holiday special in which the purchase of $100 gift card results in a promotional $20 gift card being given to the purchaser. The journal entry to record this transaction is $100 to cash, $120 to deferred revenue liability and $20 to gift card promotion liability (contra liability to gift card deferred revenue).
As with the breakage revenue mentioned above, it is encouraged to set up a contra liability account to record promotional expenses too for additional transparency. As the gift card is redeemed, this additional $20 promotion will be expensed at the ratio at which it was offered to marketing expense.
In the above example, for every $6 redeemed, $1 of promotional expense would be recognized. This is due to the matching principle as the promotion itself is not an expense, yet the future redemption of the promotion is, thus the delayed expense recognition.
Additionally, just like with escheatment rules, a company cannot generate breakage revenue from promotional gift card sales and these cards should be excluded from the breakage calculation.
Accounting for restaurant gift cards and certificates can get complicated quickly. There are many moving parts in gift card accounting and our team has experience handling the different types of transactions that can occur.
Baker Tilly's restaurant specialists can help untangle your restaurant gift card accounting. Our team works with restaurants operating in multiple states, including those that sell cards through large third-party distributors, and can assist with setting up and recording gift card transactions of all shapes and sizes.
If you have questions on accounting for gift cards, please contact your Baker Tilly advisor.