Everything You Didn’t Want to Know About Gift Certificates

Everything You Didn’t Want to Know About Gift Certificates

 

Ever wonder if there was any benefit or difficulty in offering Gift Cards (GC) or Gift Certificates to your customers/clients? They can be a good way to gain new customers and provide opportunity to show what a great job you do.  GC customers that paid full price should never have restrictions or be treated any differently than a customer with cash in their hand.

GCs have many legal considerations, and this article is not meant to be legal advice, but rather offer considerations and a road map to guiding you through the ramifications of selling GCs.

Let’s start with Accounting for GCs…

Selling GCs is a bit of a misnomer, because you are not “selling” but rather exchanging dollars today for future products or services. Therefore, on your books you are simply exchanging an asset that you are receiving for a future liability or debt.  This money IS NOT revenue.

Here’s how you would account for gift certificates at various stages:

Issuing the Gift Certificate (Sale of the Gift Certificate)

When a customer purchases a gift certificate, you record it as a liability, not revenue, because the business has an obligation to provide goods or services in the future. The journal entry would be:

• Debit: Cash or Bank (for the amount received)
• Credit: Gift Certificates Outstanding (or Unearned Revenue)

This entry reflects the fact that the business has received cash but has not yet delivered the goods or services.

When the Gift Certificate is Redeemed

Once the gift certificate is redeemed, the liability is reduced, and revenue is recognized because the business has fulfilled its obligation. The journal entry would be:

• Debit: Gift Certificates Outstanding (to reduce the liability)
• Credit: Sales Revenue (to recognize revenue from the sale of goods or services)

If there is a sales tax applicable, the entry might also include a credit to a sales tax payable account for the tax portion of the transaction.

Unredeemed or Expired Gift Certificates (Considered Breakage)

In some cases, there may be gift certificates that do not get redeemed before they expire, or customers may never use them. In this situation, you can recognize revenue after a reasonable period, depending on local laws and company policy regarding unredeemed certificates. The entry is:

• Debit: Gift Certificates Outstanding (to reduce the liability)
• Credit: Revenue from Expired Gift Certificates or Miscellaneous Income

This assumes that the business no longer has the obligation to provide goods or services once the certificate expires.

There are cautions however on how to handle breakage, and we will get to that shortly.

Partial Redemption

If a gift certificate is redeemed partially (i.e., only part of the certificate value is used), the entry will be for the used portion, and the remaining balance stays as a liability. The remainder will continue to be listed under Gift Certificates Outstanding until redeemed.

By correctly tracking the issuance, redemption, and expiration of gift certificates, you ensure that your financial statements accurately reflect the timing of income and liabilities.

Expiration of GCs

The legalities surrounding the expiration of gift certificates (or gift cards) vary depending on the jurisdiction, as different countries and states have specific regulations to protect consumers. Please consult your local, usually state, laws before expiring them.

Gift Certificates for Specific Services

There is a common exception to the rules for gift certificates or cards issued for specific services rather than for a monetary value (e.g., a certificate for a spa treatment or a hotel stay). These types of gift certificates may have stricter or shorter expiration periods since they are tied to specific products or services.

Key Considerations for Businesses

Clear Disclosure: Always ensure that expiration dates, fees, and terms of use are clearly communicated to consumers. Compliance with Local Laws: Since gift card laws vary widely, businesses should consult local regulations to ensure compliance with both federal and state/provincial laws.

Breakage of GCs

The breakage rate for gift certificates refers to the percentage of gift certificates that are purchased but never redeemed. In the U.S., breakage rates can vary depending on several factors such as the type of business, the value of the gift card, and consumer habits.

I have seen published breakage rates vary from 2% to over 50%.  I have also seen business owners count on this breakage as pure profit and cash flow for their bottom line.

GC’s as Unclaimed Property

That money isn’t yours until redeemed.  And when redemption doesn’t happen “Unclaimed property” rules regarding gift certificates (or gift cards) determine whether and how unredeemed gift card balances must be turned over to the state under escheatment laws. These laws vary by state in the U.S. and generally apply when gift certificates or cards are not redeemed after a certain period of time.

There are considerable laws that apply to “unclaimed property” so it is best to seek the required regulations in your state/province.

Gift Cards Redeemable for Cash

In certain states, gift cards with a cash redemption feature are more likely to be subject to escheatment. In states like California, consumers can request to redeem the remaining balance of a gift card for cash if the value is below a certain threshold (e.g., less than $10). This regulation ensures that consumers are not left with small, unused balances on their cards.

Unclaimed Property Process

If the gift certificate is subject to unclaimed property laws, here’s what happens:

1. Dormancy Period: The business keeps track of unredeemed gift certificates and waits for the dormancy period to end (e.g., 3-5 years of inactivity).
2. Reporting to State: After the dormancy period, the business reports the unclaimed gift certificate balance to the state’s unclaimed property office.
3. Remitting Funds: The unredeemed balance is sent to the state, and the business no longer holds the liability. The state is now responsible for holding those funds.
4. Claim by Holder: The consumer who originally purchased or received the gift certificate can search the state’s unclaimed property database and file a claim to recover the unredeemed funds.

States frequently audit businesses to ensure compliance with unclaimed property laws, especially if they have a significant number of unredeemed gift cards or gift certificates. Failure to comply can result in penalties and interest.

Unclaimed property laws for gift certificates require businesses to remit the balance of unredeemed gift cards to the state after a certain period of inactivity, depending on the jurisdiction. However, many states offer exemptions for retail gift cards, promotional cards, or specific types of certificates. Businesses must carefully track and comply with state-specific escheatment rules to avoid penalties and ensure proper reporting.

Once again, GCs can be a great tool for your business, however, this article is designed to provide the business owner with an overview of the considerations needed before implementation. It is best to check the laws and regulations that apply to your state or province.

Happy selling and keep in mind that the offering of Gift certificates and Gift Cards may be a great tool for added benefit in gaining new clients. But as you can see, there are significant considerations when beginning to do so. Quite often, an accountant or an attorney can help you navigate the restrictions.

 

 

 

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