Are Gift Cards Deferred Revenue and What It Means for Your Business

Gift cards are a popular way to give the gift of choice, but did you know that they can also be considered a form of deferred revenue for your business?

According to the article, a gift card is essentially a promise to provide goods or services to the cardholder in the future, which is why it's classified as a liability on your balance sheet.

For example, if you sell a gift card with a face value of $100, you'll need to recognize the revenue associated with it when the card is redeemed, not when it's sold.

This means that the $100 is considered a liability until it's used, and you'll need to account for it as such on your financial statements.

Deferred revenue is a type of revenue that's received in advance of delivering a product or service to the customer.

This means that the payment is made before the benefit is received, and the revenue is recognized over time as the product or service is delivered.

A fresh viewpoint: Received Cash Advance Journal Entry

For instance, if you buy a gift card, the payment is made upfront, but the gift card can be used later to purchase something. As you use the gift card, the deferred revenue is recognized proportionally on the income statement.

Unused gift cards are a classic example of deferred revenue, as the benefit of the gift card is delivered when it's redeemed.

Subscription plans, like an annual newspaper subscription, also involve deferred revenue. The payment is made upfront, but the benefit of the subscription, such as access to news articles, is delivered over time.

Service agreements associated with product purchases can also involve deferred revenue. For example, if you buy a new smartphone and the manufacturer offers a service agreement for future software upgrades, the payment for the agreement is made upfront, but the benefit of the upgrades is delivered over time.

Here are some common examples of deferred revenue:

Deferred revenue is a common phenomenon, especially in industries where customers pay for services or products upfront, but the benefit is delivered later. For example, unused gift cards are a type of deferred revenue.

Subscription plans, such as annual newspaper subscriptions, are another example. When you pay for a subscription, you're essentially paying for access to a service over time.

Service agreements associated with product purchases can also be considered deferred revenue. This is because the customer is paying for a product and a service, but the service hasn't been delivered yet.

Implied rights to future software upgrades can also be classified as deferred revenue. This is because the customer is paying for a product, but the upgrade hasn't been delivered yet.

Upfront insurance premium payments can also be considered deferred revenue, as the customer is paying for a service that will be delivered later.

In the retail industry, deferred revenue can occur when customers pre-order goods that haven't been released yet. This can include online orders for designer clothes and shoes.

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Gift cards are another example of deferred revenue in retail. Customers purchase gift cards in advance, but the goods or services haven't been delivered yet.

Here are some common examples of deferred revenue:

Gift cards are considered deferred revenue because they represent a payment received in advance of delivering goods or services. This means the revenue is not immediately recognized, but rather is recorded as a liability on the balance sheet.

The sale of a gift card is essentially a promise to provide goods or services in the future. As a result, the revenue is deferred until the gift card is redeemed.

According to accounting standards, the sale of a gift card is recorded as a liability, not as revenue. This is because the goods or services have not yet been provided to the customer.

The liability associated with a gift card is recorded as a deferred revenue account. This account represents the amount of revenue that has been received but not yet earned.

On a similar theme: The Journal Entry to Record a Payment on Account Will

Here's a simple example of how this works:

In this example, the sale of a gift card is recorded as a debit to cash and a credit to deferred revenue. The revenue is not recognized until the gift card is redeemed.

As the gift card is redeemed, the liability is reduced, and the revenue is recognized. For example:

In this example, the liability associated with the gift card is reduced, and the revenue is recognized. This is the basic process for recognizing revenue from gift cards.

Deferred revenue can be complex, but it's essential to understand the nuances to accurately account for it. Gift cards, in particular, can have multiple layers of complexity.

Gift cards with unredeemed balances can be a significant issue for businesses, with an estimated $1B worth of unredeemed gift cards annually. To address this, companies can recognize breakage income in proportion to the value of actual gift card redemptions.

Breakage income can be calculated based on historical redemption patterns, allowing businesses to estimate the amount of unredeemed gift cards. For example, if a company has a 90% redemption rate, they can recognize 10% of the gift card value as breakage income.

A company can use journal entries to track the recognition of breakage income, such as:

This process can be even more complex when gift cards are used to place orders for products that are not yet in stock. In such cases, businesses may need to account for deferred revenue and breakage income separately.

Here's a summary of the key points:

By understanding these advanced topics in deferred revenue, businesses can accurately account for gift card sales and recognize breakage income, ensuring compliance with accounting standards and tax regulations.

Deferred tax treatment is a crucial concept in accounting, and it applies to gift cards. The tax implications of gift cards arise when they are redeemed for goods or services, not when they are sold.

Sales tax is a significant consideration for businesses selling gift cards. In many jurisdictions, sales tax is not collected at the time of the gift card sale but rather when the card is used to purchase taxable items.

Businesses must be vigilant in tracking gift card transactions to avoid potential tax compliance issues. This requires meticulous record-keeping to ensure accurate sales tax collection and remittance.

Breakage revenue can also affect income tax reporting. If a company recognizes breakage revenue, it must consider the tax consequences of this recognition.

Temporary differences can arise when breakage revenue is recognized for financial reporting purposes but not for tax purposes. This can affect deferred tax assets and liabilities, requiring careful management to ensure accurate tax reporting.

Recommended read: How to Record Sales Tax Payments in Quickbooks Online

In the world of deferred revenue, things can get even more complex. For instance, let's say a company sells $1,000 in gift cards to customers in January, and the journal entry for these transactions shows $1,000 in cash and $1,000 in unearned revenue.

As we saw earlier, companies can estimate breakage income in proportion to the value of actual gift card redemptions. In this example, let's assume the company estimates that 10% of the gift card value will remain unclaimed. This means they can estimate total gift card redemptions of $1,000 x 90% = $900, and estimated breakage of $1,000 x 10% = $100.

Now, imagine a customer uses a $100 gift card to place an order for a product with a price of $1,500, but the order isn't yet in stock. The company requires at least 50% up front to place the order, so they book $500 to accounts receivable and $500 to deferred revenue.

On March 1, the item is back in stock, and the company charges the customer's credit card for the remaining $500. Upon delivery of the product, they can immediately recognize $1,000 of previously unearned revenue from the gift cards, $500 for the additional deferred revenue unrelated to the gift card, and $100 in breakage income.

Here's a breakdown of the journal entries:

Some states exempt gift cards from escheatment laws, but a number have enacted abandoned property laws for unredeemed gift card balances. Most states allow a dormancy period of either 3 or 5 years before requiring retailers to turn over the unredeemed value.

Retailers in states with escheatment laws may need to surrender a percentage of the unredeemed value, usually 60%. This adds complexity to revenue recognition processes.

Gift card balances can be turned over to the state after a dormancy period of 3 or 5 years.

A different take: Accounting Period (UK Taxation)