Article written by:
Anna Markin, CPA, MBA
Manager, Assurance & Business Advisory Services

The holiday season is quickly approaching, and gift card promotions remain top of mind for management. As promised in Part I of our gift card accounting series, we are pleased to share Part II of the seasonal reminder for gift card accounting as you finalize promotions.

A tricky part of gift card accounting is the “breakage analysis” which can result in revenue recognition before a gift card is redeemed in full. Often, gift cards are left fully or partially redeemed which triggers “breakage rules” in accordance with ASC 606-10-55-48. During 2019 with the adoption of ASC 606, the method of recognizing breakage changed and actually accelerated the recognition of revenue related to gift card breakage. Previously, most private companies would wait to recognize breakage until two years of gift card inactivity, which is an industry standard. As year-end quickly approaches, let us revisit how breakage is recognized now under ASC 606 with an example calculating breakage.

Breakage

Breakage is a recognition of expected unexercised right or forfeiture of any prepaid right or a sale incentive. The ASC 606 “breakage rule” relates to many parts of the accounting for revenue ranging from the simple sale of the gift card, gift card sales with an incentive, or bulk sale to a wholesaler, all of which create an obligation to provide a service at a future date. When a gift card is sold, and then subsequently redeemed for the full amount, revenue recognition is straightforward and is fully recognized upon redemption. However, when only a partial amount is redeemed, the company is required to continue tracking the remaining balance and perform breakage analysis at the end of each period to estimate amounts that will not be redeemed. Before jumping straight into the breakage analysis, management should consider state unclaimed property or “escheat” laws as those unredeemed balances may need to be handed over to the government (more on escheatment in the next edition of Table Talk) if the customer never demands the performance.

Breakage Analysis

For restaurants, one of the standard methods to assess breakage is to perform a historical look-back and calculate the historical forfeiture rate on gift card sales. The historical forfeiture rate is calculated by taking data for the specific gift card type since inception and averaging the redemption rate over the life of the gift card program. For new restaurant companies where historical data is not available, management can use industry data or public financial statements for restaurants in the same niche, to project the expected forfeiture rate the first year.

Assume the following:

“Restaurant A” sold 2,000 gift cards during the year with a face value of $25 each during 202X. During the year, $23,000 was redeemed and recognized as revenue by the company. Management performed analysis over historical forfeitures noting an average forfeiture rate of 10%. The restaurant is not subject to any escheatment laws. The Company prepared the following calculation of breakage:

Total gift cards sold during 202X  ($25 x 2,000) $ 50,000
Unredeemed gift card balance at year-end  ($50,000 – $23,000) $ 27,000
Historical forfeiture rate           10%
Expected forfeitures  ($50,000 x 10%) $   5,000
Expected redemption  ($50,000 – $5,000) $ 45,000
Proportion of gift cards redeemed  ($23,000 / $45,000)
          51%
.
Total breakage to recognize  ($5,000 x 51%) $   2,556

 

The Company recorded the following entry at year-end to recognize breakage:

Debit Entry Credit Entry
Gift Card Liability Contra $2,556 Gift Card Breakage Revenue $2,556

 

The best practice is to calculate breakage for each type of gift card separately. For instance, bulk sale to warehouse retailers might have different redemption rates than a regular direct-to-consumer sale of a gift card at the store. For breakage calculation, “total net gift card liability” is used; thus, the sale of a gift card with a promotion or bulk sale to a warehouse retailer would follow the same example. Further, for a promotional type gift card, such as a $25 gift card for $20, breakage is calculated on the net gift card liability, which equates to the cash received of $20. You would not recognize breakage on the $25 as you only received cash of $20. A year-end entry for sale with promotion would include a credit to a “Gift Card Liability Contra” account.

The Company should continuously monitor redemptions in the gift card monitoring system and analyze actual forfeitures on gift cards to ensure proper breakage. As such, proper set-up for tracking purposes is required from the beginning. Having a reliable system to track gift card balances helps alleviate end-of-the-year stress, provides a full picture of outstanding amounts, and ensures compliance with accounting rules.

GBQ and its dedicated team of restaurant industry experts stand ready to assist you. To discuss this information in more detail, please contact Anna Markin or other members of GBQ’s Restaurant Services team.

 

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Tags: Audit/GAAP