When Saks Inc., the luxury department-store chain, recently announced that its third-quarter profit margins on merchandise faced pressure from other economic factors, it noted, however, that one factor helped it to break even. Saks’s savior was unused gift cards, a growing phenomenon that allows companies in many states to turn hanging liabilities into an extra boost of income.
Although most retailers hope customers will flock to their stores and spend their gift cards — and more — with abandon, many get a lift from cards that languish in wallets and purses. For instance, Ruth’s Chris, a popular chain of steakhouses, said last summer that it expected to gain an added $2.2 million in operating income this year thanks to unredeemed gift cards. That, along with growing revenues, helped spur a 33.8 percent increase in operating income.
Companies clearly have something to gain from the growing number of unclaimed gifts. A new survey by Consumer Reports found that 27 percent of those who received gift cards last year haven’t used them, up from 19 percent the year before. And Deloitte, the accounting firm, published a survey this month that found nearly half of consumers have a gift card that’s at least partially unused.
But when can a company redeem an unused gift card? In some states, the value must be turned over to the government as unclaimed property. But in states without such laws, companies are allowed to convert the liability of the unredeemed card into income. That transfer is known as “breakage,” and it’s not always clear when the breakage point occurs for gift cards, especially those that never expire.
“It becomes unknown property,” says Mark Paolillo, director of the unclaimed-property division at Deloitte and Touche. “It’s floating out there and then becomes revenue.”
According to new research in the Journal of Accountancy, companies look at historical patterns to determine the likelihood of a gift card being used over time. Since companies don’t want endless liabilities on their balance sheets, they use those patterns to estimate whether the card will ever be used. “Once a reliable estimate is established, the retailer may claim to have a basis for removing the gift-card liability from the books,” writes Charles Owen Kile Jr., an accounting professor at Middle Tennessee State University.
Two years ago, Best Buy, an electronics retailer, did precisely that. It first moved $39 million attributed to unredeemed gift cards from liability to income. It then determined that, on average, gift cards that haven’t been used after two years never will be. Best Buy continues to part ways with “tens of millions of dollars” of unused gift-card liabilities every quarter, according to Charles Marentette, senior director of investor relations at Best Buy. “If you have a liability that’s not really a liability, you have to take it off your books,” Marentette told CFO.com.
Yet the point at which companies can declare a breakage remains left to their own discretion. Such subjectivity could be dangerous, as firms count on unused gifts cards to pad their revenues. “Some companies depend that people will not use their cards,” says Paolillo, who estimates that up to $8 billion in gift cards go unredeemed. “They already have the cash and they don’t have to expend their goods.”
Kile notes in his study that the Securities and Exchange Commission hasn’t taken a stance on gift-card accounting other than to say companies should not immediately recognize any amount of revenue at the point of a sale. The SEC did not respond to a request for comment from CFO.com. In another report this month, the CPA Journal suggests that the Financial Accounting Standards Board should take action on gift-card accounting.
“If a given state does not have an unclaimed property law, it could be up to the company to decide when it believes the unused card values are unredeemable and able to be recognized as income,” write Timothy Forsyth and Ronald Marden, accounting professors at the Walker College of Business of Appalachian State University in North Carolina. “There’s no telling what process is used for this estimate.” They suggest that FASB create rules to ensure that companies are clear and forthcoming about how they handle accounting for gift cards. Christine Klimek, a FASB spokesperson, says they have no such plans at this time.
Of course, companies don’t admit to hoping that gift cards never return to their stores. Marentette, of Best Buy, explains that if customers do not spend their gift cards, people will stop purchasing them as presents. Still, for some retailers gift-card usage is a moot point. Ben Bridge Jeweler, a 79-store retail chain owned by Berkshire Hathaway, doesn’t have a breakage policy, since most of its customers are quick to use their gift cards, according to Jerry Gronfein, the company’s CFO. In the case of the jeweler, the amount on gift cards tends to be relatively large to pay for high-priced baubles. “People want to convert that higher ticket sooner rather than later,” says Gronfein.