Gift Cards–Gross or Net

Gift cards are ubiquitous these days. People buy them for gifts, for loyalty points they provide and as an easier way to pay for goods and services without having to carry around cash. Originally you could only buy a gift card from the retailer or restaurant that would ultimately redeem the gift card. Now you can buy a gift card for any number of business from any number of different businesses which raises the question, when a business sells a gift card from a different business, should they book the revenue from that sale at the gross amount (the amount they sold it for) with the cost reflected as an expense or the net amount (the amount they sold it for less the amount they had to pay the other business) with no cost recorded since the cost was already recognized in the reduced revenue.

GAAP has specific rules on determining if a sale should be recorded gross or net. There several indicators to be evaluated two of which – who is the primary obligor and is there inventory risk – are given more prominence than the other indicators such as the ability to set the price and credit risk. Let’s look at these indicators as they relate to gift cards.

It would seem the seller of the gift card has discretion in setting the price. While most retailers sell a gift card for the face value, there are some like Sam’s Club that sell gift cards below face value. Really the only limit on a retailer’s ability to set the price is what the customer is willing to pay and how little profit the seller wants to make. In fact a retailer could sell a gift card as a loss leader to get people in the store to buy other goods. Credit risk also seems to reside with the seller of the gift card. If the check the customer used to pay for the gift card bounces or the credit card ends up being stolen, it is the seller that is out the money, but as I said, these two indicators are not given as much weight in today’s GAAP.

A more important indicator is inventory risk, but that can result in different evaluations depending on how the seller pays for the gift cards. If the seller buys the gift cards up front from the other business then they would certainly appear to have inventory risk. On the other hand, it seems many gift cards have no value until activated at the time of sale. If the seller doesn’t send money to the other business until the gift card is sold, then there doesn’t appear to be much inventory risk for a bunch of plastic rectangles with no value indicated on some computer server in the cloud.

The term “primary obligor” sounds intimidating, but what it really means is who does the customer see as the provider of the good or service they are buying. That’s where gift cards get tricky. Does the customer see the item they are buying as the gift card itself or as the meal or electronics it can buy from the other business? Before you answer let’s bring in some more thoughts. How many people buy gift cards to give as gifts? In their eyes are they buying the gift card itself? They certainly don’t intend on using what the gift card can buy. They intend to use the gift card itself. I can hear those of you stuck with worthless Boarders gift cards say, but the gift card is only worth something when it can be submitted in payment to the other business. That is not entirely true. There is a vibrant market for gift cards. As the seller you won’t get face value, but there clearly is a value for the gift card. So if the gift card itself has value, is it unrealistic to say the customer is buying the gift card itself and not the right to trade it for goods from some other party?

And if you think the accounting for Gift cards is fun now, wait until the new revenue standard is in effect and the indicators I discussed above are all given equal weight in evaluating whether the seller is acting as the principal or agent.

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