Calculating a business’s costs and potential liability from selling gift cards is complicated, but there are written rules about it. Here’s what you need to know.
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Dear Your Business Credit,
My partner and I are buying a massage therapy practice where we’ve worked for the past five years. What are the laws when it comes to gift card sales?
If the current owners keep the money earned from gift card sales then my partner and I will be responsible for paying employees that provide the service. This is what’s happening and I need advice.
I don’t think the current owners should keep the money earned from the gift card sales. – Erica
It’s great that you are taking an active interest in the accounting at your future business.
The good news is that how the business handles gift cards is not a matter you have to work out with the sellers. There are accounting standards in place that govern how this revenue from gift card sales is recognized.
How businesses should process income from gift cards
Under Accounting Standards Update (ASU) 2016-09, Revenue from Contracts with Customers, a business must recognize a “liability” on its books when it sells a gift card.
That is because the business has received money before delivering the goods or services.
How to calculate ‘breakage’ income from gift cards
However, if time passes and the cards are never used, then the liability must be reduced and the business must start recognizing the revenue. The revenue that gets recognized is called the “breakage” amount.
To come up with the breakage amount, companies must analyze their historical percentage of breakage income to estimate what percentage of gift cards go unused. Let’s say 25 percent of cards have gone unused in the past. Then the business must recognize 25 percent in additional breakage income.
This is a little complicated. QuickBooks, an accounting software provider, has published an excellent article that explores the fine points of recognizing gift card revenue. I recommend that you read it.
How to enter sales from gift cards
MyQuickbookKeeping, a site on QuickBooks accounting, has also posted a quick video tutorial – that you can watch below – on how gift card sales should be entered. Seeing how the entries should look may be helpful to you in understanding what is actually going on in the accounting.
These accounting standards, which previously offered other options for recognizing breakage, are taking effect this year for non-public companies.
Seek professional accounting help
I would recommend that before you buy the business, you hire an accountant experienced with business transitions to analyze the books. A good accountant will be able to determine if the gift card sales have been handled properly.
Because the laws on “unexercised consumer rights” (such as use of a gift card) may vary depending on where you live, it’s also important to ask the accountant about how that affects the bookkeeping in the business.
If it looks like you’re taking on a large liability, in terms of gift card sales for which the business owes future services, you may need to negotiate the price of the business accordingly.
You should be able to get an idea of how likely it is that the cards will be redeemed from the accountant’s review of the books. While you can’t negotiate accounting rules, you can negotiate the amount you pay for the business.
Best of luck on this new entrepreneurial adventure!