Introduction
Revenue recognition is an accounting principle which stipulates the exact time on which revenues from an activity can be recognized in the financial statements of a company. According to this principle, the appropriate time for revenue recognition is when the service has been rendered, as opposed to when the revenue is collected from the client. Explained in practical terms, Trackon ltd, company that sells consumer goods and commits to a transaction in the last month of an accounting year, whereas the revenues are collected in the next accounting period, in the books of account Trackon ltd will record the income in the ending financial year then carry on the debt till it is paid by the creditor. The principle is adopted to enhance matching activity with the income generated, whether collected or accrued. On a closer look, this concept will tell volumes on the long term financial health of the business, giving a chance for amends to be carried out where necessary.
A gift card is an instrument that transfers value from one person to the other on a platform of safety convenience, and within reasonable timelines for all parties involved. On economic perspective, it is more reliable to use a gift card since it is acceptable for a wide array of operations hence gaining unprecedented population as a mode of money transfer in the U.S economy.
Analysis of the current state of affairs
As noted from the research conducted on U.S. economy, the use of gift cards has gained prominence among the American people.Concequently; businesses are taking this as golden opportunity to strengthen their income streams by ensuring that trading using this facility remains firmly in their portfolio. From the booming business, profits will be made, reputation of business enhanced and way forward business wise crafted. On the negative side though, there lies pitfalls on which the businesses engaging in this commercial activities risk stumbling in (Murden, 2010).
To begin with, the case of unclaimed gift cards brings a lot of losses to the retailers of these noble instruments. It is worth noting that these instruments are issued within specific timelines, by which the person whom it is issued in favor of is supposed to claim the benefit. On this point, in case the mentioned person does not claim the gift, the government through the regulatory authority will claim the benefit. Even though this is done in the pretext of safeguarding consumers against loss by the dealers, it makes a very discouraging statement to the willing dealers of these assets. (Murden, 2010).
Deepening the woes of the dealers about these instruments is the fact that the clients may not claim all the benefits drawn in their favor. This arises in case the beneficiary uses part of the benefit and deliberately ignores the other bit, or after claiming one part he /she forgets about the unused part. As explained earlier, the bit that is unclaimed is taken by the state’s regulatory authority, and the issuers have nothing they can do to claw back the benefit they had passed on to their clients (Duff,2011).
Taking an empirical example of the case:
$7million worth gift cards were transferred in year 2010. Only $ 5.7million worth of gift cards were redeemed by the end of 12 months
Then:
The remaining $1.3 million will be deferred to the following year 20x11to await redemption failure to which the regulatory authority will claim them.
The $5.7 million is what constitutes to tax payable. The unredeemed gift card portion is not taxed.
Of concern regarding this business is when to recognize the income from sale of gift cards for taxation purposes. As earlier highlighted, the time during which the dealers of gift cards draw them in favor of the client and the redemption time of this benefit differs. A client can wait for a very long period before redeeming the benefits as passed on, ruining the state of affairs of the retailers. As a way of example, when a retailer sells a gift card, it is promptly recognized as a liability of the retailer’s balance sheet. For a specific timeline, which is after twelve months, all the unredeemed gift cards are supposed to be recognized as revenues for tax purposes. A reprieve is though given by the federal reserve laws to extend the duration to two years (twenty four months) if the outstanding balance of unredeemed assets is justifiable (Murden,2010).
From the above standpoint, the exercise brings on board a very complicated tax administration burden for the traders as they have to keep track of all the records in a way of ensuring that every bit depicted in the statement of accounts is accurate (Wal-Mart, 2010).
It is worth noting that recognition of gift cards is not a simple affair. To begin with, increase in number of business people from all walks of life using these cards in different ways has sparked confusion among the administrators on behalf of the retailing business. There is the mortal fear that these assets my go unclaimed, or the card can fail to swipe due to various reasons heavily linked with technical problems (Murden, 2009).
Reportedly, there are cases of fraud happening between employees of the businesses dealing with gift cards. Any retail store that uses gift cards can fall victim to fraud, either due to customers or employees colluding to perpetrate the fraud. Customers can shoplift cards, using the cards themselves or reading the authorization then claiming the benefits information from the magnetic strip with an electronic device.
Stolen, fake, and empty cards are also frequently sold on auction sites or bargain sites. Employees are just as likely to steal cards, but also have other opportunities to commit fraud. They may pretend a customer’s card is empty or deactivated and convince the customer to hand over the card. Or they may use sleight of hand to swap the customers card with an empty one. Losses from fraud can be significant, but the benefits a company gains from its gift card program often far outweigh the losses (Suttora, 2010).
Accounting for gift cards is also an unclear territory since GAAP offer little regarding how gift card revenue should be recorded and reported. The main issue that is confounding both of these perspectives is what to do with gift cards that are unlikely to be redeemed. It’s estimated that the percentage of gift card balances that remain unredeemed, known as breakage, range from 10 to 19 percent. (Grant Thornton LLP, 2011)
Potential solutions to the above problems
One on one analysis of the stinging issues affecting the smooth running of gift card businesses is needed to prevent further complications. Drawing attention to the taxation, the pit falls highlighted above can be avoided if proper steering of the business is undertaken by the respective stakeholders. In the business’s quest to see all this evaded, the following can be done:
For the businesses whereby accounting procedures are not enhanced to avoid the misery brought about by poor record keeping, setting up a liability account to track the movements’ of gift cards is necessary. In this account, all the sold gift cards that are yet to be redeemed are properly recorded. This amount will remain outstanding on this account till that point in time when person whom it is drawn in favor of fully exploits all the benefits on card. At the point of full redemption of the gift card, it will be recognized as revenue and thus will be ready for taxation purposes. This simplified procedure will reduce the psychological toll on the administrators when it comes to analyzing which instruments are ready for taxation purposes (Suttora, 2010).
In general revenues is recorded when it is earned for financial accounting purposes, and when it is received for tax purposes. Retailers that used gift cards understandably were resistant to this. To have all their gift card sales count upfront would make it so that they could not balance out these sales with their related expenses as they would not have been incurred yet. The IRS forbids realizing COGS before the cards is redeemed as it cannot be predicted what product will be purchased with the card. (Suttora & Bender, 2009) If a company can properly use the advance payment deferral rules from Treasury Regulation § 1.451-5 and Revenue Procedure 2004-34 then unredeemed gift card income can be deferred until up to the last day of the second tax year after the card is sold. (Smith, 2009) Treasury Regulation § 1.451-5 defines what an advance payment is, the length of the possible deferral and which types of advance payments are subject to deferral. Namely, transactions where the taxpayer: is accounting for them using the accrual method for financial reporting reasons, cannot determine what goods will be used to satisfy the advance payment, and has goods on hand at all time that could satisfy the advance payment. (Treasury Regulations, Subchapter A, Sec. 1.451-5, 2005)
These initial regulations on gift card revenue recognition were a start but were not perfect. The IRS has since made a few clarifications and revisions to its policy regarding gift cards. Examples of the clarifications include the following; that gift cards are the electronic versions of gift certificates and thus are still covered by § 1.451-5; that re-loadable gift cards begin their deferral period when additional funds are added, not on the original purchase date; that any dormancy fees or other fees attached to a gift card must be recorded when they occur; that bulk sales discounts on gift cards should be expensed in relation to the recognition of income from gift cards; that income from gift cards that expire before the 2 year deferral period must be recognized on the expiration date; and that promotional gift cards given away should be treated as deferred advertising expense. (Suttora & Bender, 2009) While some of these may seem self evident, when it comes to taxation and legality, all of these were necessary to have spelled out.
One other concern was how to account for when gift cards are issued in exchange for returned merchandise. Rev. Proc. 2011-17 determined that taxpayers who are retail businesses, and use the accrual method of accounting overall may treat gift cards issued for returned goods as the payment of a cash refund followed by the sale of a gift card to the customer who made the return. The taxpayer may then account for the amount deemed received for the sale of the gift card under Treas. Reg. § 1.451-5 or Rev. Proc. 2004-34, if otherwise eligible. (Grant Thornton LLP., 2011)
The second step in stream lining taxation issues will be full disclosure of gift card trading for tax purposes. Full disclosure in this case means explaining fully the nature of every transaction captured the liability account of the gift card dealer, probably with an ageing report. When this is done, the GAAP officials will not be at pains to extend the payment time of tax to years instead of the stipulated twelve months .This exercise provides the much needed tax cushion that will definitely improve the long term financial health of the business enterprises engaging in this business opportunity (Murden, 2009).
With regard to employee and customer defrauding the owners of the business, it sounds as more of weak internal control systems. It can be noted with concern that authorization is a key factor in this business, and for the sensitive parts like authentication of personal identification numbers (PIN), this should be left to the owners of the enterprise to determine who the right person to carry out such sensitive exercises is. Alternatively they can do the task for themselves, or in gravest circumstances appoint someone they trust in the firm to do that (Wal-mart, 2010).
With regard to the trading offices, it is imperative that security devises should be fixed to curb any desperate attempt by employees defraud the company. Measures like installation of CCTV cameras and other related control devices will keep employees who harbor such unethical activities at bay, and probably aligning them to the company’s policies. In event that any employee is spotted carrying out any activity likely to harm the business along the above mentioned lines, the only solution is replacement after which legal action will be taken on his person in the court of law (Murden, 2009).
These tough rules are meant to ensure that any fraudulent plan by the employees will not be undertaken with ease, as strong controls will always ensure that there are landmarks on any attempted activity by the employees. To up the security measures, segregation of activities will be the key. Keeping every task with a particular person will curb any attempt by anyone working in the firm to eliminate other employees for his own personal gain. Finally, employees are dynamic and so is fraud. Most employees who can commit fraudulent activity if control allow will get a window if regular reviews on the control measures are not done. In bid to prevent these activities from mutating to more serious ones, it will be imperative to uphold security measures (Wal-Mart, 2010).
The problem of revenue classification on selling of gift cards is more of industry failure than business shortcomings. It will be gathered that authorities have the final say in the direction to take on issues relating to control of businesses within a specific territory, but industry players can do part to ensure the industry is stream lined. The first step in achieving this will be a group call of all the participants trading gift cards to brainstorm on the pitfalls these firms face in the line of execution of their duties. This will be first step in lobbying the control authorities to soften their stance on some activities, say on the issue of unclaimed gifts and the partially utilized ones that may eventually be surrendered to the authorities (Schumann, 2012).
Unprecedented unity among the players in the industry will be the hallmark of ironing out the regulatory in efficiencies as these costs the businesses a lot (Murden 2009).
Ethical considerations
It is a fine decision by the FASB to allow for an extra one year for those gift cards that have not been claimed by the holders, but the battle for reducing the cases of unused gift cards is far from being over. It will be a good idea to incorporate constant reminders to all the holders of issued gift card notes so that every one is aware of what he/she can gain from the deal. This decision is informed by the fact that it sounds irrational for someone to ignore a gift drawn to his favor; actually it is at worst abomination and at best sheer arrogance (Derrick, 2010)
The Federal Reserve on 2009, effort to protect customers who use gift cards as a mode of transferring funds issued a directive that would be followed by all the stakeholders in the gift card industry. This involves putting hefty fine on dormancy, inactivity and service fees, which can only kick off after the customer has failed to use the credit card for more than one year. Even though there were high expectations from this law, it has been left to compete with morass of conflicting state laws due to the fact that state does not pre-empt state law unless the state law is inferior to the federal laws. As a result of this, the companies have to analyse on a state by state basis whether or not gift card programs are compliant, says Caroline Osborne, chair of a law firm in Carolina.
From the stand point of the regulator, it brings mischief to learn that all the unclaimed assets are taken by the regulator as a way of customer protection while in reality it becomes more difficult to follow up the original benefits. On a fair platform, the sellers ought to be in frame when it comes to reverting back the value in the gift card to the original issuer. It will be fair if the regulator just facilitates the process instead of claiming the unredeemed gifts. (Derrick 2010)
It will be in the best interests of the regulator to keep eye on the problems that belittle the gift card industry and be ready to give solutions since failure to this will lock some firms out of the industry, at the same time eroding the profitability of the ones that are already struggling to make a mark in the market place (Derrick, 2010).
Recommendations
It would have been difficult to follow the principle of recognizing revenues when they are earned for financial accounting and taxation purposes in the case of gift cards because it would have implied recognising gift card sales upfront before any balancing for the expenses related to these sales could occur. The IRS forbids realizing COGS before the cards is redeemed as it cannot be predicted what product will be purchased with the card. (Suttora & Bender, 2009) If a company can properly use the advance payment deferral rules from Treasury Regulation § 1.451-5 and Revenue Procedure 2004-34 then unredeemed gift card income can be deferred until up to the last day of the second tax year after the card is sold. (Smith, 2009).
The IRS has made further policy changes regarding revenue recognition of gifts, and some of these include; that gift cards are the electronic versions of gift certificates and thus are still covered by § 1.451-5; that re-loadable gift cards begin their deferral period when additional funds are added, not on the original purchase date; that any dormancy fees or other fees attached to a gift card must be recorded when they occur; that bulk sales discounts on gift cards should be expensed in relation to the recognition of income from gift cards; that income from gift cards that expire before the 2 year deferral period must be recognized on the expiration date, and that promotional gift cards given away should be treated as deferred advertising expense. (Suttora & Bender, 2009)
In accounting for gift cards, there is also the concern of how to account when the gift cards are issued in exchange for goods returned. Rev. Proc. 2011-17 determined that taxpayers who are retail businesses, and use the accrual method of accounting overall may treat gift cards issued for returned goods as the payment of a cash refund followed by the sale of a gift card to the customer who made the return. The taxpayer may then account for the amount deemed received for the sale of the gift card under Treas. Reg. § 1.451-5 or Rev. Proc. 2004-34, if otherwise eligible. (Grant Thornton LLP., 2011)
It will be my humble opinion that the regulator, that’s FASB, state and Federal state officers develop follow up procedures to help retailers and other stakeholders providing gift cards track unused gifts, and if necessary develop structures to help them overcome the reasons behind the failure to claim the benefit. In the long run, this will help stream line the industry (Suttora 2009)
It will also be in the best interests of the industry if federal government will impose compulsory tax on those who fail to claim the benefits deliberately, thus giving chance to the unclaimed ones that the deadline has not passed by a long time span to be withdrawn from the unused ones.
The SECC has given a description of only two methods of recognizing breakage, and these are identification and the homogenous pool method. The identification method requires that companies must recognize breakage income when the chance of a specific card being redeemed is remote. As most cards loaded electronically, it is not terribly difficult to keep track of when specific cards are issued and redeemed. The SEC does not specify how long a company should wait before recognizing breakage, but 2 years is typical. (Grant Thornton LLP., 2011). The second method, homogeneous pool method, companies will estimate how much a value of a pool of cards will end up unredeemed. Then, brekage income will be recognized as the value of this proportion to the amount redeemed over the cards useful life. For this to be done; 1) All of the cards in the pool must be homogenous, 2) there must be a remote likelihood that 100% of the cards’ value will be used, 3) The breakage amount can be reasonably and objectively determined, and 4) the estimated useful life of the cards can be reasonably and objectively determined. (Grant Thornton LLP., 2011)
Enhancing proper accounting procedures is crucial to maintaining the growing preference of this method of transfer of value. For the companies trading with gift card that find it impossible to implement the required reporting standards must outsource experts from accounting bodies to bridge the gap.(Blackstone, 2012).
Engaging the all the customers in an enlightenment exercise to ensure that they are well informed of the benefits of using to the last penny all the benefits that are enshrined in the gift cards. My idea is informed by the fact that sometimes the bearer of this card may take their worth for granted, failing to utilize its benefits. The mere fact that the customer (bearer) for this case is not aware of the effects of his/her decision on the seller may be the reason behind such dismal usage, as most of these cards goes unexhausted. For this case, it will be a in win situation for all the parties (the seller and buyer) since when the usage of gift cards increase, it means more business for the sellers of the gift cards (cheesecake, 2010).
Since security seems to be the single threat to this booming business in the U.S economy, it will it will be in the best interests of the business to hire expatriates in the line of security so that all the noted loop holes are plugged to prevent unexpected downfall (Schumann,2012).
Conclusion
It should underlined that the growth of this way of transferring value is not by coincidence with technological advancements; its efficiency, flexibility and simplicity plays major role in attracting more people to try it. Viewing the opportunity through lenses of reality depicts that it is the mode to beat. Hence to ensure that it does not lose taste in future among the users and potential customers, all the problems highlighted above should be ironed out in due time.
It has been underlined that the growing popularity of gift cards will continue in future, highlighting the necessity for making the following changes
With regard to the operations of FASB, I am of opinion that some guidelines should be chanced. Not ignoring the hard task they are doing to bring the business of gift cards in to global spot light; it will be fair to say their operations are not optimal. The following weak points should be strengthened:
Unifying the accounting procedures so as to reduce the reporting quagmire among different stakeholders, that is retailers, their appointed third parties and every one who plays part in the regulatory procedure of gift cards.
Further enactment of deferral rules such that the benefits from this gift cards do not expire after short duration of time. As a way of example, keeping constant watch to ensure every one gets his/her due since some eventualities may hinder the possibility of this within the stipulated time span. Example is a crippling sickness on whom the gift card is drawn to favor.
Alteration of rules by the FASB to ensure rider benefits can apply on gift cards. A prudent example will be endorsing another party by the person whom it is drawn to favor. This will help curb unavoidable circumstances like death of the holder, old age hindrances and transferability benefits.
Bringing in the attention of various stakeholders the benefits of being conversant with all the revised rules of gift cards for purposes of keeping phase with growing industry usage.
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