the Restaurateur Restaurant Owners, Are You Accounting for Gift Cards Correctly? September 17, 2019 Are you accounting for gift cards properly in your restaurant? Keep in mind that the updated revenue recognition standard has changed this process. Learn more. Does your restaurant sell gift cards? Offering gift cards is a fantastic opportunity to improve sales, increase your company’s brand awareness, and attract new business…but make sure you’re accounting for these sales correctly. How has the new revenue recognition standard changed this process? Here are the details. Some helpful background What is revenue recognition? Revenue recognition is a generally accepted accounting principle (GAAP) that determines the specific conditions in which revenue is recognized or accounted for. Check out our blog Changes in Revenue Recognition Rules. It differs greatly from the simple cash basis treatment of recording revenue upon cash or credit card receipt. What is ASU 2014-09? The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers in May 2014, marking the most significant revision to revenue recognition standards that GAAP has ever seen. Do you record revenue when a customer purchases a gift card? No! When a customer purchases a gift card at your restaurant, you must record it as a liability because you have an obligation to provide the goods/services at a later point in time. Once the customer redeems the gift card, you reduce your company’s gift card liability and record revenue for the sale. What is breakage? Breakage is any type of service (paid in full) that goes unused by a customer. Gift cards are the most common origin of breakage. If someone buys a $25 gift card for your restaurant, you now have $25 in cash and a liability for future services of $25. Gift card amounts that are never redeemed are known as “breakage”. Revenue recognition rule changes Prior rules- Under prior guidance, gift card breakage was recognized under one of three methods: Released obligation method- Breakage revenue isn’t recognized until the company is legally released from its obligation (when the gift card expires, for example). Remote method- Breakage revenue is recognized once the probability of gift card redemption becomes “remote,” in other words unlikely which could be due to a long passage of time post-sale. Redemption pattern method- Breakage revenue is recognized on a pro-rated basis determined by the historical redemption pattern of gift cards redeemed. New rules- The FASB expressed concern that three different methods allows for inconsistencies in practice and reduces comparability of financials. Under the new revenue standard, restaurants and other companies are expected to use the redemption standard. The new rules hold that breakage is determined by the historical redemption rates and recognized in proportion to the actual redemptions of the gift card. ASU 2014-09 does still allow companies to use the remote method, however, the standard states that this method should only be used when a company expects there to be no breakage at all. When is the standard effective? Public companies were required to comply with the new standard for the year ended December 31, 2018 while most nonpublic companies are provided an additional year requiring compliance for the year ending December 31, 2019. All companies that offer unexercised customer rights (gift cards, loyalty rewards points, etc.) must comply with the new standard and should start assessing the impact it will have on their revenue recognition policy. While we focus on restaurants here, the concepts apply to all hospitality companies. Questions? Contact us.Check out part two of this blog series where we dive into the Tax Considerations for Gift Card Sales.