The holiday season has just passed, which means your arts organization may have seen a spike in gift certificate sales as communities focused on supporting local businesses and not-for-profits in the challenging climate of COVID-19.
Yet as easy as it is for the consumer to buy the gift certificate, the seller should be aware of the related tax, legal, and accounting considerations in order to prevent unintended exposure.
New Washington Law Regarding Gift Certificates
Effective July 1, 2020, the Washington State Legislature, under RCW 19.240, removed its existing exemptions for not-for-profit arts organizations, thereby disallowing expiration dates for gift certificates to conform with other industries in Washington State. The RCW includes the following definitions:
- Gift card – means a record in the form of a card, or a stored value card or other physical medium, containing stored value primarily intended to be exchanged for consumer goods and services. This does not include prepaid telephone calling cards or prepaid commercial mobile radio services.
- Gift certificate – means an instrument evidencing a promise by the seller or issuer of the record that consumer goods or services will be provided to the bearer of the record to the value or credit shown in the record and includes gift cards. This does not include prepaid telephone calling cards or prepaid commercial mobile radio services.
Accounting for the New Gift Certificate Law
Since Washington State does not require entities to remit unused gift certificates to unclaimed property, U.S. GAAP allows entities to calculate breakage. Breakage is the process of recognizing revenue on unredeemed gift certificates.
As a result, arts organizations will need to perform an analysis of historical gift certificate sales to determine what percentage were typically redeemed. This breakage analysis will allow arts organizations to record an allowance against the gift certificate liability and revenue for the estimated percentage of gift certificates that will not be ultimately redeemed.
The newly implemented ASC 606 revenue recognition standard for contracts with customers has provided new guidance related to gift certificates and how to calculate and record breakage. Here are a few excerpts:
“A customer’s nonrefundable prepayment to an entity gives the customer a right to receive a good or service in the future (and obliges the entity to stand ready to transfer a good or service). However, customers may not exercise all of their contractual rights. Those unexercised rights are often referred to as breakage.
If an entity expects to be entitled to a breakage amount in a contract liability, the entity should recognize the expected breakage amount as revenue in proportion to the pattern of rights exercised by the customer. If an entity does not expect to be entitled to a breakage amount, the entity should recognize the expected breakage amount as revenue when the likelihood of the customer exercising its remaining rights becomes remote.”
The guidance indicates that the organization would assess breakage each time the gift certificate holder redeems a portion of the gift certificate, applying that percent breakage calculation to the remaining balance outstanding. This detailed approach may not be feasible in instances where the organization does not have an automated tracking system for gift certificates. As a result, many organizations will instead analyze breakage as a part of its annual close process.
In practice, we often see organizations record the gift certificate liability upon the sale of the gift certificate, and then use the following process to calculate the related breakage at year end. Organizations may calculate breakage by creating a schedule which tracks the historical collection percentages based on the number of years the gift certificate has been outstanding, and then apply those percentages in tranches to the year when the gift certificates were sold.
Gift certificates represent a wonderful opportunity for arts organizations and other not-for-profits, but it is important to follow the above-mentioned rules and regulations when accounting for them. If you have any questions about the new Washington State law or the U.S. GAAP treatment for breakage, please send me an email.
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