Similar Concepts – Different Areas of Accounting
As I have been making videos for the FMAA (Financial and Managerial Accounting Associate) Exam, I have had the pleasure of recording videos about topics like accounting for inventory, accounting for fixed assets, and accounting for receivables. I have always liked the way that certain concepts and ideas appear throughout different areas of accounting. For example, for all assets, we want to make certain that we do not overstate the value of the asset. We do this through the lower cost of market for inventory, impairment for fixed assets, and the allowance for bad debts for receivables.
Valuation Methodologies for Inventory and Fixed Assets
I have also liked the similarity of how we determine the value we record for inventory and the value we record for fixed assets. For inventory, it is “all of the costs necessary to get the item ready and available for sale to the customer.” For fixed assets, it is “all of the costs necessary to get the item ready and available for use.” It is very similar; it just changed the nature of the asset.
The Importance of Estimates in Accounting
Another common thing that we do in accounting is we make estimates. We make estimates about bad debts, the useful life of a fixed asset, the salvage value of a fixed asset, and the future cash flows related to an intangible asset.
Accounting Challenges with Gift Cards
Some businesses have another estimate that they need to make that can be a large amount. This is the estimate related to how many gift cards will not be redeemed in the future. I know that giving gift cards as presents is growing around the world. As companies sell more and more gift cards, the accounting issues connected to gift cards become more material. In brief, when a company sells a gift card, it will debit cash and set up a liability of unearned revenue for the amount of the gift card. And then when the gift card is used, they will close the unearned revenue for that gift card and recognize the revenue because the revenue is now earned. That process is clear and simple.
The Concept of Breakage and its Financial Impact
But, as most of us know from our own experience, not every gift card is redeemed. If a company does make an adjustment for that, the amount of unearned revenue (a liability) that a company has on its balance sheet will grow over time.
Therefore, companies make estimates of how much of that unearned revenue from gift cards will never be provided as a good or service. This is called breakage, and this is another estimate that some companies need to make. For companies that sell a lot of gift cards, this is a significant estimate. Starbucks reported $212 million in revenue from breakage in 2022.
State Regulations and Unclaimed Gift Cards
To me, this estimate for breakage is just the opposite of the bad debt estimate. Instead of estimating how much our customers will not pay us in the future, the breakage estimate is estimating how much our customers donated to us. This is another example of the application of an accounting process (estimates) being applied to an area that we don’t often think about.
In a note for completeness, some states in the United States require that the company attempt to return the money for unused gift cards to the consumers. If the company is unable to return the money to the customer, the money is used by the state for public initiatives.
Brian Hock, CMA, CSCA, CIA, CRMA
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