Required 1. Why does the article state that investors get hurt when companies offer gift cards/ generous
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1. Why does the article state that investors get hurt when companies offer gift cards/ generous incentive programs?
2. When deciding how to account for gift card revenue and incentive programs, which accounting principles must be considered?
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NOVEMBER 2007 - Gift cards come in two basic types: those that are affiliated with credit card companies such as Visa and MasterCard, and those that are not. The nonbank cards, often purchased from retailers, do not come under the jurisdiction of the federal banking laws, and very little GAAP guidance addresses how to account for them. There would appear to be a variety of ways that companies are accounting for the revenues and disclosures associated with nonbank cards, to the detriment of comparability. This article discusses differences in gift-card financial reporting and disclosures, and the possible issues with reporting transparency. Nonbank gift cards are frequently referred to as closed-system or closed-loop cards because they are used only at the retailers that issue them. (Besides retailing, other types of uses for closed-system cards include telephone calls, restaurants, grocery stores, movie theaters, coffee shops, vending, and even payroll.) There is not much legal regulation of nonbank gift cards, leading to a variety of conditions attached to the use of this plastic currency. In some cases these cards carry monthly fees, carry activation fees, and have an expiration date that can literally bring the original value of the card down to zero if the card is not used over time. For example, if the card had an original value of $20 and carried a monthly fee of $2, the $2 monthly fees would eventually bring an unused card's value to zero in less than a year. Because these kinds of fees have been the basis of many consumer complaints, many nonbank card issuers have stopped attaching monthly fees or expiration dates. For consumers, another persistent negative aspect of nonbank gift cards is that most issuers will not allow the customer to redeem unused value for cash. Despite these limitations, gift cards have become big business. Big Business Companies like gift cards because they are moncy-makers. According to estimates from the National Retail Federation, 80% of all shoppers purchased at least one gift card in 2006, with total annual gift card sales estimated at around $53 billion. The 2006 end-of-year holiday sales were some $27 billion, up almost 34%. During the 2006 holiday season, the average consumer spent about $116 on gift cards, actually overtaking clothing as the most popular of holiday gifts (Elizabeth Wayke, "Someone's Been Using My Gift Card," Business Week, January 15, 2007). Additionally, companies are keen on cards because gift recipients effectively extend the retail holiday season for another month or two. Cards turn the January and February clearance sales into one of the most important nonholiday times of the year for retailers. Customers are fond of gift cards because they can be handy when one doesn't know what to give "that special someone" for a holiday or other occasion. Gift cards can also be practical for relatives at a distance, especially as an alternative to shipping presents. And, in some cases, love may have nothing to do with it: Many appreciative employers use gift cards as incentives and awards. Either way, most everyone seems to like gift cards because they're convenient, easy to use, flat, lightweight, easily stored, virtually unbreakable, and, perhaps most important, the recipient is saved the predicament of having to return unwanted gifts. Current Accounting for Gift Cards One way a company profits from gift cards is the phenomenon of people frequently spending more than the actual amount on the card. According to Providence College marketing professor Daniel R. Home (in the above- referenced Business Week article), consumers, buoyed by a sense of "found money," spend an average of 1.4 times the amount on their cards. If applicable, issuers can profit through monthly service or renewal fees (if the card has an expiration date). In addition, some purchasers don't use the entire amount on the card, leaving a small balance that is forgotten or disregarded. Some customers may even lose the card before using it at all, and unused cards can add up to substantial amounts.. Interesting questions are raised for auditors, gift card issuers, and financial statement users. If there are no fees or expiration dates, how should a company account for the initial transaction and ultimate disposition of the monies when a customer pays, say, $100 for a gift card but never uses the card? Assume that the $100 is recorded as cash and that the company now has a liability (uncarned revenue) in the same amount. If the card has no expiration date, will the liability stay on the books indefinitely? At what point can the company decide that the card will indeed never be used for the amount recognized as income (referred to as breakage income)? Keep in mind that while $100 may not seem material, it's been estimated that as much as 10% of the total value of gift cards sold in the United States goes unused, totaling nearly S8 billion due to unredeemed value, expiration, or lost gift cards (Cerise A. Valenzuela, "New Fraud Makes Rounds This Holiday Season," Copley News Service, The Alert Consumer, December 11, 2006). Companies account for gift card sales in different ways. Moreover, not all companies disclose their policies for recognizing breakage income. A review of the notes to the 2006 10-Ks of four well-known retail chains that offer gift cards reveals different accounting for each. In all four cases, the cards are very popular because they do not impose expiration dates or fees, they can be used online and in stores, and they can be replaced if lost or stolen. • In its 2006 10-K. Best Buy states that it recognizes breakage income for unused cards that have heen outstanding for 24 months. because at that point. the "likelihood of redemption is deemed to be remote." In this NOVEMBER 2007 - Gift cards come in two basic types: those that are affiliated with credit card companies such as Visa and MasterCard, and those that are not. The nonbank cards, often purchased from retailers, do not come under the jurisdiction of the federal banking laws, and very little GAAP guidance addresses how to account for them. There would appear to be a variety of ways that companies are accounting for the revenues and disclosures associated with nonbank cards, to the detriment of comparability. This article discusses differences in gift-card financial reporting and disclosures, and the possible issues with reporting transparency. Nonbank gift cards are frequently referred to as closed-system or closed-loop cards because they are used only at the retailers that issue them. (Besides retailing, other types of uses for closed-system cards include telephone calls, restaurants, grocery stores, movie theaters, coffee shops, vending, and even payroll.) There is not much legal regulation of nonbank gift cards, leading to a variety of conditions attached to the use of this plastic currency. In some cases these cards carry monthly fees, carry activation fees, and have an expiration date that can literally bring the original value of the card down to zero if the card is not used over time. For example, if the card had an original value of $20 and carried a monthly fee of $2, the $2 monthly fees would eventually bring an unused card's value to zero in less than a year. Because these kinds of fees have been the basis of many consumer complaints, many nonbank card issuers have stopped attaching monthly fees or expiration dates. For consumers, another persistent negative aspect of nonbank gift cards is that most issuers will not allow the customer to redeem unused value for cash. Despite these limitations, gift cards have become big business. Big Business Companies like gift cards because they are moncy-makers. According to estimates from the National Retail Federation, 80% of all shoppers purchased at least one gift card in 2006, with total annual gift card sales estimated at around $53 billion. The 2006 end-of-year holiday sales were some $27 billion, up almost 34%. During the 2006 holiday season, the average consumer spent about $116 on gift cards, actually overtaking clothing as the most popular of holiday gifts (Elizabeth Wayke, "Someone's Been Using My Gift Card," Business Week, January 15, 2007). Additionally, companies are keen on cards because gift recipients effectively extend the retail holiday season for another month or two. Cards turn the January and February clearance sales into one of the most important nonholiday times of the year for retailers. Customers are fond of gift cards because they can be handy when one doesn't know what to give "that special someone" for a holiday or other occasion. Gift cards can also be practical for relatives at a distance, especially as an alternative to shipping presents. And, in some cases, love may have nothing to do with it: Many appreciative employers use gift cards as incentives and awards. Either way, most everyone seems to like gift cards because they're convenient, easy to use, flat, lightweight, easily stored, virtually unbreakable, and, perhaps most important, the recipient is saved the predicament of having to return unwanted gifts. Current Accounting for Gift Cards One way a company profits from gift cards is the phenomenon of people frequently spending more than the actual amount on the card. According to Providence College marketing professor Daniel R. Home (in the above- referenced Business Week article), consumers, buoyed by a sense of "found money," spend an average of 1.4 times the amount on their cards. If applicable, issuers can profit through monthly service or renewal fees (if the card has an expiration date). In addition, some purchasers don't use the entire amount on the card, leaving a small balance that is forgotten or disregarded. Some customers may even lose the card before using it at all, and unused cards can add up to substantial amounts.. Interesting questions are raised for auditors, gift card issuers, and financial statement users. If there are no fees or expiration dates, how should a company account for the initial transaction and ultimate disposition of the monies when a customer pays, say, $100 for a gift card but never uses the card? Assume that the $100 is recorded as cash and that the company now has a liability (uncarned revenue) in the same amount. If the card has no expiration date, will the liability stay on the books indefinitely? At what point can the company decide that the card will indeed never be used for the amount recognized as income (referred to as breakage income)? Keep in mind that while $100 may not seem material, it's been estimated that as much as 10% of the total value of gift cards sold in the United States goes unused, totaling nearly S8 billion due to unredeemed value, expiration, or lost gift cards (Cerise A. Valenzuela, "New Fraud Makes Rounds This Holiday Season," Copley News Service, The Alert Consumer, December 11, 2006). Companies account for gift card sales in different ways. Moreover, not all companies disclose their policies for recognizing breakage income. A review of the notes to the 2006 10-Ks of four well-known retail chains that offer gift cards reveals different accounting for each. In all four cases, the cards are very popular because they do not impose expiration dates or fees, they can be used online and in stores, and they can be replaced if lost or stolen. • In its 2006 10-K. Best Buy states that it recognizes breakage income for unused cards that have heen outstanding for 24 months. because at that point. the "likelihood of redemption is deemed to be remote." In this
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Answer rating: 100% (QA)
1 Because gift cards entail risks Please be guided accordingly with the cons of Gift Cards a Interestfree loan to the company When you buy a gift card ... View the full answer
Related Book For
Income Tax Fundamentals 2013
ISBN: 9781285586618
31st Edition
Authors: Gerald E. Whittenburg, Martha Altus Buller, Steven L Gill
Posted Date:
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