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Breaking The Card

Gift card breakage is complicating retail sales accounting at a time when the plastic money is the gift that keeps on giving. And giving.

No, breakage doesn't refer to mangled cards; it defines an issuer's ability to report as revenue the value of cards sold but not expected to be redeemed. Up to now, gift card sales generally weren't added to the bottom line — meaning breakage didn't occur — until the cards were exchanged for products, or until they expired. Increasingly, however, retailers who don't impose a cut-off date are working out formulas, based on past experience, to determine when it is appropriate to turn the liability into sales — and not be surprised by redemptions later.

Best Buy Co., for example, got a nice boost in its third-quarter earnings reported in December by reducing its liability from gift cards purchased from 1995 to 2003 by $29 million. It was the first time the firm wrote off that presumably lost business and moved it into the sales column. And in June, Home Depot Inc. took $43 million in income from gift cards that are unlikely to be redeemed.

The question then becomes, when is it appropriate to reap the rewards of unused cards. Pamela Schlosser, a professional accounting fellow in the office of the SEC's chief accountant, told the American Institute of Certified Public Accountants in a December speech that if not handled appropriately, breakage could be used to artificially boost profits before there is proof the cards have been lost or forgotten.

Finding a formula for when to move the liability to the income statement is increasingly important. Sales were expected to hit $18.48 billion this holiday season, up 6.6 percent from 2004, according to a National Retail Federation survey conducted by BIGresearch.

In fact, two-thirds of consumers were expected to buy on average almost five gift cards, according to a Deloitte & Touche survey.

Springing into action

Most holiday cards are redeemed for products in the last week of December and the first two months of the new year, according to a 2004 survey by Paymentech, a Dallas-based payment processor, for ICSC. In the survey of 800 gift-card holders, 16 percent used the cards by Dec. 28 while 41 percent planned to shop within two months.

As a result, January, once a clearance sale backwater has potential for a bonanza of sales at full-margin prices, leading some to expect merchandising changes. “The gift card customer is willing to buy spring product, so I think there should be new product introductions in January,” says Annette McEvoy, a retail consultant based in New York.

And expect recipients to spend more than the value of the card, further stimulating January sales. First Data Corp., a unit of Value Link, says a recent study indicates that 56 percent pay more than card amount.

But, the question remains, when will the remainder of the cards be used, if it all. And when should retailers count the revenue as sales?

Based on past experience, Best Buy plans to sweep in breakage every quarter after a card is held for two years. “That's relatively conservative,” says Charles Marentette, the chain's senior director of investor relations. “And we will continually assess the policy.”

Evidence indicates that many recipients do indeed fail to use the plastic cash. The Deloitte survey found that respondents had an average of two unused cards from last year, and only 48 percent had used up all the funds on the cards they received as gifts a year earlier.

These factors combine to make breakage accounting murky, said Schlosser. While some cards have expiration dates or include a fee-structure for holding on to them — controversial practices that landed Simon Property Group in hot water with some attorneys general — most are considered valid until they are lost or forgotten.

As gift cards become a more lucrative part of holiday retail revenue, expect more chains to develop formulas too. Meanwhile, the SEC will be monitoring breakage to see it's not accounted for inappropriately.

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