Question

The Show Time movie theatre sells thousands of gift certificates every year. The certificates can be redeemed at any time because they have no expiry date. Some of them may never be redeemed (because they are lost or forgotten, for example). The owner of the theatre has raised some questions about the accounting for these gift certificates.

Instructions

Write an email to answer the following questions from the owner:

a.  

Why is a liability recorded when these certificates are sold? After all, they bring customers into the theatre, where they spend money on snacks and drinks. Why should something that helps generate additional revenue be treated as a liability?

b.  

How should the gift certificates that are never redeemed be treated? At some point in the future, can the liability related to them be eliminated? If so, what type of journal entry would be made?

Answer 1

Gift Cards or Vouchers issued should be recorded only as a liability when issued and not as a sale because sale is not confirmed and no movement of goods/Inventory takes place.It is a future Obligation to sell for the cash received

Since it is a future Obligation it is recorded as a liability and not as a sale

It brings revenue hence cash is debited on sale of gift vouchers (if sold for money) but on receipt of cash or on issue of vouchers the Owner is liable for future commitments to sell the goods when it is redemeed.Hence though it helps in generating additional revenue it is treated as liability untill it is used and an actual sale(movement of goods)are made

For gift cards with no expiration date the legal obligation to provide goods and services never expires but after waiting for a reasonable time if the liability is still in books it will affect the position of the company and doesnot reflect a true picture because of  recording liabilities that are not payable. In many cases Owner of Voucher loses the voucher or gift cards and eventually the owner never purchases anything and seller doesnot owe anything.This results in Brekage revenue as it is commonly referred as

In this case Breakage revenue can be measured and liability can be reduced based on a pro rata basis .To calculate the Pro rata basis the company needs to know its historic pattern of breakage

Just like measuring a pattern of receivables as bad debts based on percentage of baddebts for previous years,in this case pattern(percentage) of gift cards not redeemed in previous years can be taken to account the breakage revenue(gift cards that will never be redeemed)

Liability can be eliminated based on historic pattern of non redemption of gift vouchers

Journal entry would be

Liability against vouchers XXX

(Pro rata) Income XXXX