The rumblings over gift card sales and accounting continue to grow. The recent hubbub began after Motley Fool Stock Advisor selection Best Buy
It's not unreasonable to keep an eye on how a company accounts for its gift card sales. They've become common offerings from a broad spectrum of retailers and restaurants, including Gap
Bear in mind that the sale of a gift card isn't immediately treated as revenue. Instead, it's considered both a receipt of cash and the assumption of a liability on the balance sheet (because goods will later be sold). To a certain extent, gift cards for retailers are analogous to float for an insurance company; the retailer receives money in advance and is free to use that money, but one day, a claim will come from a customer looking for goods. In most cases, a customer eventually goes to the store and redeems the gift card for merchandise. At that point, the liability comes off the balance sheet and revenue is finally recognized on the income statement.
But things get interesting for a company, and for investors, when a customer loses a gift card or forgets it has a balance on it. This leaves a company with a liability on its balance sheet that will never be recognized, which inflates a company's liabilities and keeps it from ever recognizing the sales and profit on the sales of the gift cards.
That's the conundrum Best Buy faced last quarter, when it finally recognized revenue on gift cards that it determined would not be redeemed because of age or expiration (which can vary by state). Best Buy's accounting for its gift cards seems fair to me, and actually made its financial statements more accurate. I don't agree with the assumption that what Best Buy did was some sort of cheap trick. However, investors have every right to believe that any future benefits from the recognition of unused gift card revenue will be smaller, and that the company's income from operations was a bit soft.
As investors, I believe we should ignore the scuttlebutt that gift cards are inherently bad. However, we do need to recognize that gift cards have their pros (float, unredeemed cards) and cons (potentially deceptive accounting), and pay attention to how each company accounts for its cards. But as long as companies are waiting to recognize revenue until a gift card is either redeemed or expired, I think the overall benefits of issuing gift cards outweigh the risk, for companies and investors alike.
For related Foolish gifts:
Best Buy and Gap are both Motley Fool Stock Advisor recommendations.
Nathan Parmelee owns shares in Outback Steakhouse but has no financial stake in any of the other companies mentioned. If you have a different take on gift cards, feel free to email him. The Motley Fool has an ironclad disclosure policy.