What it means
When a customer purchases a gift card, your business receives cash immediately. Under standard accounting rules, you cannot record that cash as revenue right away because you still owe the customer a product or service.
Instead, it goes on your balance sheet as a liability, often called unearned revenue or deferred revenue. This liability decreases only when the customer redeems the gift card.
At that moment the balance moves from the balance sheet onto the income statement as earned revenue. Tracking this accurately matters for non-finance managers because mismanaging it can give a false impression of your monthly profit.
If you spend gift card cash before the card is used, you risk a severe cash flow shortage when customers return to redeem their cards all at once, such as during the holiday shopping season. Many gift cards also go partially or fully unused over time.
This leftover amount is known as breakage. Depending on local laws and regulations, businesses can often recognise breakage as revenue after a set period of inactivity.
The timing and method vary by region, so agree the policy with your accountant before releasing any balance to revenue. Imagine buying a ticket for a theme park ride.
The park takes your money now, but it owes you a ride, and until you actually get on the rollercoaster, that money sits in its books as an outstanding promise.
In practice
Real-world examples
Example 1
A coffee shop owner sells $150 worth of gift cards in December. She records the $150 as a gift card liability rather than sales, and keeps the cash set aside until customers redeem the cards for lattes in January. As each card is used, the matching amount moves into revenue.
Example 2
A boutique clothing shop issues $50 digital gift vouchers for birthdays. The finance manager keeps the money off the monthly sales report until the voucher is spent and the clothing is handed over. A monthly report lists every unredeemed voucher so the balance in the books matches the voucher system.
Example 3
An independent book publisher sells online gift tokens worth $500 in total. They monitor the unspent balance carefully to ensure cash reserves match their future delivery obligations. If some tokens are never redeemed, the publisher recognises that breakage only after the period allowed by local rules.
Think of it
Imagine buying a ticket for a theme park ride. The park takes your money now, but they owe you a ride. Until you actually get on the rollercoaster, that money sits in their books as an outstanding promise.
Formula
Calculation
Closing Liability = Opening Liability + New Gift Card Sales - Redemptions - Breakage.
Example: A shop starts the month with a zero opening liability. It sells $1,000 of gift cards, sees $600 redeemed and recognises $50 of breakage, so the closing liability is $0 + $1,000 - $600 - $50 = $350. The following month that $350 becomes the opening liability; with $400 of new sales and $500 of redemptions and no breakage, the closing liability is $350 + $400 - $500 = $250. At each month end, the cash set aside should at least match the liability on the books.
Breakage Rate = Breakage / Gift Card Sales. In the first month that is $50 / $1,000 = 5%, a figure finance teams review to judge whether their breakage policy is realistic before they release any balance to revenue.Case study
Seen in the real world
This is a fictional, illustrative scenario. Oak Tree Spa launched a holiday gift card campaign, selling $2,000 worth of vouchers in November. The operations manager incorrectly celebrated this entire sum as November profit, using the cash to buy new equipment. In January, local clients arrived to redeem $1,200 of those spa vouchers. Because the cash was already spent, Oak Tree Spa faced an unexpected cash crunch and had to delay supplier payments.
The owner quickly consulted an accountant to set up a proper gift card liability tracking system. The new policy was to keep cash equal to the outstanding liability in a separate reserve account until the treatments were delivered. Under the correct treatment, November's income statement would have shown $0 of voucher revenue and the balance sheet a $2,000 liability. After January's redemptions, $1,200 became revenue and the liability fell to $800. By February, the spa had stabilised its finances and treated future gift card sales strictly as liabilities until the treatments took place.
Watch out
Common mistakes
- Recording gift card sales as immediate revenue instead of a liability.
- Forgetting to account for breakage income when cards expire or remain unused.
- Spending the cash collected from gift card sales before the cards are redeemed.
Questions
People also ask
Why is a gift card considered a liability?
It is a liability because the business has a legal obligation to provide goods or services in the future for money already collected.
What happens to gift cards that are never used?
Unused balances, known as breakage, can often be recognised as company revenue after a set period, depending on regional regulations.
Does selling gift cards improve my monthly profit?
No. Selling gift cards boosts your cash balance, but profit is only recorded when the customer actually redeems the card for goods or services.