Gift Card Accounting: Redemption and Breakage Made Simple
Gift card accounting works like this: when a business sells its own gift card, it records cash and a liability (a contract liability, often called unearned revenue), not revenue. It recognizes revenue when the customer redeems the card. Expected unused balances, called breakage, become revenue in proportion to redemptions, as long as the estimate is well supported.
Watch Professor Farhat: The gift card segment of this video runs from 5:51 to 7:35. One heads-up: this is an older recording, and it mentions recognizing unused balances after three months. Current rules (ASC 606) don’t allow that shortcut. Follow the breakage method explained below, and keep any amounts owed to a state as a liability.
Watch the relevant Farhat Lectures segment on YouTube
Is a gift card sale revenue or a liability?
A retailer that collects cash for its own gift card still owes merchandise or services. The buyer has paid, but the retailer has not yet performed. This is a specific application of unearned revenue accounting. Under ASC 606, the official name for this obligation is a contract liability. Companies may label it unearned revenue, deferred revenue, or gift card liability, and all of these describe the same thing.
The distinction matters because treating every gift-card sale as immediate revenue reports income too early. It can also hide the value of future purchases the retailer must honor. These examples concern a retailer’s own prepaid cards, not cards sold as an agent for another company.
New to the five-step revenue model? Start with these revenue recognition examples, then come back here.
Hypothetical example: North Pier Books sells 100 gift cards for $40 each. Total cash received is $4,000. Assume no sales tax, fees, discounts, refunds, or other complications.
| At issuance | Debit | Credit |
|---|---|---|
| Cash | $4,000 | — |
| Unearned Gift Card Revenue | — | $4,000 |
No merchandise has left inventory. Therefore, selling the cards alone does not create cost of goods sold.
Gift card accounting at redemption: journal entries
First assume every card will be fully redeemed. Customers use $1,200 of the card balances to buy books. The books have a recorded inventory cost of $720.
| At redemption | Debit | Credit |
|---|---|---|
| Unearned Gift Card Revenue | $1,200 | — |
| Sales Revenue | — | $1,200 |
| Cost of Goods Sold | $720 | — |
| Inventory | — | $720 |
The revenue entry reduces the obligation. The cost entry records the books actually delivered. The remaining gift-card liability is $4,000 − $1,200 = $2,800. Cash is absent from both entries because it was collected when the cards were issued.
What is gift card breakage?
Breakage is the portion of prepaid customer rights expected to remain unused. For example, customers may forget a card or leave a small balance unspent. Breakage is not a discount given at checkout and is not the inventory cost of merchandise.
Under the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 606-10-55-46 through 55-49, expected breakage is recognized proportionately when the seller expects entitlement to it, subject to the constraint on estimates. In plain language, the company needs solid evidence, usually its own redemption history, so that it is probable that recognizing the estimated breakage will not lead to a significant reversal of cumulative revenue when the uncertainty is resolved. FASB calls this the constraint on variable consideration (ASC 606-10-32-11 through 32-13). Otherwise, recognize breakage when further exercise of the remaining rights becomes remote. See FASB’s Topic 606 guidance on customers’ unexercised rights.
Amounts that must be paid to a government under unclaimed-property requirements remain liabilities. An old balance or printed expiration date alone does not establish that the retailer can recognize revenue.
Worked example: calculate proportional breakage
Now use an alternative version of North Pier’s example. Do not add these entries to the no-breakage version. Assume reliable evidence supports 10% expected breakage, the recognition constraint is satisfied, and none of the unredeemed amount must be remitted to a government.
Expected breakage is $4,000 × 10% = $400. Expected redemptions are $4,000 − $400 = $3,600. Customers have redeemed $1,800 to date.
| Calculation | Result |
|---|---|
| Redemption progress: $1,800 ÷ $3,600 | 50% |
| Cumulative breakage revenue: 50% × $400 | $200 |
| Total cumulative revenue: $1,800 + $200 | $2,000 |
| Remaining liability: $4,000 − $2,000 | $2,000 |
Quick check: the $2,000 remaining liability equals the $1,800 of expected redemptions still to come ($3,600 − $1,800) plus the $200 of breakage not yet recognized ($400 − $200).
Cumulative breakage revenue = expected breakage × actual redemptions to date ÷ expected total redemptions.
Use redemption dollars when cards have different values or partial balances. Counting cards works only when the facts make those counts representative of the rights exercised, such as equal-value cards redeemed in full.
How to record breakage revenue: journal entries
Assume no redemption or breakage entries have yet been recorded in this alternative case. The books delivered have a recorded cost of $1,080.
| Account | Debit | Credit |
|---|---|---|
| Unearned Gift Card Revenue | $2,000 | — |
| Sales Revenue—Redemptions | — | $1,800 |
| Sales Revenue—Breakage | — | $200 |
| Cost of Goods Sold | $1,080 | — |
| Inventory | — | $1,080 |
There is no inventory cost associated with the $200 of breakage: no books were delivered for that portion. This does not mean the retailer has no operating expenses; it means breakage itself does not remove inventory.
If $80 of breakage revenue had already been recognized, the additional breakage entry would be $200 − $80 = $120. Always compare the required cumulative amount with what is already recorded.
What if the breakage estimate changes?
Estimates get updated as new redemption data comes in. Suppose that, after the $1,800 of redemptions above, North Pier now expects only 4% breakage instead of 10%.
New expected breakage is $4,000 × 4% = $160. New expected redemptions are $4,000 − $160 = $3,840. Redemption progress is $1,800 ÷ $3,840 = 46.875%, so cumulative breakage should be 46.875% × $160 = $75.
North Pier already recorded $200, so it reduces breakage revenue by $200 − $75 = $125 in the current period:
| Account | Debit | Credit |
|---|---|---|
| Sales Revenue—Breakage | $125 | — |
| Unearned Gift Card Revenue | — | $125 |
The remaining liability becomes $4,000 − $1,800 − $75 = $2,125. That equals $2,040 of expected redemptions still to come ($3,840 − $1,800) plus $85 of breakage not yet recognized ($160 − $75). The change is handled in the current period. Earlier financial statements are not restated.
Gift cards you sell for another company
Everything above applies to a retailer’s own cards. If a store sells another company’s cards, such as a grocery store selling a restaurant chain’s gift cards, it usually acts as an agent. The cash mostly belongs to the other company, so the store records a payable to that company and recognizes only its commission as revenue.
Example: A grocery store sells $500 of a restaurant’s gift cards and keeps a 5% commission.
| Account | Debit | Credit |
|---|---|---|
| Cash | $500 | — |
| Payable to Restaurant | — | $475 |
| Commission Revenue | — | $25 |
How are gift card sales taxed?
Tax rules differ from the book rules, which matters for EA and CPA REG candidates. An accrual-method business generally includes an advance payment, such as cash from an eligible gift card sale, in taxable income in the year it receives it. Under IRC Section 451(c) and Treasury Regulation 1.451-8, it can elect a one-year deferral instead: include the amount recognized as revenue in its applicable financial statement (AFS, such as audited financial statements) this year, and include the rest next year, even if those cards are still unused. A business without an AFS has a similar one-year deferral based on when the payment is earned. A cash-method business includes the cash when it receives it.
Example: On December 20, 2026, a calendar-year retailer with audited statements sells $10,000 of gift cards. By December 31, customers redeem $3,000, and its financial statements recognize $3,000 of revenue (no breakage yet). Using the deferral method, it reports $3,000 of taxable income in 2026 and the remaining $7,000 in 2027, whether or not those cards are redeemed in 2027.
Unclaimed property (escheat) is different from tax. It is a state’s claim on money owed to someone else, which is why those amounts stay a liability on the books.
Common gift-card mistakes
- Using cards sold as the denominator: With expected breakage, measure progress against expected redemptions.
- Recording all breakage immediately: The proportional method follows customers’ exercise of rights.
- Applying inventory cost to breakage: Only actual merchandise delivered reduces inventory.
- Treating an expiration date as a revenue trigger: An expiration date alone does not make unused balances revenue. Follow the breakage rules and any unclaimed-property law.
- Confusing security deposits with cards: A returnable security deposit is normally settled by returning cash. Compare customer advances and refundable deposits.
- Mixing up gift cards and returns: A customer’s right to return goods creates a refund liability, not a gift card liability. See refund liability journal entries and sales returns and allowances.
Want to keep going? The Intermediate Accounting course covers unearned revenue and the rest of current liabilities lesson by lesson. You can try the free sample course first.
Gift Card Breakage Accounting Practice
Gift card breakage is the value customers leave unused. When a retailer expects to be entitled to estimated breakage, it recognizes that revenue in proportion to customer redemptions. Practice the calculation, journal entries, and treatment of balances owed to a government.
Haven sells ten $200 gift cards and estimates that 20% of their value will go unused. Customers redeem six cards in April and two in May. Merchandise cost is 70% of the value redeemed. For questions 1–5, assume Haven is entitled to the estimated breakage.
Review the worked answers
- How much gift card value does Haven expect customers to leave unused? Estimated breakage is $2,000 × 20% = $400. Expected redemptions are $1,600.
- What percentage of estimated breakage does Haven recognize in April? Six April redemptions out of eight expected redemptions represent 75%.
- Which entry records April’s redemption revenue and breakage revenue? Six $200 redemptions generate $1,200 in sales revenue. Breakage revenue is $400 × 75% = $300. The total debit to Unearned Gift Card Revenue is $1,500.
- Which entry records the cost of merchandise delivered in April? Merchandise cost is $1,200 × 70% = $840. Breakage carries no merchandise cost because no goods were delivered for the unused value.
- How much redemption revenue and breakage revenue does Haven recognize in May? Two $200 redemptions generate $400 in sales revenue. They represent the remaining 25% of expected redemptions, so May breakage revenue is $400 × 25% = $100.
- How should Haven treat unused gift card amounts that it must remit to a government entity? Amounts subject to government remittance remain liabilities until settled and are excluded from breakage revenue.
Practice questions with explained answers
1. Card issuance
A shop sells $6,000 of its own gift cards. No cards have been used. What is the initial revenue?
Answer: Zero. Debit Cash $6,000 and credit a gift-card liability $6,000.
2. Breakage calculation
Expected redemptions are $5,400 and eligible expected breakage is $600. Actual redemptions reach $2,700. What cumulative breakage revenue is appropriate?
Answer: $600 × ($2,700 ÷ $5,400) = $300. Half the expected customer rights have been exercised.
3. Merchandise cost
A retailer recognizes $900 from redemptions and $100 from breakage. The delivered goods cost $540. What is cost of goods sold?
Answer: $540. The extra $100 of revenue does not represent additional merchandise delivered.
Key takeaways
- Selling your own gift card creates a liability (a contract liability), not revenue.
- Revenue is recognized when customers redeem cards for goods or services.
- Expected breakage becomes revenue in proportion to redemptions: expected breakage × redemptions to date ÷ expected total redemptions.
- With no supportable estimate, recognize breakage only when further redemption becomes remote.
- Amounts owed to a state under unclaimed-property law stay a liability and never become breakage.
- Breakage has no cost of goods sold, because no merchandise leaves inventory.
Frequently asked questions
Is selling a gift card the same as selling merchandise?
No. The card sale creates an obligation; merchandise revenue generally arises when the card buys delivered goods.
Can breakage be recognized without a supportable estimate?
Do not invent a percentage. If expected entitlement cannot be established, the remote-exercise approach applies, subject to any government remittance obligation.
Is breakage other income?
For the retailer’s own customer cards in this lesson, breakage is revenue under the customer-contract model. Separate ledger labels help explain its source.
What is the journal entry when a gift card is sold?
Debit Cash and credit Unearned Gift Card Revenue (a contract liability) for the full amount. No revenue and no cost of goods sold are recorded at the sale.
Do gift cards expire in the United States?
Under Regulation E, funds on a covered store gift card generally must remain available for at least five years after the last load. The card itself can expire before the funds. Certain promotional products are excluded, and state law can provide additional protections. A printed expiration date alone does not establish breakage revenue.
Where does the gift card liability appear on the balance sheet?
It is usually shown as a current liability, because customers can redeem their cards at any time.
How does IFRS 15 treat gift card breakage?
IFRS 15 uses the same proportional breakage approach (paragraphs B44 to B47). For the revenue constraint, IFRS 15 uses “highly probable” and ASC 606 uses “probable” to express the same intended level of confidence that a significant reversal of cumulative revenue will not occur.
What about bonus gift cards given with a purchase?
When a customer gets a bonus card only because they bought something, the bonus card is usually a material right under ASC 606. Part of the price paid is allocated to it and deferred, then recognized as the bonus cards are redeemed, with expected unused bonus value following the same breakage pattern.
Lesson context: Section 12.2, Unearned Revenues. All numerical examples and practice questions in this article are original, hypothetical learning examples.
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About the author: Mansour Farhat is the instructor behind Farhat Lectures, which offers CPA, CMA, and EA exam review and accounting courses. Every example on this page is an original teaching example.
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