Why Gift Cards Expire
Local retailers commonly issue gift
certificates. You pay the retailer some money,
and the retailer gives you a piece of paper with the amount you
paid written on it. You can give the
certificate to someone else, and they can use it to buy things
from the retailer.
Over the last 20 years, many local retailers have been supplanted
by big-box category-killer retail
chains.
Retail chains don't issue gift certificates: they sell gift
cards.
Conceptually, gift cards work the same as gift certificates: you
give the retailer money in exchange for the card; then you can
use the card to buy merchandise from the retailer.
Physically, gift cards are a bit slicker than gift certificates
- they are plastic, not paper, so they don't get torn and
dog-eared
- they are plastic, not paper, so they seem slightly more
substantial when given as a gift
- they are the size and shape of a credit card, so they are
easy to carry in your wallet
- They have a bar code or magnetic stripe, which keys the card into the retailer's
database.
Expiration date
There is one other significant difference between gift certificates and
gift cards: Gift cards expire.
Typically, a gift card retains its full value for a year or two.
After that, a "service charge" or "maintenance fee" kicks in.
Each month, the card loses a few dollars or a few percent of its value,
until it becomes worthless.
It's isn't obvious why companies do this;
it hardly seems worth the bad PR
- They've already got your money;
it's sitting in their bank account earning interest.
- The cost of keeping track of the card in their corporate database
is negligible.
- It annoys consumers; some states have restricted or outlawed the practice.
- The amount of money at stake is generally small.
Alternately, if you think it is obvious—they're
greedy—then it isn't obvious why local retailers
don't do it: a retailer can as easily write an
expiration date on a gift certificate.
As it turns out, the big companies aren't specially greedy,
and the local retailers aren't specially virtuous.
In fact, it's an accounting problem.
Accounting
There are two fundamentally different kinds of accounting: cash and
accrual.
Cash
Cash accounting is pretty much what it sounds like: you keep track of
your cash
- when a customer buys something, you have more cash
- when you buy inventory, you have less cash
- when you buy equipment, you have less cash
- when you pay an employee, you have less cash
All that matters is how much cash you have.
Small businesses—like local retailers—typically use cash
accounting. When a customer buys a gift certificate from a small
business, the business has more cash, which is good. Someday, the
customer may redeem the gift certificate for merchandise. That's fine:
the store is full of merchandise, and redeeming the certificate
doesn't reduce the store's cash position. Or the certificate may be
lost, or forgotten, and never redeemed. That's fine too: the store
still has the cash.
In short, local retailers issue gift certificates that never expire,
because once they have the cash, they don't much care if the
certificate is ever redeemed or not.
Accrual
Big companies—and especially, publicly traded companies—can't use cash accounting.
One reason is that there is more to know about a company than how much cash is in the drawer.
Companies have
- inventory
- equipment
- investments
- debts
- intellectual property
and all of these things have to be accounted for in order to get an
accurate picture of the company's finances.
Another reason is that cash is volatile.
A company's cash position changes every time a check clears,
and the bigger the check, the bigger the change.
For a company doing millions of dollars in business,
a cash accounting would fluctuate so wildly and rapidly as to be useless.
Big companies use accrual accounting.
In accrual accounting, you keep track of your assets and liabilities.
Furthermore, you account for things not when they actually happen,
but at the point in time when you know they will happen.
Buying inventory
For example, suppose a company buys $1,000,000 of inventory.
When they take delivery, they get
- inventory worth $1,000,000
- an invoice for $1,000,000
They have the inventory, so they enter it on their books as an asset.
They haven't paid the invoice yet, but they are obligated to pay it,
so they enter it on their books as a liability.
The asset and the liability are equal, so the company's net worth is unchanged.
Eventually, the company pays the invoice.
This removes $1,000,000 of cash from the company's books, and it also
removes the invoice from the books.
Since the amount of the cash and the amount of the invoice are the
same, the company's net worth is again unchanged.
Selling gift cards
Now watch what happens when a company sells a $20 gift card
- the customer gives the company $20 in cash
- the company gives the customer a $20 gift card
- the company enters the $20 in cash on its books
So far, it looks just like the local retailer who uses cash accounting.
But for a company that uses accrual accounting, it doesn't stop there.
The gift card obligates the company to deliver $20 of merchandise to
the customer at some time in the future. To represent that fact on its
books,
So a $20 gift certificate, sold by a local retailer who uses cash
accounting, puts $20 of cash into the retailer's drawer. But a $20
gift card, sold by a company that uses accrual accounting, doesn't add
to the company's revenue, because it's offset by the pre-paid sales
liability.
Eventually, the customer redeems the gift card for merchandise. Then
- the company delivers the merchandise to the customer
- the company invalidates the gift card in their database
- the company removes the $20 pre-paid sales liability from their
books
Only after the pre-paid sales liability goes away can the company
recognize the $20 of revenue, and any associated profit.
If the gift card isn't redeemed—if it's lost
or forgotten—then the company can never remove
the liability from their books.
Recognizing revenue
You can imagine how annoying this must be. They can see the money;
it's sitting in their bank account. But they can't report it as
revenue: as long as the pre-paid sales liability remains on their
books, they can't say that the money is theirs.
Granted, this pre-paid sales liability is an accounting fiction,
but it's a fiction that matters. It matters to accountants, and
auditors, and investors: to the people who determine the company's
stock price and reward its executives.
So companies that issue gift cards find ways to make them expire.
When a gift card loses value to a "service charge", the company isn't
actually performing a service for you; when a card loses value to a
"maintenance fee", there isn't any actual maintenance being done on
it. All that's happening is that the company is removing some of the
pre-paid sales liability from its books, so that it can recognize the
money you paid for the card as revenue.
When gift cards expire, accounting trumps public relations, customer
good-will, and common sense.
Notes
- keys the card into the retailer's database
- So the value of the card is stored in the database, not on the card
itself. For an application where this makes a big difference, see
How Disney made the gray market in
multi-day passes evaporate.
- pre-paid sales
- The term "pre-paid sales" refers to the fact that the
customer has paid for merchandise but hasn't yet received it.
Translations
Bulgarian courtesy of Zlatan Dimitrov
Steven W. McDougall /
resume /
swmcd@theworld.com /
2004 Aug 17