It's in the Cards

Which Company Has the Best Smelling Gift Card?      In its first gift card program, Shoney's restaurants just introduced a card that gives customers a whiff of the chain's strawberry pie when they scratch a photo.     The company, with 272 restaurants nationwide, is also planning two more gift card scents by the end of the year: hot fudge cake and pancakes (with the aromas of chocolate and maple syrup).     Shoney's joins the line-up of creative gift cards available at many stores. Target, for example, sells cards that light up like video games, play music and double as flashlights and crayon boxes.      Also available this year:      On its Web site, Borders book stores allows customers to create a one-of-a-kind gift card using their own photos.        For a limited time, T.G.I. Friday's restaurants are selling Bonus Bite gift cards. For every $25 spent, customers receive another $5 card.

"Consumers love gift cards because they take the guessing out of holiday shopping and retailers love them because they are easy to stock and take up minimum shelf space."  - Tracy Mullin, President and CEO of the National Retail Federation

Steps to Counter Gift Card Fraud

Although gift cards are not particularly susceptible to counterfeiting, there are other ways they can fall prey to criminals.     In one scam, thieves write down the numbers on the back of gift cards they find on store racks. Then, they buy items with them online. When the recipients try to use the cards, they find they have a zero balance. The easiest way to avoid this is to keep the cards displayed near cash registers or behind counters.     Another type of fraud occurs when thieves use stolen credit cards to purchase large quantities of gift cards. Police in Gainesville, FL, arrested six people earlier this year and charged them with using this scheme to buy millions of dollars of computers, big screen televisions and gaming devices from chain stores.      Some stores have also experienced losses after they issued gift cards for returned merchandise. Customers and employees stole items from one location and returned them to others without receipts. The stores issued gift cards as refunds.     Here are four steps your company can take to help prevent fraud and losses.     1. Limit the value. Gift cards used to total as much as $10,000 in their early days. But now the limits are closer to $500. That reduces a company's overall exposure to fraud. Be sure staff members obtain manager approval for the purchase of multiple cards that add up to a significant total.     2. Monitor employees. Establish a way to track employee use of gift cards. Dishonest managers or frontline employees may view them as an easy way to supplement wages. Some retailers have found store cashiers and restaurant servers hand customers gift cards with no value, and then pocket the real cards.     3. Provide training. Educating staff members about potential fraud serves two purposes. Employees learn what to look for and the business makes them aware that it is actively monitoring transactions.     4. Examine patterns. Many fraud schemes have identifiable indicators. Monitor the use of prepaid gift cards for patterns of abuse. A forensic accountant can provide this service.

The National Retail Federation reported that gift card sales during last year's holiday season amounted to $27.8 billion, up from $18.4 billion the year before. This year's sales are expected to be even higher.

And according to a new survey done by the retail trade group, the gifts people want to receive most this holiday season are gift cards or certificates (with 53.7 percent citing them as their top choice).

You may think that gift cards are the exclusive realm of big retailers, but that's not the case. Larger retailers started the trend because they had the resources to set up their own programs. But in recent years, there has been an increase in the number of third-party companies that manage prepaid gift card or stored value card programs for smaller businesses.

These companies create the cards, and in some cases, provide the software to process them at the point of sale. This makes it easier for smaller businesses to take advantage of the gift card market.

Even businesses that haven't historically benefited from big gift-giving seasons can jump on the bandwagon, including dentists, doctors, carpet-cleaning companies, auto repair shops, restaurants, home repair businesses, landscapers, dog groomers, spas, hairdressers, dry cleaners, and veterinarians.

One unusual example of a business getting in on the trend is Pennsylvania health insurer Highmark Inc., which recently began selling a gift card that can be used to cover prescription co-payments, elective surgical procedures, contact lenses and gym memberships.

Depending on your business, gift cards can:

 Reduce the time and resources needed to deal with merchandise returns and exchanges. 

 Increase profits, because consumers tend to spend more. The National Retail Federation survey found that nearly 51 percent of shoppers who redeemed holiday gift cards spent additional money beyond the value of the cards.

On top of that, recipients sometimes don't use the cards so the money amounts to a windfall for companies. Studies have found that 10 to 19 percent gift card dollars are never redeemed.

Accounting and Tax Issues

Increasing gift card sales have resulted in some new accounting and tax reporting issues. They occur because businesses have some flexibility in deciding when to count the revenue from gift card sales on their income statements.

Generally, the cards are not counted when they are purchased but rather, when they are redeemed. As a result, some of the money spent on gift cards may not show up in sales until months later and businesses have to carry a liability on their balance sheets.

But how are gift card sales treated for accounting purposes when consumers never redeem them? There is no single answer. One way is for businesses to estimate what percentage of card sales will go unused based on historical redemption rates.

The Securities and Exchange Commission has not issued official rules related to gift card accounting but regulators have said that determinations should be "reasonably and objectively" reached. Otherwise, they can distort performance measures used by investors to evaluate companies.

For its part, the IRS told its examiners earlier this year to be on the lookout for a variety of tax problems related to the sales of gift cards and certificates. In a memo to its directors in the retail, food and beverage industries, the IRS explained that for tax purposes, the general rule is income from gift cards (or certificates) is recognized when the gift cards are sold. However, under certain circumstances, an accrual basis taxpayer can defer the sale of a gift card from immediate income recognition.

In the memo issued earlier this year, the IRS noted that some business taxpayers are incorrectly deferring income on their tax returns or not meeting all the requirements. "Recently, with the huge increase in gift card sales this issue has grown in significance. A taxpayer may not have paid close attention to the difference between book and tax accounting." (IRS Industry Directive Memo LMSB-04-0507-039)

Some companies have solved some of the uncertainty of unredeemed cards by adding expiration dates or dormancy fees that erode values over time. However, many states have passed laws that prohibit or limit these provisions and consumers often become angry about them because they are viewed as unfair. Gift cards can also involve unclaimed property (escheat) laws in some states, as well as other requirements.

If your business has a gift card program, or wants to start one, consult with your accounting, legal and tax advisers to ensure compliance and protect your profits.