The CERCLA of life

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Like all mining and natural resource extraction companies, Teck can take a bad rap for their actual or perceived damage to the environment.  I will be a realist and admit that some damage is going to be incurred whether we are talking about the oil sands in Fort McMurray or Teck’s lead/zinc smelter in Trail, BC.  Of course I am still very concerned about the extent of the damage and companies must be doing all they can to minimize the impact on the earth and the people affected.  The smelter in Trail BC is currently owned by Teck, but some of what I’ll mention here preceded their ownership.  Historically the Trail, BC smelter has not been the cleanest enterprise in the world.  In fact the city of Trail was ranked as the second most polluted city in North America.  As early as 1925, nearby settlers sued the smelter for damages to crops and forests. The real push to clean up their act started in 1975 when a study of the lead levels in young children were well above any reasonable safe level.


Teck has recently been in the news for some pollution that they have admitted they dumped into the Columbia river that flows past the smelter.  Trail, BC is a stones throw away from the US border and the Columbia river flows south so the pollution has ended up in the US.  I’d been reading the recent news stories and then bumped into the Teck controller the other day.  I asked him how the lawsuit was affecting their financial reporting, expecting him to say that they were accruing millions of dollars for the potential costs.  Nope.  It turns out that while everyone knows what was dumped in the river, no one is all that clear on how much damage has occurred.  Some people (mostly Teck employees) claim very little damage has occurred.  So they’re paying for a bunch of environmental studies but no accrual beyond the costs of those studies has happened.

Then the controller mentioned to me that their bigger concern is selenium.  What?  I’ve studied Teck for years and never heard of selenium, how bad could it be?  It turns out its not good news.

Ok, so Teck has some trouble with pollution of the Columbia river and then this selenium problem.  How do these impact their financial statements?  I was expecting the Columbia river lawsuit to show as an accrual which is a liability.  Check out the balance sheet (the December 2012 financial statements have not yet been released).  First, note that Teck is financially very healthy: total debt ($16 Billion) is less than 50% of the total assets ($34 Billion) and the current assets ($7.4 Billion) far exceed the current liabilities ($2.1 Billion).  Next, realize that to find out very much about the accruals we’ll need to dive into the financial statement notes, particularly note 20 for “Other liabilities and provisions”. Also, notice at the bottom of the balance sheet, that contingencies are discussed in note 22, that will be interesting to read as well.  Access the full financial statements and notes from the left hand side, “Consolidated Financial Statements (PDF)”.

Here is a portion of note 20:


This is a complex financial reporting topic but notice that selenium is mentioned in the second paragraph.  Accounting for these types of costs requires a lot of estimation: how much the remediation may cost, when it will occur, an appropriate inflation rate, and an appropriate discount rate.  Be very clear that the number shown in the financial statements is an estimate.  I look forward to seeing how they adjust the December 2012 financial statements, I suspect the remediation costs will be dramatically higher.

Now let’s turn to note 22, the contingencies:



The important paragraph to read is that last one, “until the studies … are completed, it is not possible to estimate the extent and cost …”  What that means is that Teck has not recorded any liability yet for the Columbia river pollution.  They simply have no idea how much they may be on the hook for, if any amount, so have not recorded anything.  This isn’t devious or wrong, its in accordance with generally accepted accounting principles (IFRS) and highlights again how estimation and judgement are a huge part of the financial reporting.

Now back to the title, “CERCLA of life” – yes its a bad pun, my apologies to Simba et al.  CERCLA is the US Comprehensive Environmental Response, Compensation and Liability Act, otherwise known as Superfund.  It does affect Teck, it has no impact on the Lion King.

 Note: this blog was originally posted on my site hosted by Pearson Education(

Groupon’s coupons, Botox and revenue

I posted about Groupon’s difficulty figuring out how to record revenue 18 months ago.  It got its knuckles rapped then and, as I mentioned in my latest post on Livent, revenue recognition is a common problem in accounting errors and frauds.  Groupon has some tricky revenue to sort out, its not exactly clear to many people what Groupon sells.  Do it simply broker transactions between the customers paying for the coupons and the restaurants, spas, and Botox providers or does it do more than that?  

In the financial reporting world we refer to this as the “principal versus agent” (or “gross versus net”) revenue recognition problem.  For instance, assume Groupon sells you a coupon that you pay $10 for.  Further, assume that Groupon pays $8 of the $10 to the Botox provider.  Should Groupon record revenue of $10 and cost of sales of $8 for net income of $2?  Or should they record revenue of $2 and net income of $2?  A simple view of this says, “Who cares!?  Net income is the same under both approaches!”  But it does matter.  It affects things like revenue growth rates and gross profit margins.  Investors care about those sorts of things.

This is a tricky area and has caught many large businesses including Ebay and Amazon.  IFRS, particularly IAS 18: Illustrative example #21, deals with exactly this type of revenue and reporting dilemma and is very similar to US GAAP (EITF N0. 99-19) which Groupon reports under.  Answering “yes” to most of the key factors from that standard determine whether Groupon should record the gross or net revenue.  The key criteria are:

  1. Does Groupon have any inventory and inventory risk? (In my opinion, no),
  2. Does Groupon establish the selling price? (In my opinion, perhaps),
  3. Does Groupon have the primary responsibility for providing the spa or Botox treatment? (In my opinion, no).
Groupon used to report their revenue using the gross method, that is the $10 of revenue and $8 of costs.  After getting its hands slapped 18 months ago, it seems that it adjusted its revenue recognition policies.  The income statement (or statement of operations) below indicates that Groupon earned $1.8 Billion in revenue from coupon sales (third party transactions) and only recorded $297 Million in related costs.  That very high gross profit suggests that they are recording net revenue, that is the $2.


To really figure this out though we need to dive deep into Groupon’s financial statement notes, particularly Groupon’s December 31, 2012 financial statements, Note 1, pages 72-73 which is copied below for easy reference.  Look carefully at the third paragraph, particularly the portion I’ve highlighted for you.  Groupon now records the net revenue, that is just the $2 (based on the $10 it initially receives from the customer less the $8 it submits to the merchant/Botox provider).  The final sentence of that paragraph clearly explains that the revenue recognition policy is based on the interpretation that Groupon is simply an agent, matching buyers and sellers.  That is completely consistent with my brief analysis of Groupon’s business model using the criteria from IAS 18.

The final thing I will point out is in the fourth paragraph and highlighted for you as well – Groupon loves it when you buy a coupon and don’t ever redeem it.  You lose the coupon, they win.  You forget about the coupon, they win.  It reminds me of the gift card scam, millions of dollars of gift cards expire and the retailers love it.

Finally, I will point out that I have nothing against Groupon although I’ve personally never bought a Groupon coupon.  Perhaps when I need a Botox injection in a few years …


The following excerpt is copied directly from Groupon’s December 31, 2012 financial statements, Note 1, pages 72-73:

Revenue Recognition

The Company recognizes revenue when the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred; the selling price is fixed or determinable; and collection is reasonably assured.

Third party revenue recognition

The Company generates third party revenue, where it acts as a third party marketing agent, by offering goods and services provided by third party merchant partners at a discount through its local commerce marketplace that connects merchants to consumers. The Company’s marketplace includes deals offered through a variety of categories including: Local, National, Goods, Getaways and Live. Customers purchase the discount vouchers (“Groupons”) from the Company and redeem them with the Company’s merchant partners.

The revenue recognition criteria are met when the number of customers who purchase a given deal exceeds the predetermined threshold (where applicable), the Groupon has been electronically delivered to the purchaser and a listing of Groupons sold has been made available to the merchant. At that time, the Company’s obligations to the merchant, for which it is serving as a marketing agent, are substantially complete. The Company’s remaining obligations, which are limited to remitting payment to the merchant and continuing to make available on the Company’s website information about Groupons sold that was previously provided to the merchant, are inconsequential or perfunctory. The Company records as revenue the net amount it retains from the sale of Groupons after deducting the portion of the purchase price that is payable to the featured merchant, excluding any applicable taxes and net of estimated refunds for which the merchant’s share is recoverable. Revenue is recorded on a net basis because the Company is acting as a marketing agent of the merchant in the transaction.

For merchant payment arrangements that are structured under a redemption model, merchant partners are not paid until the customer redeems the Groupon that has been purchased. If a customer does not redeem the Groupon under this payment model, the Company retains all the gross billings. The Company recognizes revenue from unredeemed Groupons and derecognizes the related accrued merchant payable when its legal obligation to the merchant expires, which the Company believes is shortly after deal expiration in most jurisdictions that have payment arrangements structured under a redemption model.

Direct revenue recognition

The Company evaluates whether it is appropriate to record the gross amount of its sales and related costs by considering a number of factors, including, among other things, whether the Company is the primary obligor under the arrangement, has inventory risk and has latitude in establishing prices.

Direct revenue is derived primarily from selling consumer products through the Company’s Goods category where the Company is the merchant of record. The Company is the primary obligor in these transactions, is subject to general inventory risk and has latitude in establishing prices. Accordingly, direct revenue is recorded on a gross basis, excluding any applicable taxes and net of estimated refunds. Direct revenue, including associated shipping revenue, is recorded when the products are shipped and title passes to customers. For Goods transactions where the Company is performing a service by acting as a marketing agent of the merchant, revenue is recorded on a net basis and is presented within third party revenue.

 Note: this blog was originally posted on my site hosted by Pearson Education(