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:
- Does Groupon have any inventory and inventory risk? (In my opinion, no),
- Does Groupon establish the selling price? (In my opinion, perhaps),
- Does Groupon have the primary responsibility for providing the spa or Botox treatment? (In my opinion, no).
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:
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(http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)