A cheque in the mail is better than a tweet?

After my post a month ago bemoaning the potential death spiral facing Canada Post, I thought I would provide some balance by discussing the merits of Royal Mail, England’s original version of Canada Post.

In the world of old mail and new mail, there are two key stories right now: the initial public offering (IPO) of Royal Mail and the IPO of Twitter. Perhaps on the outset these two companies don’t seem to have much in common, but at their core they are both in the business of sharing information. Royal Mail delivers traditional letters and packages (a lot of packages these days due to online shopping). Twitter delivers breaking news stories from around the world and LOL cats.

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Image Source: http://www.lolcats.com/

With most traditional IPOs, security regulators require substantial disclosure, including audited financial information months prior to the actual IPO date. Twitter is using a special IPO procedure, the Jumpstart Our Business Startups (JOBS) Act, which allows for substantially less disclosure than a normal IPO. In order to qualify for the JOBS Act IPO, Twitter must have less than $1 billion in revenue. This is about all the financial information we currently know about Twitter. The Globe and Mail had an interesting piece in which the writer stated that they preferred the Royal Mail IPO to the Twitter IPO. Shocking, perhaps, particularly after my post about Canada Post. Royal Mail might seem like a dusty old horse compared to Twitter’s 500 horsepower shiny red convertible. But the G&M article has some excellent points that are worth raising for all accounting students.

Basically, don’t let flash and sparkle distract you from a company’s underlying business model. One thing that financial statements generally do not tell a reader is what the future profitability of the company will be. Financial statements, by design, are historical—they reflect the past. The past is a decent predictor of the future… until it’s not.

What do I mean by that? Well, consider Royal Mail’s history. It has been in the delivery business for over 100 years. It has infrastructure (trucks and buildings) in place and some consistent market demand. Clearly the mail delivery business has changed over the past 100 years and Royal Mail will need to continue to adapt as the market continues to change. But until people stop sending letters and birthday packages, and until people stop buying goods on the Internet and having them delivered, Royal Mail has a stable or slightly declining market. Now lets consider Twitter. Tweeting is free (you get what you pay for in my opinion), so it doesn’t cost Suzi or Tom anything to tweet about their meal or their clothes or some celebrity gossip. Twitter earns revenue through advertising. Companies pay to have their tweets pushed to your twitter account. This can be annoying and I, for one, rarely (if ever) click on those ads. So how effective are those ads? We don’t know—we need to wait to see Twitter’s financial statements.

Now consider the barriers to entry for Royal Mail and Twitter. If you want to compete with Royal Mail, the barriers to entry are high. You need to build a network of collection and delivery locations and you need trucks, buildings, and delivery people. If you want to compete with Twitter, you need a few computer science gurus, some servers, and some late night pizza. The next Twitter could be right around the corner. Instagram, Tumblr, and their like could very well trump Twitter. Then what happens to its advertising revenue? Cue descending slide-whistle sound effect.

Perhaps you remember one of Aesop’s most famous fables, “The Tortoise and the Hare.” Slow and steady may win the race, so choose your investment wisely.

The Tortoise and the Hare, by Arthur Rackham

Note: this blog was originally posted on my site hosted by Pearson Education(http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)

 

Interest Can Fly Under the Radar

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Image source: http://www.bombardier.com/en/home.html

Bombardier is one of Canada’s larger manufacturers and has frequently made the news recently as the production of its new C-Series commercial jet gets tantalizingly close. The C-Series jet is apparently key to Porter Air’s expansion plans out of the Toronto Island Airport (YTZ), and it is obviously very important to the future success of Bombardier.

Bombardier (BBD.B) already has 177 firm orders in place with hopes of another 150 orders a year or two from now. The development costs of this new jet are close to $4 billion. When Bombardier sells a C-Series jet to Porter (or any other airline), the price of the aircraft must include a portion of these development costs in addition to the direct labour and materials involved in building the plane itself. As the development costs creep higher, Bombardier really only has two options: (1) charge more for each jet once they start selling, or (2) give up any hope of recovering the development costs. Under IFRS (IAS 38), it is important to distinguish research costs from development costs. The distinction is important: development costs can be capitalized as an asset while research costs much be expensed. IAS 38.57 defines the development phase of a project to be when six criteria are met:

  • technical feasibility can be demonstrated
  • there is intention to complete the project for use or for sale
  • there is ability to use or sell the asset
  • there is existence of a market for the output (sale)
  • there are adequate resources ($$) to complete the project
  • the expenditures for the project can be accurately tracked

Obviously the C-Series jet is in the development phase. Bombardier also has other aircraft in the development phase but does not provide a breakdown of development costs by jet-type. The chart below shows how much the development cost asset has grown over the past three years. We will assume the bulk of this growth is due to the C-Series.

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These development costs include the costs of the prototypes, scientists’ salaries as they figure out aerodynamics, retooling costs, building and tweaking engines, testing prototypes, etc. All of these costs are capitalized up to the time that Bombardier starts actually selling C-Series jets. Then, Bombardier must start amortizing its development cost asset, in this case on a per-unit basis calculated on a best-guess for the number of jets to be sold.

If you’re in introductory financial accounting, or you are like 90% of the population and just dabble (or less) in accounting, I suspect this idea of capitalizing development costs may seem strange. Recall that an asset is a cost that has been incurred that has future benefit. A very common asset is a company’s property, plant, and equipment (PPE). We allow companies to capitalize PPE (i.e., set it up as an asset) because the PPE will hopefully generate a future stream of cash flow through product sales or service sales. Development costs aren’t all that much different, except they are intangible. The development costs related to a new jet allow the company to sell a new product and keep current with technology. Without spending money on development, Bombardier would find itself using outdated technology while trying to compete with other plane manufacturers that have new technology. This is unlikely to be a successful strategy.

Now that we have a decent understanding of development costs, we can explore Bombardier’s costs a bit more. According to the September 17, 2013 Globe and Mail article, Bombardier doesn’t seem to clearly understand how much it has actually spent on developing the C-Series. This is not really true; some accountant inside Bombardier knows exactly how much the company has spent. The issue here is whether Bombardier should be including the interest cost in its development costs. This is covered in IAS 23 (Borrowing Costs) and is an intermediate to advanced topic. The basic idea is that if Bombardier borrowed money to fund development costs, then the interest related to the borrowed money should be included in the capitalized development costs, hence increasing the development costs. There are only a few instances where interest costs are not immediately expensed, so if capitalizing interest seems odd to you, you’re not alone.

Another example of when interest can be capitalized is building a new factory. Assume for a second that you are building a new factory and borrow $1 million to fund the construction costs. Interest related to your loan should be capitalized during construction and is hence considered part of the overall cost of the factory. That cost will be amortized over the useful life of the factory. Interest incurred on the construction loan after the factory is put into use would be immediately expensed. The same is true for Bombardier’s development costs. So in the Globe and Mail article, the confusion stems from one Bombardier executive speaking about direct costs related to development while another, likely with more accounting experience, included interest costs related to the development. The second person is technically correct.

So what is the quick synopsis for us?  First, development costs, when they meet the definition, can be capitalized. Second, interest costs can also be capitalized in certain circumstances. And third, planes are bloody expensive!!

Note: this blog was originally posted on my site hosted by Pearson Education(http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)

Yeah right, the cheque is in the mail

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When was the last time you mailed something?  I mean, really mailed it?  Stamp, envelope, dropping it off in a red box?  Alternative forms of communication have clearly replaced traditional letter mail and Canada Post is suffering as a result.  Badly.  If you take a moment to think about the business model of Canada Post, you realize that a large portion of their costs must be the delivery process which is primarily done by individuals walking through neighbourhoods, hand delivering … flyers, packages from Amazon, and the odd letter from Grandma.  We used to complain about our mail boxes being full of bills but even those are being delivered electronically now.  The graph below summarizes the basic problem with Canada Post’s business model – shrinkage:

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But even that doesn’t tell the whole story.  The other side of the problem is the increasing number of houses/addresses that require some delivery:

 

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So we’ve got a business with a delivery system that needs to expand, but shrinking revenues.  No surprise then that Canada Post is losing money,

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But wait.  Maybe its not losing money.  Fo the year ended December 31, 2012 they had net income of $94 million, that looks pretty good.  Yes, except that net income is inflated by $152 million due to a one-time, non-cash pension correction.  If you look at the second line under “Cost of operations” you will notice that the employee benefits are about $130 million less than the prior year.  Essentially Canada Post squeezed the union in their latest round of of negotiations and was able to reduce some of the pension and benefits.  That reduction shows up as a one-time gain in 2012.  I’ll admit that Canada Post is very upfront about that adjustment in their annual report.  I would argue that they are more transparent about their true loss than most for-profit businesses that I have seen.

The most latest quarterly report (June 2013) isn’t any more favourable, showing losses for the first two quarters of 2013:

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There is one more view of this that I want to point out – the Statement of Cash Flows.  Remember that the statement of cash flows summarizes how the business got cash and where it spent cash.  That summary is broken down into three main categories: Operations (the main business activities), Investing activities, and Financing activities.  I’ve written about the importance of analyzing the statement of cash flows before, you may want to read that post as well. 

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What do we see here?  On a first glance it looks OK.  Canada Post is obviously a mature business so we should expect the operating activities to be generating sufficient cash to support the investing activities and the financing activities.  In 2012, it looks like it does.  Let’s ignore the financing activities for a moment since (a) the total financing activity cash flows are very small and (b) its a non-traditional business that is owned by the Government.  Now focus on the investing activities and pick out just the capital asset expenditures.  This is for items like new delivery trucks and sorting machines.  In each of the last two years, the capital expenditures have been pretty constant, about $1/2 a billion per year.  Now compare the operating cash flows to the capital expenditures required and you will see the rest of the problem.  Canada Post is struggling to earn enough money to replace its necessary capital assets.  Without those capital assets for delivery, Canada Post has no business model.  No cash, no assets.  No assets, no business.  No business, no cash.  And the death cycle begins.

Canada Post has one massive financial problem that I haven’t mentioned yet – pensions.  I won’t go into that here since I talked about that in the last post.

The Globe and Mail had a terrific story about the issues that Canada Post is facing and included some potential solutions such as less-frequent delivery or not doing door-to-door delivery.  Neither of those likely affect you or I since we get very few traditional letters.  I am sure that the older generations are more frequent users/receivers of traditional mail and I suspect they’re not going to be very happy with any reduction in service.  Perhaps its our job to explain the dilemma that Canada Post finds itself in?  One weekend when you visit your parents, friends’ parents or grandparents I encourage you to ask them what they think about Canada Post, explain the financial issues, and see what solutions you can come up with.  Then submit your ideas to Canada Post, they’re actively soliciting them on the the homepage.  You might as well put your financial acumen to work and help solve this problem.

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Note: this blog was originally posted on my site hosted by Pearson Education(http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)

Retirement planning by the Vulcans

“Live long and prosper” is best known as a Spock greeting in Star Trek but may be the new call to arms for retirees, pension plans, and employers.  It seems that on average, we’re living longer.  Surely that’s good news – more rounds of golf, more time with the (future) grandkids, more time to enjoy retirement.  Who can argue against that?!  Of course, those activities, retirement in general, requires substantial retirement savings.  Traditionally those savings have come from employer-organized defined benefit (DB) pension plans.  I’ve written about pension plans before here and here.  Given my prior posts, does pension accounting really deserve another look?  In my opinion, absolutely.  Especially with the latest revelation that we’re living longer.

You may ask yourself, “What impact does average life span have on pension plans?”  That’s a good question, and a bit complex but to keep it simple, if you promise to pay your best friend $100 a year until they pass away you quickly understand how their expected lifespan matters.  Longer life = more money that you owe them.  The same is true for pension plans except that it is on a much bigger scale.

Take the University of Toronto as an example.  They owe their employee over $4 billion for future retirement payments.  If those employees live longer, U of T is on the hook for even more than that.  Now the good news – if you can call it that – U of T has put away $2.9 billion as savings towards that pension liability.  That pension asset doesn’t change as employee lifespan changes.  Perhaps you’ve seen the problem already: $2.9 billion in assets – $4 billion in liabilities = trouble.  Yes, that’s right.  U of T as an unfunded pension plan to the tune of $1.1 billion.  Take a look at the liability portion of U of T’s latest (April 30, 2013) balance sheet below (the columns are from left to right: April 30, 2013, April 30, 2012, April 30, 2011).  What’s the biggest liability U of T has?  Pensions.  The “Deferred capital contributions” are just a fancy way of accounting for revenue and all of that amount has already been received as cash but U of T can’t call it revenue yet, so let’s remove the $1,076.4 from the bottom of the column.  That leaves $3,254.7 million of actual liabilities.  Now take the “Accrued pension liability” plus the “Employee future benefit obligation …” for a total of ($1,122.9 + $734.7) $1,857.6 million.  That is  57% of U of T’s real liabilities.  Nearly $2 billion is owed with no savings for that portion.

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Perhaps you say to yourself, “big deal.  U of T is a massive enterprise with billions of dollars of revenue.”  And you’d be partly correct. U of T does have billions of dollars of revenue but in fact they have very little flexibility on raising additional dollars of revenue.  As large as U of T is (~50,000 students), the unfunded pension liabilities are almost double the total amount of tuition dollars raised every year.

This situation is not sustainable.  As more employees retire and live longer, the pension assets will quickly be used to support them.  Current employees who contribute to the plan are not really saving anything for themselves; they’re funding the older, retired faculty as they golf and play with their grandkids.  Another way of looking at this is that for every dollar of tuition that a U of T student pays, a portion of that is going to fund a retired U of T employee – an individual that is not contributing to the student’s current experience.

What is U of T’s plan to get out of this mess?  Beyond a terrible reversal in the expected lifespan of its retirees and employees, U of T must be hoping for a dramatic positive performance in the stock market.  If they could double their pension asset within a reasonable window, say 10 years, they would mostly be out of this mess.  Of course that would require an average rate or return of about 10%, far in excess of traditional pension plan returns.  Other than that miracle cure, all they can do is continue to save excess cash where they can and add it to the pension assets.  That’s tough to do when you have to provide services to 50,000 current students, support Nobel prize-winning researchers, and maintain 100 year old buildings.

Three last points: (1) U of T is not the only enterprise in this mess.  I could quickly identify about 25-50 other large, well known Canadian businesses that have similar pension problems.  (2) Accounting standards around pension plans (for instance, IAS 19) are finally providing relevant information to financial statement users – I encourage you to ask your financial accounting instructor for their opinion on the standards and on pension plans in general.  (3) Why does this matter to you?  You are likely YEARS away from retirement, pension plans are the farthest thing from your mind.  Similar to many other problems in the world however, the problems of one generation get passed to the next.  As a future employee, a future contributor to CPP, a future caregiver to your parents, as a student paying tuition, this pension problem is yours.  Sorry.  I encourage you read some more, here’s a recent Globe and Mail commentary that you may find interesting.

I’d be interested in your thoughts on pension plans.  How do you think U of T should get out of this mess?  Is it fair to pass the buck to the next (your) generation?  What are your plans for funding your retirement? Comment below.

Note: this blog was originally posted on my site hosted by Pearson Education(http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)

Barbie needs some cash

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Looking at Mega Brands most recent audited financial statements (December 31, 2012), in many ways they look financially stable.  Their current ratio (current assets/current liabilities) is in decent shape, their debt:equity ratio (total liabilities/total equity) is improving year over year, they had positive earnings for the past two years, and they have a positive cash balance.  So the transaction I’m about to describe wasn’t done in a panic, it was done to take a reasonably healthy company and make it stronger.  Imagine for a second that you are the CEO or CFO of Mega Brands.  You don’t like paying 10% interest since that requires more cash than you feel is really deserved for debt repayment.  You need your other cash resources for day-to-day operations, and you don’t have excess assets that you can sell to generate cash.  What do you do?

Well, you look closely at your balance sheet and you remember that in 2010 Mega Brands issues a whole bunch of warrants.  Warrants are just like a stock option.  It is a financial instrument that gives the investor the right to purchase a common share of the company at a set price.  For general background on options and warrants, see this.  The investors originally paid to get the warrants ($0.50/warrant) and then have to pay again if they exercise their option to purchase the common share (called the strike price, $9.94/share in this case).  Obviously no investor would exercise their warrant if the common share was trading at a price below the strike price.  These particular warrants expire about two years from now and in most cases, finance theory suggests that a holding strategy is optimal.

Mega Brands wanted to raise some cash and had ~240,000,000 warrants still outstanding.  If they could convince all those warrant holders to exercise their warrants, pay the exercise price Mega Brands would receive ~$115 Million.  That essentially enough to cover all the long term debt which would then wipe out the debt with the 10% interest payment.  Early news releases don’t suggest any modified terms, rather Mega Brands executives just had some friendly chats with the major holders of the warrants (i.e. institutional investors) and explained the situation.  The warrants were already in the money since the common shares were trading above $13.  Remember that a warrant holder receives a common share (market value ~$13/share) by paying $9.94/share.  That’s a good deal.  Further, the executives explained that the cash they raised would be used to repay that expensive 10% debt thereby reducing the interest cost and increasing cash available for expansion and dividends.  Win-win for the company and the warrant holders.  No surprise then that approximately 1/2 of the warrant holders have agreed to early exercise.

What will be the impact on the financial statements?  Let’s do this on a single share basis, but in reality closer to 600,000 shares will be issued.  First Mega Brands receives the exercise price from the warrant holders (Dr Cash $9.94) removes the warrant value from equity since the warrants no longer exist (remove at the initial value Dr Warrants (equity) $10) and recognize the new common share being issued in exchange (Cr Share capital $19.94).  Then Mega Brands will turn around and use that cash to reduce their debt, Cr Cash XX, Dr Long term debt XX.  So when the next financial statements get released we should see an increase in equity and an equal decrease in liabilities.

Warrants and options are very common financial instruments.  Mega Brands move to tap into them as a way to raise cash is interesting and a little unusual but quite admirable.

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The full financial statements are here.  I encourage you to look at the balance sheet (page 5), and Notes 15 and 16 in particular (pages 33-35).

Note: this blog was originally posted on my site hosted by Pearson Education(http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)

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.

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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:

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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:

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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(http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)

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.

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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 …

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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(http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)