All posts by Abhishek Sharma

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G/reyvenue Recognition

Working on the case of priceline.com got me wondering as to whether there was an e-commerce company that had to change its method of revenue recognition from Gross to Net and the impact it had on the financial statements and the reputation of the company.

Enter Groupon.com.

Groupon.com is a website that provides daily discount deals usable at local or national companies. For example, a $100 jacket could be purchased by the consumer for $60 through Groupon. The $60 would then be shared by the retailer and Groupon on the basis of the decided ratio usually 50:50. Groupon followed the gross method of revenue reporting until the company filed for its Initial Public Offering (IPO). This means that the company showed the entire receipt from the customers as its revenue. In this example it reflected $60 as its revenue instead of $30.

However, the Securities and Exchange Commission pressured the company to change how it accounted for its revenue from the gross method to the net method. Analyzing the impact this had on the reported revenues of the company:

Screen Shot 2013-09-20 at 6.12.40 PM

The reported revenues of the company fell by more than 50% after the restatement. Another interesting aspect to analyze is the marketing cost to revenue ratio after the restatement.

 

Marketing cost to Revenue Ratio Gross Method of Revenue Recognition Net Method of Revenue Recognition
2009 14.92% 33.51%
2010 36.89% 90.86%

After restating the revenues using the net method, the marketing cost to total revenue ratio goes up to 90.86%. This means that to earn $100 as revenue the company spent $90.86 as marketing cost. This is basically the amount the company would have to spend on marketing to acquire new customers leaving them with really low margins to recover other costs, let alone earn profits (the company had started focusing on new customers in the year 2010). This represents dim future prospects for the company. Now this ratio becomes extremely evident on reporting the revenues by the net method but that’s not the case when using the gross method as it just comes to 36.89%.

This restatement did raise questions on the management of Groupon just before the opening of its IPO. Yet the IPO was oversubscribed and the stock opened above its IPO price, which was $20. However within a period of 3 weeks, the stock price fell below the price at which the IPO was offered ($16.96 as on November 23, 2011) and as on September 20, 2013 the stock is trading at $12.64. I don’t attribute the fall in the stock price of Groupon to the revenue restatement, however the reported revenue figures post restatement were definitely an indication of the future prospects of the company.

groupon_stock_chart

So finally gross or net or a combination of both, I am sure this question will continue to trouble companies and analysts for many more years to come.

Article:

http://online.wsj.com/article/SB10001424053111903791504576589211214409214.html

http://www.businessweek.com/news/2011-09-23/groupon-operating-chief-leaves-as-company-restates-revenue.html

Reference Material:

http://dealbook.nytimes.com/2011/09/23/groupon-changes-its-revenue-accounting/?_r=0

http://www.cfoworld.com/accounting/36127/groupons-material-weakness-restated-revenue-raise-questions-about-both-it-and-ey

http://finance.yahoo.com/q/hp?s=GRPN&a=10&b=4&c=2011&d=10&e=23&f=2011&g=d

http://www.theverge.com/2013/3/1/4043566/andrew-masons-deal-with-the-devil