Theory in Practice 11.1 Groupon Inc. is a large U.S.-based firm that sells In No
ID: 2558424 • Letter: T
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Theory in Practice 11.1 Groupon Inc. is a large U.S.-based firm that sells In Novernber 2011, Groupon issued an IPO that discount coupons on the Internet for a wide range attracted great interest from irvestors. Priced at of food and merchandise. The coupons enable the USS20, the shares quickly exceeded S30 in early purchaser to buy these products from local mer- trading. However, the company's accounting issues chants with whom Groupon had negotiated the returned. In April 2012, Groupon reported, in finan- discount price. The company was created in 2008 cial statenents submitted to the SEC, a "material and grew quickly, creating a large customer base. weakness" in internal controls (such reports are From its beginnings, Groupon adopted aggres- required by the Sarbanes-Oxley Act, see Section 1.2). sive accounting practices. For example, it recorded This weakness had allowed a material understate- revenue as the full amount received from cus- ment of expected refunds to customers (Groupon tomers, despite its obligation to pay a significant has a policy of refunding their money to customers portion to the merchants involved. In this way, it who are not satisfied), and forced the company to showed an impressive top line" on its income restate its fourth quarter 2011 financial statenents statement. Recording revenue net of amounts Groupon had done nothing illega-material weak- owed to merchants would have reduced this top nesses, for example, do not have to be reported in IPO prospectuses. Nevertheless, investors suspected The company also emphasized "adjusted con- that managernent must have known earlier about solidated segment operating income (ACSO), the underprovision and resulting profit overstate- a version of pro-forma income (Section 7.11.2) ment but said nothing until forced to reveal it under which marketing costs were capitalized several months following the IPO. These suspicions and amortized rather than deducted as expenses. added to already existing concerns about Groupons Since the company was working hard to build accounting described above. Furthermore, addi up its customer base, it regarded these costs as tional concerns arose that Groupon may have been an investment in its future rather than a current attempting to hide a decline in its customer base. As period expense. In this way, Groupon claimed a result, the company's shares were trading below to be profitable, despite substantial losses on a $5 in late December 2012 increasing to only $12 in line by about 60%. GAAP basis. December, 2013Explanation / Answer
ANS A: No, I do not agree with Groupon's policy of capitalizing marketing costs.
Under GAAP, the marketing expenses are considered to be “other expenses”. Unless the company can produce evidence that a specific marketing will create long term benefits, all marketing costs should be expensed instead of capitalized. There should be generation of some intangible asset so as to capitalize marketing cost. Merely increasing customer base do not justify capitalising marketing cost.
ANS B: The core principle of the revenue recognition standard is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
Out of the full amount received from customer, obligation to pay to marchants should be deducted for true and fair view of revenue in financial statements.
ANS 3: A market is efficient when security prices reflect all the available information. Material weakness do not have to be reorted in IPO prospectus. Investor suspected that management must have known earlier about the understatement & resulting profit overstatement. This shows that investors do not have all the information available. Hence management has not accepted securities market efficiency.
ANS 4: During IPO, impressive top line was evident from income statement but in fact it was wrong represantation of revenue. After IPO share prices falls as management was forced to reveal material weakness. Hence It can be said that share price behaviour was consistent to alot extent with securities market efficiency.
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