sign in sign up
<<
Home , Andrew Mason, Cost of goods sold, General journal

ISSUES IN EDUCATION American Accounting Association Vol. 29, No. 1 DOI: 10.2308/iace-50595 2014 pp. 229–245 Growing Pains at

Saurav K. Dutta, Dennis H. Caplan, and David J. Marcinko

ABSTRACT: On November 4, 2011, Groupon Inc. went public with an initial market capitalization of $13 billion. The business was formed a couple of years earlier as an offshoot of ‘‘The Point.’’ The business grew rapidly and increased its reported from $14.5 million in 2009 to $1.6 billion in 2011. Soon after going public, prior to its announcement of its first-quarter results, the company’s auditors required Groupon to disclose a material weakness in its internal controls over financial reporting that impacted its disclosures on revenue and its estimation of returns. This case uses Groupon to motivate discussion of financial reporting issues in e- commerce businesses. Specifically, the case focuses on (1) practices for ‘‘agency’’ type e-commerce businesses, (2) accounting for with a right of return for new products, and (3) use of alternative financial metrics to better convey the intrinsic value of a business. The case requires students to critically read, analyze, and apply authoritative accounting guidance, and to read and analyze communications between the Securities and Exchange Commission (SEC) and the registrant.

Keywords: Groupon; revenue recognition; allowance for sales returns; e-commerce; non-GAAP metrics.

GROWING PAINS AT GROUPON

s an undergraduate music major at , Andrew Mason eagerly sought a version of rock music that would fuse punk with the Beatles and Cat Stevens. A Little did he imagine that within ten years he would be the CEO of one of history’s fastest- growing businesses. After Northwestern and faded dreams of rock stardom, Mason, a self-taught computer programmer, was hired to write code by the firm InnerWorkings. InnerWorkings was founded in 2001 by Eric Lefkofsky, who had built several businesses around call centers and the Internet. In 2006, Lefkofsky became interested in an idea of Mason’s for a website that would act as a social media platform to bring people together with a common interest in some problem—

Saurav K. Dutta is an Associate Professor and Dennis H. Caplan is an Assistant Professor, both at University at Albany, SUNY; and David J. Marcinko is an Associate Professor at Skidmore College.

We thank the editor, associate editor, and two reviewers for their helpful insights, comments, and suggestions. We also acknowledge our accounting students who completed the case and provided us with valuable feedback. Editor’s note: Accepted by William R. Pasewark Published Online: August 2013

229 230 Dutta, Caplan, and Marcinko most often some sort of social cause. Lefkofsky provided Mason with $1 million of capital to develop the concept that became known as ‘‘The Point.’’1 Virtually no one associated with The Point initially envisioned commercial aspirations for the venture. In the fall of 2008, at the height of the financial crisis, ventures with little or no commercial aspirations were in jeopardy. Lefkofsky and Mason faced a decision on how to proceed with The Point. Lefkofsky seized on an idea proposed by a group of users of The Point. This group attempted to identify a number of people who wanted to buy the same product, and then approach a seller for a group discount. Mason had originally mentioned group-buying as one application of The Point, and now Lefkofsky latched onto the concept and pursued it relentlessly. In response, Mason and his employees began a side project that they named Groupon. The business plan was relatively simple. Groupon offered vouchers via email to its subscriber base that would provide discounts at local merchants. The vouchers were issued only after a critical number of subscribers expressed interest. At that point, Groupon charged those subscribers for the purchase and recorded the entire proceeds as revenue. Subsequently, when the subscriber redeemed the voucher with the merchant, Groupon remitted a portion of the proceeds to the merchant and retained the remainder. For example, a salon might offer a $100 hairstyling in exchange for a $50 Groupon voucher and agree to a 60-40 split of the price. Once a sufficient number of subscribers agreed to the deal, Groupon sold the voucher for $50. After providing the service, the salon would submit the voucher to Groupon and receive $30. Groupon would keep the remaining $20. The idea took off with enthusiastic support from the local media in Chicago. By the end of 2008, it was clear to Lefkofsky and Mason that The Point would become Groupon. Understanding that the key to competitive success would be a massive increase in scale, Lefkofsky pushed the company to grow vigorously through quick expansion to many cities. Within a year, the new company had 5,000 employees, and by 2012 had more than 10,000. The company’s revenue growth was also impressive. Beginning with $94,000 in 2008, revenue had grown to $713 million in 2010. In the first quarter of 2011, the company nearly equaled its entire 2010 sales, reporting revenue of $644 million, and total revenue for 2011 was $1.6 billion. Andrew Mason became a media star, appearing on CNBC and The Today Show. In August of 2010, he appeared on the cover of Forbes magazine, which touted Groupon as ‘‘the fastest growing company—ever.’’ The spectacular growth attracted more than media attention. Groupon quickly found itself pursued by corporate suitors. By mid-2010, Yahoo! offered to purchase the company for a price between $3 billion and $4 billion—it was an offer that Mason, who had no wish to work at Yahoo!, quickly turned down. then approached Groupon with an offer that would eventually grow to nearly $6 billion. Groupon rejected Google’s offer, as well. Faced with an ever-growing need for , this decision left Mason and Lefkofsky with only one option: to take Groupon public. They did so on November 4, 2011, at an IPO price of $20 per share, yielding a market capitalization of $13 billion. On the day of the IPO, the stock closed near its all-time high of $26 a share. It traded in the range of $18 to $24 for several months following the IPO. The stock price then declined precipitously after March 30, 2012, as shown in Figure 1, following the announcement of a material weakness in internal controls, when Groupon announced that it planned: to take additional measures to remediate the underlying causes of the material weakness, primarily through the continued development and implementation of formal policies, improved processes and documented procedures, as well as the continued hiring of additional finance personnel. (Groupon 2012b, 23)

1 For additional background information on Groupon, see Steiner (2010), Carlson (2011), and Stone and MacMillan (2011).

Issues in Accounting Education Volume 29, No. 1, 2014 Growing Pains at Groupon 231

FIGURE 1 Groupon’s Stock Price Chart

REVENUE RECOGNITION Sale of products to customers prior to purchase by the vendor/retailer is a common business model for ‘‘e-tailers’’ such as Expedia and Priceline. These vendors provide a platform for exchange of goods, but do not necessarily transact in those goods. When the customer makes a purchase through an e-tailer’s platform or interface, the e-tailer takes the payment from the customer and places an order with the supplier to send goods directly to the customer. At a later date, it remits a payment to the supplier for the prearranged price. Like a traditional business, the e-tailer retains the difference between the payment received from the customer and the payment it makes to the supplier. However, unlike a traditional merchandiser, the e-tailer never takes possession of the merchandise. The manner in which these transactions are recorded has significant impact on the financial statements. There are primarily two ways of recording the transaction: on a ‘‘gross’’ or ‘‘net’’ basis. Under the gross method, the entire amount received from the customer is recorded as revenue, and a corresponding of sales is recorded to for the payment made to the supplier for the merchandise. Under the net method, only the difference between what is received from the customer and what is paid to the supplier is recorded as revenue. This is consistent with recognizing that the vendor earns a commission on the sale. We illustrate the concept further with the use of an example. Suppose an e-tailer sells an airline ticket to a customer for $1,000 online and remits $950 to the airline. The issue is how the e-tailer should journalize the two transactions: (1) the sale to the customer, and (2) the payment to the airline. Under the gross method of recognizing revenue, on the date of sale to the customer, the journal entry is:

Issues in Accounting Education Volume 29, No. 1, 2014 232 Dutta, Caplan, and Marcinko

Cash 1,000 Revenue 1,000

Cost of Sales 950 950 When the company pays the airline, the corresponding journal entry is:

Accounts Payable 950 Cash 950

Under the net method of recording the transaction, the journal entry on the date of sale to the customer is:

Cash 1,000 Accounts Payable 950 Revenue 50

And on the date of payment to the airline, the journal entry is identical to the gross method:

Accounts Payable 950 Cash 950

The differences between the gross and net methods of recording the transactions are: Higher revenue is recorded under the gross method. Higher cost of sales is recorded under the gross method. However, gross profit—the excess of revenue over the cost of sales—is the same under the two methods; $50 in our example. In its original S-1 filing with the SEC on June 2, 2011, Groupon noted in its footnote on revenue recognition that, ‘‘The Company records the gross amount it receives from Groupons, excluding taxes where applicable, as the Company is the primary obligor in the transaction’’ (Groupon 2011a, F-11). In its response to the S-1, the SEC commented: it is unclear to us why you believe the company is the primary obligor in the arrangement. Please advise us, in detail, and provide us management’s comprehensive analysis of its revenue generating arrangements and explain the consideration given to each of the indicators of gross reporting and each of the indicators of net reporting found in ASC 605- 45-45 ... If, in fact, the company is the primary obligor, then explain to us why it is appropriate for the company to recognize revenue prior to delivery of the underlying product or service by the merchant to the customer. (SEC 2011a, 11) In its response, Groupon reasserted that it was the primary obligor and, hence: it recognizes revenue on a gross basis in accordance with ASC 605-45-45 based on its assessment of the facts and circumstances of the arrangement. The purchase of a Groupon voucher gives the Customer the option to purchase goods or services at a specified price in the future. For instance, a Customer may pay $25 for a Groupon that entitles him or her to $50 of merchandise or services at a Merchant’s store. However, it is important to note that the Company is not selling the underlying goods or services, only the voucher to obtain discounted goods or services. (Groupon 2011b, 31)

Issues in Accounting Education Volume 29, No. 1, 2014 Growing Pains at Groupon 233

TABLE 1 Abridged Income Statements for Groupon 2009 2010 Account Gross Net Gross Net Revenue $30.4 M $14.5 M $713.4 M $312.9 M Cost of Sales 19.5 M 4.4 M 433.4 M 32.5 M Gross Margin 10.9 M 10.1 M 280.0 M 280.4 M Marketing 4.6 M 4.9 M 263.2 M 284.3 M General and Admin. Expense 7.5 M 6.4 M 233.9 M 213.3 M Other 203.2 M 203.2 M Net Loss 1.34 M 1.09 M 413.4 M 420.1 M Net Loss to common shareholders 6.92 M 6.92 M 456.3 M 456.3 M EPS (Basic) (0.04) (0.04) (2.66) (2.66)

This information was obtained from Groupon’s S-1 filing with the SEC on June 2, 2011, and the amended filing (Amendment No. 4) on October 7, 2011.

The SEC followed up: Considering your view that the Company, and not the merchant, is the primary obligor in the Groupon transaction, please explain the terms and conditions included in the Company’s website that state ‘‘Vouchers you purchase through our Site as a Groupon account holder are special promotional offers that you purchase from participating Merchants through our service’’ and further that ‘‘The Merchant is the issuer of the voucher and is fully responsible for all goods and services it provides to you’’ and why you believe this is consistent with your view. (SEC 2011b,4) In response, Groupon contended: the Company believes that, by virtue of the credit risk it bears and the Groupon Promise, it is both a seller and an issuer of vouchers. The Company is the primary obligor when it issues a Groupon voucher on behalf of a merchant, which in turn is solely responsible to deliver goods or perform services. (Groupon 2011c,2) Although the Company provides the Groupon Promise, the Company does not accept any other responsibility for the delivery of goods or services provided to a customer and has never delivered the goods or services underlying a Groupon voucher to a customer on behalf of a merchant or otherwise. (Groupon 2011c,3) However, in an amended S-1 filing on October 7, 2011, Groupon changed the related footnote on revenue recognition to identify itself as the agent for the merchants. It noted: we record as revenue the net amount we retain from the sale of Groupons after paying an agreed upon percentage of the purchase price to the featured merchant excluding any applicable taxes. Revenue is recorded on a net basis because we are acting as an agent of the merchant in the transaction. (Groupon 2011d, 68) The effect of this change in definition of revenue from gross to net on the income statement is shown in Table 1. The first and third columns present the Income Statements for 2009 and 2010 as originally reported on June 2, 2011, when revenue was reported on a gross basis. The second and

Issues in Accounting Education Volume 29, No. 1, 2014 234 Dutta, Caplan, and Marcinko the fourth columns present the Income Statements for 2009 and 2010 as amended in the October 7 filing, to reflect revenue recognition on a net basis. Groupon further elaborated on the change in revenue recognition when it filed its first-quarter 10-Q on May 15, 2012. The company noted that it had to ‘‘restate’’ the Statements of Operations filed with the SEC on June 2, 2011, to ‘‘correct for an error in its presentation of revenue.’’ It explained the change as follows: The Company restated its reporting of from Groupons to be net of the amounts related to merchant fees. Historically, the Company reported the gross amounts billed to its subscribers as revenue ...The effect of the correction resulted in a reduction of previously reported revenues and corresponding reductions in cost of revenue in those periods. The change in presentation had no effect on pre-tax loss, net loss or any per share amounts for the period. (Groupon 2012c, 10) The controversy over reporting revenue on a net versus gross basis is not new. This was a much-debated issue in 1999, when the company in the center of the controversy was Priceline. In the third quarter of 1999, Priceline reported revenue of $152 million. This amount included the full price the customers paid to Priceline for hotel rooms, rental cars, airline tickets, and holiday packages. However, much like travel agencies, Priceline retained only $18 million, a small portion of the $152 million; the rest it remitted to the actual service providers, the hotels, the airlines, etc. The revenue recognition issue was resolved in 2000, when Priceline reported only the commission as revenue. During the same period, Priceline’s stock decreased about 98 percent from April to December 2000. Subsequent to the Priceline revenue recognition controversy, the SEC issued Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements. This guidance specifically required firms to report revenue on a net basis when the firm acts as an agent or broker without assuming the risks of ownership of the goods or the risk of default on payment. Concurrently, the SEC directed the Standards Board (FASB) to explore the issue. In July 2000, the Emerging Issues Task Force (EITF) of the FASB reached a consensus on Issue No. 99-19. The FASB affirmed the guidance of EITF 99-19 in ASC Section 605, Revenue Recognition.2 Although is generally not affected by the use of gross versus net revenues, the issue is important because revenue itself is a critical component in the financial statements, and revenue is materially affected by the choice. ASC Section 605-45-45 (FASB 2012b) identifies indicators supporting the use of gross revenue rather than net revenue. Two of these indicators, credit risk and risk, can be assessed for Groupon from its and related footnote disclosures. These are reproduced in Table 2 from Groupon’s original S-1 filing on June 2, 2011 (Groupon 2011a, F-4, F-9).

SALES WITH A RIGHT OF RETURN Companies that provide a right of return to customers are required to establish an allowance for sales returns if the amount is material. A merchandiser satisfies its obligations when it provides the product to the customer and, hence, can recognize revenue for the amount of sale. However, if the possibility exists that the customer could return the merchandise for a full or partial refund, the company is required to create a for such occurrences. The amount to be reserved is based on past experience with returns and management estimates of future trends. When historical data do not exist and estimation of future returns is not possible, recognition of revenue must be deferred

2 See Phillips, Luehlfing, and Daily (2001) for a discussion of SAB No. 101 and EITF 99-19.

Issues in Accounting Education Volume 29, No. 1, 2014 Growing Pains at Groupon 235

TABLE 2 Groupon Selected Disclosures Balance Sheet Excerpts (in ’000s) December 31 2009 2010 Current assets: Cash and cash equivalents $12,313 $118,833 , net 601 42,407 Prepaid expenses and other current assets 1,293 12,615

Total current assets 14,207 173,855 Property and equipment, net 274 16,490 — 132,038 Intangible assets, net 239 40,775 Deferred income taxes, non-current — 14,544 Other non-current assets 242 3,868

Total Assets $14,962 $381,570

Footnote Disclosure of Accounts Receivable, net: Accounts receivable primarily represent the net cash due from the company’s credit card and other payment processors for cleared transactions. The carrying amount of the company’s receivables is reduced by an allowance for doubtful accounts that reflects management’s best estimate of amounts that will not be collected. The allowance is based on historical loss experience and any specific risks identified in collection matters. Accounts receivable are charged off against the allowance for doubtful accounts when it is determined that the receivable is uncollectible. The company’s allowance for doubtful accounts at December 31, 2009, and 2010 was $0 and less than $0.1 million, respectively. The corresponding bad debt expense for the years ended December 31, 2008, 2009, and 2010 was $0, $0, and less than $0.1 million, respectively (Groupon 2011a, F-9). until the right of return has expired (FASB 2012a, ASC 605-15-25). Until then, any cash received should be accounted for as unearned revenue, a liability. Groupon’s business plan entails selling coupons for a product or service, and collecting cash prior to the merchant providing the product or service. That is, customers pay up front for a coupon for services or goods, and can redeem the coupon within the next six months. Moreover, the product is provided by a separate merchant, independent of Groupon. To entice customers to transact with Groupon, rather than directly with the vendor, Groupon features a generous right of return for its subscribers at least on par with the vendor’s own right of return. The return policy is featured prominently on the company’s website. Since Groupon does not directly provide the service, it guarantees the quality of services/goods on behalf of the vendor. Furthermore, since customers pay cash to Groupon while receiving services/goods from the vendor, customers expect ‘‘cash-back’’ from Groupon should they be dissatisfied. Groupon summarizes its policy as ‘‘The Groupon Promise,’’ which states simply: ‘‘If Groupon ever lets you down, we will return your purchase—simple as that.’’ In addition, it allows for full or partial refunds in the following situations: If a business closes permanently; Any unredeemed Groupon can be returned for a full refund within seven days of purchase;

Issues in Accounting Education Volume 29, No. 1, 2014 236 Dutta, Caplan, and Marcinko

In other cases, unredeemed Groupons are evaluated on a ‘‘case-by-case’’ basis; After the expiration date, the Groupon is still worth the amount paid, which never expires. In reviewing Groupon’s initial S-1 filing, the SEC noted: It appears that the ‘‘Groupon Promise’’ is unconditional. In light of your rapid growth and entry into new markets, explain to us why you believe the amount of future refunds is reasonably estimable. (SEC 2011a, 11) While acknowledging its rapidly growing and expanding markets, Groupon defended its ability to reasonably estimate returns: as the Company deals with more and more merchants, it does not believe the characteristics of its merchants within a geographical region differ from one another such that it would materially affect the Company’s estimates. (Groupon 2011b,35) As Groupon expanded to other markets, its product diversity increased from small-ticket items such as restaurant meals and salon services to high-ticket items such as international vacations and expensive medical services. Entering new markets with little or no historical experience, it became increasingly difficult for Groupon to estimate customer returns. In early 2012, Groupon’s internal discovered that the amount of customer refunds in January exceeded all previous models Groupon had constructed to predict customer behavior. One example was a large number of refund requests for a deal involving Lasik eye surgery. Interestingly, many consumers that purchased the Groupon for eye surgery did not realize that they had to be in good physical condition to undergo surgical procedures. Hence, when these subscribers were deemed unfit to undergo the surgical procedure, they returned their purchase to Groupon and asked for a refund. However, Groupon had already recorded the sale and reported the revenue in the previous quarter without having made an adequate for returns. The high level of refund activity was significantly correlated with high price-point deals that the company had only begun offering in 2011. These circumstances led to yet another financial restatement by the young company. The revision to previously reported financial results for the fourth quarter of 2011 was announced in the press release reproduced below: Groupon, Inc. (NASDAQ: GRPN) today announced a revision of its reported financial results for its fourth quarter and year ended December 31, 2011 ... The revisions are primarily related to an increase to the Company’s refund reserve to reflect a shift in the Company’s fourth quarter deal mix and higher price point offers, which have higher refund rates. The revisions have an impact on both revenue and cost of revenue. (Groupon 2012a) The press release also noted: The revisions resulted in a reduction to fourth quarter 2011 revenue of $14.3 million. The revisions also resulted in an increase to fourth quarter operating expenses that reduced operating income by $30.0 million, net income by $22.6 million, and by $0.04 ... There is no change to Groupon’s previously reported operating cash flow of $169.1 million for the fourth quarter 2011 and $290.5 million for the full year 2011. (Groupon 2012a) Retroactively, Groupon adjusted its refund reserve, which is a liability for estimated to provide refunds that are not recoverable from merchants. The reserve amount as of December 31, 2011 was $67.45 million, and on March 31, 2012 had increased to $81.56 million. The increase of

Issues in Accounting Education Volume 29, No. 1, 2014 Growing Pains at Groupon 237

$14.1 million in the balance of this account signifies the excess of accrued expense over actual cash disbursements due to customer refunds. By its decision to go public, Groupon imposed upon itself the requirements of Section 404 of the Sarbanes-Oxley Act, which requires the company’s auditors to report annually on the effectiveness of the company’s internal controls. The SEC permits a company going public to wait until its second 10-K to comply with this requirement. When preparing for its initial Section 404 as required for the year ending December 31, 2012, Groupon and its auditors identified and reported this material weakness in its 2011 10-K. The need to restate the refund reserve was attributed to a material weakness in Groupon’s internal controls over its ‘‘financial statement close process’’ (Groupon 2012a).

ACSOI: AN ALTERNATIVE FINANCIAL METRIC As a private company, Groupon relied upon a non-GAAP measure of company performance called Adjusted Consolidated Segment Operating Income (ACSOI). This metric was related, but not identical, to the commonly used non-GAAP metric Earnings before Interest, Taxes, , and (EBITDA). While ACSOI included all of the revenues, it excluded some common expenses, including: marketing expenses, acquisition-related costs, stock compensation costs, interest, and tax expenses. ACSOI is even more aggressive than EBITDA because it ignores some significant expenses related to Groupon’s business. In its initial S-1 filing with the SEC, Groupon appeared more profitable under ACSOI than under the GAAP metrics of net income and operating income. While on a GAAP basis, the company lost $413.4 million for 2010 and $113.9 million in the first three months of 2011, the ACSOI measures were a positive $60.6 million and $81.6 million, respectively. The difference was in large part due to excluding from ACSOI online marketing costs to attract new customers. In its response to Groupon’s initial S-1 filing, the SEC commented: We note your use of the non-GAAP measure Adjusted Consolidated Segment Operating Income, which excludes, among other items, online marketing expense. It appears that online marketing expense is a normal, recurring operating cash expenditure of the company. (SEC 2011a,4) In its response, the company provided the following rationale for excluding marketing expenses from this metric: The Company’s management utilizes Adjusted CSOI internally as a measure to assess the performance of the business ... In utilizing Adjusted CSOI as a performance measure, management does not rely on the non-recurring, infrequent or unusual nature of online marketing expense. It focuses instead on the fact that such expenses are almost entirely discretionary and incurred primarily to acquire new subscribers. (Groupon 2011b, 11)

EPILOGUE In a letter to Groupon employees in early March 2013, CEO Andrew Mason wrote: After four and a half intense and wonderful years as CEO of Groupon, I’ve decided that I’d like to spend more time with my family. Just kidding—I was fired today. If you’re wondering why ... you haven’t been paying attention. From controversial metrics in our S-1 to our material weakness to two quarters of missing our own expectations and a stock price that’s hovering around one quarter of our listing price, the events of the last year and a half speak for themselves. As CEO, I am accountable. (Washingtonpost.com 2013)

Issues in Accounting Education Volume 29, No. 1, 2014 238 Dutta, Caplan, and Marcinko

CASE REQUIREMENTS 1. Compare and contrast the business model of Groupon with the business models of Amazon and Wal-Mart. Referring to the risk factors in the MD&A sections of their 10-Ks, compare significant risks and opportunities across these companies. How do these business risks translate to risks in financial reporting? 2. ‘‘Revenue and revenue growth are more important than income and income growth for new businesses, especially in the new-age economy.’’ Do you agree with this statement? Support your opinion by analyzing the relationship between Amazon’s revenue, income, and its stock price from 1997 to 2010. 3. Using the data provided in Table 1, prepare common size income statements using revenues and cost-of-goods-sold in the original S-1 and amended S-1. Analyze trends of expenses as a percentage of revenue for 2009 and 2010. Compare and contrast the following ratios: a. Gross Margin Percentage; b. Turnover Ratio. 4. In the months leading up to Groupon’s IPO, the SEC posed a number of questions regarding Groupon’s choice of accounting principles for revenue recognition. Specifically, the SEC referred to the requirements in FASB’s ASC 605-45-45. a. Compare the amount of revenue reported in the original and amended S-1s. What caused the difference? b. Which of the two amounts do you think Groupon preferred? Why did they prefer it? c. In correspondence with the SEC following its initial S-1 filing, how did Groupon justify its method of reporting revenue? d. With reference to ASC 605-45-45, which of Groupon’s arguments were weak, and why? 5. Groupon had recognized revenue for the sale of high-ticket items in late 2011. Purchasers of the Groupons have a right of return, as specified in the ‘‘Groupon Promise,’’ prominently featured on its website. a. Assess the U.S. GAAP requirement for recognition of revenue when right of return exists, specified in ASC Section 605-15-25, in the context of Groupon’s business model. b. Do you agree with Groupon’s accounting? Why or why not? c. What could Groupon have done differently, and how would the financial statements have been affected? 6. Groupon’s restatement of 2011 fourth-quarter financials resulted in a reduction of $14.3 million of revenues and a decrease of $30 million of operating income. However, its operating cash flow was unaffected. Explain how this is possible. 7. The refund reserve amount for Groupon as of December 31, 2011, was $67.45 million, and on March 31, 2012, had increased to $81.56 million. Assume that the accrued expense for refund reserve was $100 million for the first quarter of 2012. a. How much refund was issued in 2012? b. Explain why the expense recorded in the first quarter does not equal the amount paid during the quarter. 8. In its initial S-1 filing, Groupon presented a non-GAAP performance metric called ACSOI. It was subsequently removed after the SEC objected. a. Why did the SEC question the inclusion of ACSOI in Groupon’s financial statements? b. Non-GAAP metrics are common in some industries. These include: Value-at-Risk in the financial sector, same-store-sales in retail, revenue-passenger-miles for airlines, and order-backlog in the semiconductor industry. Explain two of these metrics and assess their value to financial statement users.

Issues in Accounting Education Volume 29, No. 1, 2014 Growing Pains at Groupon 239

c. While the SEC allows the reporting of metrics identified in (b), it did question the use of ACSOI. What differences between the acceptable non-GAAP metrics in (b) and ACSOI were of concern to the SEC? d. Do you agree with Groupon’s contention that discretionary expenses, such as subscription acquisition costs, should be excluded from the financial measures of a company’s performance? 9. Groupon’s management needed significant cash to fund its growth. It had three options: (A) seek private investment, (B) sell the company to Yahoo! or Google, or (C) go public. a. Contrast the financial reporting challenges across the three options. b. In March 2012, Groupon’s auditors noted a material weakness in the company’s internal controls related to ‘‘deficiencies in the financial statement close process.’’ Would this disclosure have been made if Groupon had chosen options (A) or (B)? 10. In your opinion, do the problems with Groupon’s choice of accounting methods, use of a non-GAAP metric, and material weakness in its internal control reflect a lack of management experience or a lack of management integrity?

REFERENCES Carlson, N. 2011. Inside Groupon: The truth about the world’s most controversial company. Business Insider (October 31). Available at: http://www.businessinsider.com/inside-groupon-the-truth-about-the-worlds- most-controversial-company-2011-10 Financial Accounting Standards Board (FASB). 2012a. Revenue Recognition: Products—Recognition. Accounting Standards Codification (ASC) Section 605-15-25. Norwalk, CT: FASB. Financial Accounting Standards Board (FASB). 2012b. Revenue Recognition: Principal Agent Consider- ations—Other Presentation Matters. ASC Section 605-45-45. Norwalk, CT: FASB. Groupon. 2011a. Form S-1: Registration Statement under the Securities Act of 1933. Filed with the SEC on June 2. Washington, DC: Government Printing Office. Groupon. 2011b. Letter to SEC dated July 14. Available at: http://www.sec.gov/Archives/edgar/data/1490281/ 000104746911006336/0001047469-11-006336-index.htm Groupon. 2011c. Letter to SEC dated August 29. Available at: http://www.sec.gov/Archives/edgar/data/ 1490281/000104746911007725/0001047469-11-007725-index.htm Groupon. 2011d. Amendment No. 4 to Form S-1: Registration Statement under the Securities Act of 1933. Filed with the SEC on October 7. Washington, DC: Government Printing Office. Groupon. 2012a. Groupon Announces Revised Fourth Quarter and Full Year 2011 Results, Confirms First Quarter Guidance (March 30). Press Release. Available at: http://investor.groupon.com/releasedetail. cfm?releaseid¼660861 Groupon. 2012b. Form 10-K. Filed with the SEC on March 30. Washington, DC: Government Printing Office. Groupon. 2012c. Form 10-Q. Filed with the SEC on May 15. Washington, DC: Government Printing Office. Phillips, T. J., Jr., M. S. Luehlfing, and C. M. Daily. 2001. The right way to recognize revenue. Journal of Accountancy 191 (6): 39–46. Securities and Exchange Commission (SEC). 2011a. SEC-generated letter dated June 29. Available at: http:// www.sec.gov/Archives/edgar/data/1490281/000000000011039811/0000000000-11-039811-index.htm. Securities and Exchange Commission (SEC). 2011b. SEC-generated letter dated August 19. Available at: http://www.sec.gov/Archives/edgar/data/1490281/000000000011050412/0000000000-11-050412- index.htm. Steiner, C. 2010. The next web phenom. Forbes 186 (3): 58–62. Stone, B., and D. MacMillan. 2011. Are four words worth $25 billion? Bloomberg Businessweek 4221 (March 21): 70–75. Washingtonpost.com. 2013. Groupon’s CEO writes the best resignation letter ever (March 1). Available at: http://www.washingtonpost.com/blogs/wonkblog/wp/2013/03/01/groupons-ceo-writes-the-best- resignation-letter-ever/

Issues in Accounting Education Volume 29, No. 1, 2014 240 Dutta, Caplan, and Marcinko

CASE LEARNING OBJECTIVES AND IMPLEMENTATION GUIDANCE ‘‘Growing Pains at Groupon’’ enables students to gain a better understanding of financial reporting in the context of an e-commerce business. Students will apply GAAP to determine whether revenue should be reported gross as a principal or net as an agent, and how revenue should be reported when a right of return exists.3 These two issues are particularly interesting in the context in which Groupon operates because of the prevalence of agency relationships among companies engaged in e-commerce. Students will also evaluate the use of non-GAAP metrics to measure enterprise performance. The case is designed to take advantage of current consumer enthusiasm for Groupon, thereby providing a pedagogical vehicle that generates student interest. It allows instructors to demonstrate the increased financial reporting responsibilities and scrutiny that a company experiences when going public, relative to operating as a private company. The case takes advantage of the significant volume of correspondence between the SEC and Groupon in the months leading up to the initial public offering.4 At the instructor’s discretion, students can be required to research this correspondence, as well as the FASB’s Accounting Standards Codification, to arrive at conclusions regarding the financial reporting issues.5 In order to successfully complete the case, students must have a solid grasp of basic accounting knowledge, an understanding of the relationships among the various components of the financial statements, and awareness of authoritative guidance on revenue recognition. The case also requires analytical and written communication skills, as well as the ability to conduct basic .

Learning Objectives Specific learning objectives are as follows: LO 1: Students will demonstrate an ability to identify business risks and opportunities and related accounting issues in a new and unfamiliar business model. LO 2: Students will determine the relevant provisions of complex and technical accounting standards, and critically examine the appropriateness of a company’s financial accounting choices regarding revenue recognition and recording sales with a right of return. They will assess the impact of those choices on various elements of the financial statements. LO 3: Students will analyze the usefulness of non-GAAP metrics to evaluate business performance and consider the appropriateness of their disclosure subject to SEC Regulation G. LO 4: Students will gain an appreciation of the regulatory scrutiny applied to the financial reporting choices of companies going public.

3 Earlier teaching cases on revenue recognition include Alford, DiMattia, Hill, and Stevens (2011), Swain, Allen, Cottrell, and Pexton (2002), D’Aquila and Capriotti (2011), and Arnold, Lampe, and Sutton (1997). Alford et al. (2011) present four fictional mini-cases dealing with revenue reporting issues, one of which is gross versus net reporting in a telecommunications company. Swain et al. (2002),basedonafictionale-commerce company, rely on guidance regarding gross versus net reporting from EITF 99-19, which is similar to, but predates, the Accounting Standards Codification. D’Aquila and Capriotti (2011) address sales with a right of return in a real- world auditing context focused on financial reporting fraud. Arnold et al. (1997) use sales with a right of return to illustrate the use of an accounting database. 4 Other cases that direct students to SEC communications include Seipp, Kinsella, and Lindberg (2011)and D’Aquila and Capriotti (2011). 5 Instructors can use the Exposure Draft from the current joint FASB-International Accounting Standards Board (IASB) project on revenue recognition instead of the Codification. The relevant guidance in the Exposure Draft is clearer and more concise, but the substance of the rules is unchanged.

Issues in Accounting Education Volume 29, No. 1, 2014 Growing Pains at Groupon 241

LO 5: Students will gain experience writing about accounting issues and engaging in an informed discussion of these issues. Table 3 maps from each learning objective to the case questions that apply to that objective, and also to the relevant competencies from two sources. The first source is the American Institute of Certified Public Accountants (AICPA) Core Competency Framework (2003). The second source is the Pathways Commission (2012) final report. The Pathways Commission was jointly sponsored by the American Accounting Association (AAA) and the AICPA for the purpose of charting a path for accounting higher education. The Commission issued its final report, entitled Charting a National Strategy for the Next Generation of Accountants, in July 2012. The Pathways Commission list of core competencies is an aggregation of competencies identified from numerous organizations and professional exams, including the International Federation of Accountants (IFAC), the National Association of State Boards of Accountancy (NASBA), the AICPA Core Competency Framework, the Uniform CPA Exam, and the Certified Management Accountants Exam.

Implementation Guidance The case requirements have been structured so as to facilitate its use in all courses in financial reporting and analysis. Table 4 identifies the questions that instructors might find most appropriate for courses in financial accounting, financial statement analysis, and a capstone course. The case was field-tested by all three case authors; two at a large public university and another at a small private liberal arts college, in four courses: (1) two sections of undergraduate Advanced Accounting with about 35 students in each, (2) Analysis with 19 graduate students, (3) Intermediate Accounting II with 13 undergraduate business students, and (4) two sections of a graduate accounting capstone course with about 20 students in each. All groups of students found the material relevant and interesting. Students completed the case in teams of two or three. A small number of students elected to complete the case individually. Based on informal feedback from students, we believe the case can be completed in four to six hours. The classroom discussion of this case requires about 80 minutes. The liveliest discussions were on assessing the relative importance of revenue versus net income in evaluating e-commerce firms, and the use of non-GAAP metrics. The students were also intrigued by the financial reporting challenges faced by new businesses, especially when making the transition from a private company to a public company. All three instructors spent about ten to 15 minutes on introductory material prior to assigning the case. This material focused on the inception of Groupon and its business activity. The class visited Groupon’s website and were introduced to the ‘‘deal of the day,’’ and its business and accounting ramifications. The class was also shown the video of Groupon’s return policy from its website. The instructor might ask students to view the 60 Minutes interview of Andrew Mason prior to working on the case. The authors believe that a first-time adopter of the case, who has only a passing familiarity with the business of Groupon, would require four to five hours to prepare the case. This estimate includes two hours to become familiar with provisions of the relevant authoritative guidance.

Student Feedback In all four courses, students submitted a written case solution that comprised approximately 8 percent of their course grade. An anonymous case survey was administered at the conclusion of the case. Students were asked to respond to five questions using a seven-point Likert scale, and to two open-ended questions asking what they liked about the case and suggestions for improvement. The feedback was very positive. Students in all the classes reported that the case required them to

Issues in Accounting Education Volume 29, No. 1, 2014 242 TABLE 3 Mapping of Learning Objectives Learning Objective Case Question AICPA Core Competencies Pathways Commission Report LO 1 1, 2 Functional: risk analysis, research Technical Knowledge: Financial Accounting and Reporting: specialized industry knowledge, research skills; Broad Business Perspectives: strategic/critical Operational/: financial discipline; risk thinking, industry/sector perspective analysis and management Professional Skills: critical thinking, problem solving LO2 3,4,5,6,7 Functional: research, measurement Technical Knowledge: Financial Accounting and Reporting: accounting principles and rules, external reporting needs, research skills, judgment in the application of accounting principles Professional Skills: critical thinking, problem solving LO 3 8 Functional: research, measurement Technical Knowledge: Financial Accounting and Reporting: Personal: problem solving and decision making external reporting needs, research skills Professional Skills: critical thinking, problem solving, judgment and decision making LO4 4,5,8,9,10 Functional: research, measurement Technical Knowledge: Financial Accounting and Reporting: Personal: problem solving and decision making external reporting needs, judgment in the application of Broad Business Perspectives: legal/regulatory accounting principles, legal/regulatory perspective, research perspective skills

susi conigEducation Accounting in Issues Professional Skills: critical thinking, problem solving, judgment and decision making Marcinko and Caplan, Dutta,

oue2,N.1 2014 1, No. 29, Volume LO 5 All Personal: problem solving and decision making, Professional Skills: communications/collaboration: oral and interaction, communication written communication skills

Items in bold denote Functional Areas; items in italics denote sub-categories; and items in regular fonts denote specific competencies. Growing Pains at Groupon 243

TABLE 4 Suggested Use of Questions by Course Financial Financial Statement Capstone Accounting Analysis Course Question 1 X X Question 2 X X Question 3 X Question 4a X X X Question 4b X X X Question 4c X X X Question 4d X X Question 5a X X Question 5b X X Question 5c X X Question 6 X X Question 7 X Question 8a X X Question 8b X X Question 8c X X Question 8d X X Question 9a X X X Question 9b X Question 10 X X X understand and apply relevant accounting standards, and significantly improved their understanding of accounting issues in e-commerce. Across all the sections, students overwhelmingly found the case interesting and a worthwhile learning experience. The data are summarized in Table 5. In response to the open-ended questions, student responses to the case were favorable. Students particularly liked the relevance of the case: ‘‘Taking time to review recent relevant material in greater detail than a paragraph blurb in a textbook,’’ and how it applies to the e-commerce business model: ‘‘I liked gaining a better understanding of accounting for internet companies.’’ Students also commented on using accounting knowledge in a realistic setting, with remarks such as ‘‘I was able to relate to a real case what I have learned in accounting.’’ Students who had previously used Groupons commented on getting a better understanding of Groupon’s business model. One said ‘‘it was cool to be able to connect what we learned to the real world.’’ Another appreciated the requirement ‘‘to analyze different types of business risk and then translate to financial reporting risk.’’ A few students commented favorably on learning the changes that are undertaken when a private company goes public, with comments such as ‘‘I learned about what going public can mean for a company: more scrutiny; SEC oversight.’’ Students also reported on learning about non- GAAP metrics by ‘‘looking at 10-Ks for several companies and seeing all the non-GAAP stuff they report and how.’’ In particular, students enjoyed reading the communications between the SEC and Groupon and appreciated the novelty of the experience. One student commented, ‘‘This case list series of correspondences between SEC and Groupon which makes us better understand the revision process and ask us to investigate FASB standards.’’ Ambiguities in two of the case questions were rectified in response to student feedback after the first class presentation. Students in subsequent classes did not raise concerns about those two questions. Across all six classes, many students commented that the case required no changes. Finally, students viewed the discussion of the case favorably. The usefulness of the case in an

Issues in Accounting Education Volume 29, No. 1, 2014 244 TABLE 5 Summary of Student Evaluations of the Case Undergraduate Graduate Graduate Undergraduate Intermediate Financial Accounting Advanced Financial Statement Capstone Accounting Accounting Analysis Course (Public School) (Private School) (Public School) (Public School) Question (n ¼ 74) (n ¼ 11) (n ¼ 15) (n ¼ 37) The Groupon case was interesting. 5.29 6.00 6.27 6.24 I obtained a better understanding of accounting issues in 6.03 6.55 6.73 6.14 e-commerce from the Groupon case. The Groupon case required me to understand and apply 5.59 6.09 6.47 6.19 relevant accounting standards. The Groupon case provided me with a better 5.11 6.00 5.87 5.73 understanding of the use of non-GAAP performance measures sometimes used by companies. Overall, I found the Groupon case and class discussion a 5.78 6.55 6.60 6.54 worthwhile learning experience.

Reported numbers are mean responses on the following Likert scale: 1 ¼ strongly disagree, 4 ¼ neutral, 7 ¼ strongly agree. susi conigEducation Accounting in Issues ut,Cpa,adMarcinko and Caplan, Dutta, oue2,N.1 2014 1, No. 29, Volume Growing Pains at Groupon 245 accounting curriculum can be best summarized by the following student remarks: ‘‘The discussion of burgeoning accounting issues illustrates how dynamic the field can be’’ and ‘‘I liked that it was relevant ... It offered a topic for dinner discussion.’’

TEACHING NOTES Teaching Notes are available only to non-student-member subscribers to Issues in Accounting Education through the American Accounting Association’s electronic publications system at http:// aaapubs.org/. Non-student-member subscribers should use their usernames and passwords for entry into the system where the Teaching Notes can be reviewed and printed. Please do not make the Teaching Notes available to students or post them on websites. If you are a non-student-member of AAA with a subscription to Issues in Accounting Education and have any trouble accessing this material, then please contact the AAA headquarters office at [email protected] or (941) 921-7747.

REFERENCES Alford, R. M., T. M. DiMattia, N. T. Hill, and K. T. Stevens. 2011. A series of revenue recognition research cases using the codification. Issues in Accounting Education 26 (3): 609–618. American Institute of Certified Public Accountants (AICPA). 2003. AICPA Core Competency Framework. Available through the curriculum development link at: http://www.aicpa.org/InterestAreas/ AccountingEducation/Resources/Pages/default.aspx Arnold, V., J. C. Lampe, and S. G. Sutton. 1997. Instructional case using the NAARS database: Resolving revenue recognition issues at Carefree Environments. Issues in Accounting Education 12 (1): 99–111. D’Aquila, J. M., and K. Capriotti. 2011. The SEC’s case against California Micro Devices: A lesson in using professional skepticism and obtaining sufficient appropriate evidence. Issues in Accounting Education 26 (1): 145–154. Pathways Commission. 2012. Pathways Commission Report. Chapter 7: Constructing a Foundational Body of Knowledge. Available at: http://commons.aaahq.org/posts/a3470e7ffa Seipp, E., S. Kinsella, and D. L. Lindberg. 2011. Xerox, Inc. Issues in Accounting Education 26 (1): 219–240. Swain, M. R., R. D. Allen, D. M. Cottrell, and K. Pexton. 2002. TechMall.com: Revenue recognition in the Internet economy. Issues in Accounting Education 17 (4): 389–400.

Issues in Accounting Education Volume 29, No. 1, 2014 Copyright of Issues in Accounting Education is the property of American Accounting Association and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use.