In September 23 2011, Groupon (the Company), a rapidly growing online coupon merchant was forced by the SEC to file a restated S-1 registration statement. The reason for the restatement was that the SEC objected to the accounting methods that Groupon used in the calculation of its revenue, causing it to be overstated. According to Villanova University (2012), Groupon’s auditors at Ernst & Young stated that Groupon was not setting aside sufficient funds to cover potential refunds to customers and this was allowed to persist due to “material weakness in the company’s internal controls”. Background
When a customer purchases a coupon through Groupon’s website, the Company and the retailer split the profit 50-50, but the irregularity discovered was that the company had been reporting the entire purchase amount as its own revenue. This practice resulted in the revenue from each sale being doubled, and what Groupon reported as its Gross Profit was actually its real revenue. This accounting practice was initiated when Groupon prepared its S-1 registration using what Coenen (2012) refers to as a controversial non-GAAP metric called Adjusted Consolidated Segment Operating Income (ACSOI). In using this method the company reported explosive revenue growth from 2009 where it reported $30 million to 2010’s reported $713 million or 23-fold growth. Figure 1 shows Groupon’s year end income statements (in thousands) for the years ending 2008, 2009, and 2010. It is apparent how the effect of its revenues was overstated by not correctly reporting its revenues:
Figure 1 Source: Catanach(2011)
The company claimed the right to use this method when it used the verbiage in its S-1 that it “Records the gross amount it receives from Groupons, excluding taxes where applicable, as the Company is the primary obligor in the transaction, and records an allowance for estimated customer refunds on total revenue primarily based on historical experience. It then added “the Company also records costs related to the associated obligation to redeem the award credits granted as issuance as an offset to revenue”. According to Catanach (2011), the significance of this is that the company allows itself to record 100% of its revenue, even if it remits 50% of it to the actual merchant. For example, if the company sells a coupon for $50, it records that amount even though it remitted $25 back to the merchant. Key to this is that Groupon used a sketchy technicality in referring to itself as the primary obligor under which the Emerging Issues Task Force Statement (EITF 99-19) states that the primary obligor is but one indicator (not even a criterion) for possible gross revenue reporting. To allow itself to be called a primary obligor, Groupon had to compromise one more GAAP principle. By creating the “Groupon Promise”, it promised customers a refund of the amount paid for the Groupon if the merchant failed to deliver the goods or services in a satisfactory manner. Nevertheless, the company still acknowledged that merchants are responsible for fulfillment when a “Groupon” is redeemed. Regardless of how the company described itself in the S-1 filing, it is not by definition the primary obligor since it’s not the “party responsible to the customer for the product or service that is the subject of the arrangement” set out by EITF99-19. According to Catanach (2011), the Company was actually a guarantor by true definition. Many other gross revenue indicators are outlined by the statement that would further argue against Groupon referring to itself as a guarantor as well. There was one more error on the S-1. In Acquisition related expenses there was a $204 million dollar correction of an estimation error in an earn-out that caught the eye of SEC regulators. When considering this large amount coupled with the issues in revenue recognition discussed above from the gross revenue issues, regulators...