Groupon Accounting Shenaigan

After climbing $11 on its first day of IPO to $31, public shareholders have lost over $9 billion on Groupon stock when former CEO Andrew Mason declared that he had discovered a “material weakness” in the company’s internal controls.

Whether he knew this “material weakness” before the IPO is unknown. But, it is clear that the company tried to distract investors from standard accounting metrics to some self-defined metrics, and inflated revenue by using gross basis revenue instead of net basis revenue.

Use of Self-defined Metrics

The use of self-defined metrics is a dangerous sign. One of the reason of using metrics other than generally acceptable metrics is to distract investors’ attention. Another reason may be those metrics are common within the industry.

In the Prospectus, the company used the so called “Adjusted Consolidated Segment Operating Income”. This metric excludes marketing costs and the company explained very hard why it should be excluded. After using the self-defined metric, Groupon generated profits. But after restating the revenue, here is the difference:

The difference is more than 130%! And there will be net loss for all the years!

Gross Basis Revenue V.S Net Basis Revenue

Apart from using the strange metric, Groupon also reported its revenue on a gross basis, meaning that it included in its revenue the portion of a Groupon’s value that is shared with merchants. For example, a merchant sells a refrigerator in Groupon which cost $1,000 and Groupon charges 1% as commission. Instead of recognizing $10 revenue, Groupon recognizes $1000 as revenue and the remaining $900 as the cost of goods sold, resulting in an inflated revenue.

This is clearly dishonest!

Lesson Learnt

• Be exceptionally careful on companies that use self-defined performance metrics. Stick with accounting and finance metrics to evaluate the companies.
• Be careful on revenue recognition notes in financial reports. Look for sign that may allow the company to inflate the reported revenue.