On August 19th, the PCAOB issued a Staff Consultation Paper on Auditing Accounting Estimates and Fair Value Measurements. As discussed in the paper, Accounting Estimates is one of the most challenging topics for auditors and companies alike.
Other regulatory bodies, including the SEC, are also paying close attention to the areas of accounting that require significant judgement. In one of our previous posts, we discussed the complexity involved in changes in accounting estimates related to percentage of completion accounting. A recent SEC comment letter issued to Groupon (GRPN) sheds some light on other revenue recognition areas that are just as difficult to estimate.
In its most recent annual report, Groupon disclosed that, in the quarter ended September 30, 2012, the company recorded a one-time increase of $18.5 million to breakage revenue for an unredeemed merchant liability in Germany:
For merchant payment arrangements that are structured under a redemption model, merchants are not paid until the customer redeems the Groupon that has been purchased. If a customer does not redeem the Groupon under this payment model, we retain all the gross billings. We record revenue from unredeemed Groupons and derecognize the related accrued merchant payable when our legal obligation to the merchant expires, which we believe is shortly after deal expiration in most jurisdictions that have payment arrangements structured under a redemption model. However, prior to the quarter ended September 30, 2012, we had historically concluded based on our interpretation of applicable German law that our obligation to merchants in that jurisdiction extended for three years. Due to a German tax ruling, which required us to remit value-added taxes (VAT) earlier on unredeemed Groupons, we began recognizing revenue from unredeemed Groupons in Germany shortly after deal expiration during the quarter ended September 30, 2012, consistent with most other jurisdictions. As a result, the quarter ended September 30, 2012 included an $18.5 million one-time increase to third party revenue, which represented the cumulative impact of deals in Germany for which, based on the German tax ruling, the Company’s obligation to the merchant would have ended prior to the third quarter of 2012.
The additional revenue constituted about 3% of the total $568 mil revenue for the quarter.
In comment letters dated June 13th and July 14th of this year, the SEC requested clarification surrounding the timing and circumstances that led to the change in revenue recognition policy. Among other things, the SEC asked whether Groupon should create a legal liability after the vouchers’ expiration dates. The company responded that, based on the contractual agreements with merchants, Groupon is only required to pay for redemptions that occur within the period of validity. However, the company might still be required to refund payments to customers, and therefore established a refund reserve for Germany.
- We note, in most jurisdictions, your obligation to the merchant ends shortly after voucher expiration. However, in Germany, as a result of the consumer protection provisions of German civil law, merchants may be required to honor vouchers beyond the stated expiration date. Tell us how your agreements with merchants in Germany addressed voucher redemptions after the expiration date. Specifically, under your contracts with merchants, tell us if you were legally obligated to make a payment to a merchant in the event a voucher was redeemed after the expiration date.
Our contractual agreements with merchants in Germany specify that Groupon is only required to pay the merchant for redemptions that occur during the voucher’s period of validity (i.e., prior to expiration). As noted in our original response and in the summary above, we previously concluded that the three-year statutory performance period under German civil law might apply and extend our legal obligation to merchants beyond the stated contractual redemption period. Following the Regional Court’s decision in the German civil case, the VAT assessment from the German tax authority, and completion of our legal evaluation of the appeal in the civil case, we updated our judgment during 2012 and concluded that our legal obligation to merchants ends at the contractual expiration date.
- Please explain to us your consideration of the impact of the consumer protection provisions of German civil law on your obligations to the purchasers of Groupons in Germany. Specifically address why, as a result of the consumer protection provisions of German civil law, it was not considered reasonably possible for the Company to be obligated to refund expired vouchers in Germany.
Our obligations to provide refunds to customers are accrued for within our refund reserves. Those refund reserves reflect all estimated future refunds, including refunds expected to be issued after expiration of the related vouchers. In establishing our refund reserves for Germany, we have never asserted or assumed that post-expiration refunds are not reasonably possible. Please refer to the accounting policy disclosures in our Form 10-K for further information about our refund reserve methodologies.
Groupon is not the only company that was required to explain changes in accounting policies or material estimates disclosed in their annual or quarterly reports. In 2014 to date, 16 companies have received similar letters, compared to 29 in 2013. Based on the attention being paid to this issue by the various regulators, we expect to see a similar number of comment letters or more in the next year or so.