Groupon has been in the news again regarding how it records its revenue. To account for the likelihood that its customers will get refunds, Groupon books an estimated offset (e.g. reserve) against sales revenue. This estimated offset in effect reduces the total earnings reported in its financial statements. The accounting problem that Groupon had is that it kept its reserve too low, which resulted in an understatement of its estimate of customer refunds. As a result, Groupon had to restate and lower its actual earnings. A required restatement means something significant has occurred that impacts the historical financial history. In other words, Groupon was too aggressive in reporting its sales numbers and had to correct it. Here is a simplified example to help clarify the specific issue:
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Groupon sells 250 vouchers for spa services for $100 each resulting in total sales of $25,000
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Groupon's refund history shows a refund reserve of 1% of sales will cover estimated future refunds
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Groupon earns 50% or $12,500 in cash and books it immediately as gross revenue
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Groupon adds to its refund reserve $250 resulting in net revenue of $12,250
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The spa operator gets 50% or $12,500 in cash spread over 60 days
If none of the voucher purchasers request a refund, then the accounting treatment listed above would be fine. When a customer refund is issued, it is no longer can be counted as revenue. The revenue associated with the refund has to be reversed thereby lowering the sales number.
Adding on to our example above, customers request refunds within the allowed refund period (60 days) per Groupon's refund policy:
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Customers are issued $250 in refunds
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Groupon's reserve drops to zero
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Groupon net earnings do not drop and remain at $12,250
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The spa operator's earnings drop by $500 to $12,000
After the normal refund period has expired, additional customers request refunds totaling $2,000. Adding to our example, Groupon allows refunds after the normal refund period due to its customer satisfaction policies:
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Customers are issued $2,000 in additional refunds
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Groupon earnings drop by $2,000 to $10,250 since the reserve has been exhausted
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The spa operator earnings do not drop because Groupon has fully paid them out
As you can see, the reserve amount was too low and not sufficient enough to cover actual refunds. Groupon did not adjust its reserve estimates in light of its move into higher priced offers and higher refund rates among its customers. All accounting policies that relate to accounting estimates need to be reviewed when the underlying business drivers change. In this case, the type of offers and customers changed the revenue driver.
For those businesses that have a similar business models as Groupon - - customers pay for a service or product but can receive refunds - - proper accounting is key to forecasting credibile revenue numbers. There are many ways to prevent inaccurate revenue forecasts:
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Have a customer reserve account based on actual historical experience that is reviewed regularly
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Make sure the numbers make sense in light of sales growth
Groupon's accounting challenges are not insurmountable but investor trust has been damaged. Implement these accounting tips into your business and hold on to the trust of the supporters of your business.
