Вы находитесь на странице: 1из 5

And the same can be said for financial reporting as practiced by internet companies given

their new business models that require new accounting. Internet company financial
statements seem to mean different things to different people, not unlike a piece of artwork.
Unfortunately, some of this accounting artwork is junk, as we have recently reported in the
case of Groupon (First 10K: April Fools!). At times like this beauty rests in the I of the
artist.
How can management and directors and auditors see one thing, when the complete
opposite reflects reality? And why do internet IPOs seem particularly vulnerable? Well, we
think the problem is with the accounting standards (and we use that term loosely) that
apply to these companies. As we stated in an earlier post:
Internet company accounting is suspect given all the unsupported assertions and
assumptions that must be made to comply with generally accepted accounting principles
Think about it. The internet company balance sheet is generally dominated by intangible
assets whose values are based on assumptions that are works of art themselves. And then
theres revenue recognition in these companies with management making all kinds of
assumptions about primary obligors, selling price hierarchies, and virtual sales. Yes, what
makes internet company accounting special is that so many of the applicable accounting
rules require major assumptions, many of which could be better characterized as giant
leaps of faith. Clearly, the accounting rules used for internet companies should not be
called standards, as their many judgments make any meaningful comparison an
impossibility! Enough pontificating
Given Groupons recent accounting struggles we thought it might be interesting to see if
there were any other internet company accounting issues lurking within todays hot
internet companies. So, we looked at the most recent 10K filings of Demand Media,
Facebook, Groupon, Linked In, and Zynga, focusing primarily on revenue and expense
recognition, unusual accounting issues, and of course some of our favorites: intangible
assets, cash flows, and non-GAAP financial metrics. Here is what we found.
Revenue
Two of the five companies (Demand Media and Facebook) generate a significant amount of
their revenue from advertising. The way these companies record revenue appears to be
relatively straight-forward. Generally, ad revenue is recognized either when the ad content
is delivered, or for click-based ads, when a user clicks on an ad. Nothing very interesting or
complicated here.
Linked In, on the other hand, has a much more subjective revenue recognition method for its
hiring and marketing solutions. Most of the Companys contractual arrangements
include multiple deliverables, i.e., several products packaged together which Linked In
swears cant be pulled apart to record revenue separately. Gee, if the Companys cost
accounting system keeps track of product and service costs separately, why cant revenue
be estimated separately? Interesting question, huh? Anyway, Linked In uses convoluted
GAAP criteria to record revenue, the relative selling price method, based on a selling price
hierarchy. In short, management decides what revenue will be based on vendor specific
evidence, third party evidence, or managements best estimate of selling price, in that order
of priority. Which one do you thing management likely favors?

Then, theres our poster child for bad internet company accounting, Groupon. As you may
recall, the Company was busted by the SEC for improper revenue recognition last
September. See Groupon Finally Restates Its Numbers. Basically, Groupon ignored
accounting guidance (thats a much better word than standard) in Emerging Issues Task
Force (EITF) 99-19, as well as SEC Staff Accounting Bulletin 101 (question 10), and recorded
the gross amounts it received on Groupon sales as revenues. Since being forced to restate
its financial statements, the Company now records revenue at the net amount retained
from the sale of Groupons (gross collections less an agreed upon percentage of the purchase
price due to the featured merchant excluding any applicable taxes), since it is acting as the
merchants agent in the transaction.
It should be noted that Demand Media also faces the gross vs. net revenue issue
discussed in EITF 99-19. For revenue sharing arrangements in which the Company is
considered the primary obligor, it reports revenue on a gross basis. But for those situations
where it distributes its content on third-party websites and the customer acts as the primary
obligor, it records revenue on a net basis.
And last, but not least, there is Zynga with its consumable or durablevirtual goods! For the
sale of consumable virtual goods (goods consumed by player game actions), revenue is
recognized as the goods are consumed. On the other hand, revenue from the sale of durable
virtual goods (goods accessible to a player over an extended period of time) is recognized
ratably over the estimated average playing period of paying players for the applicable
game. Confused yet? Basically, we have to rely on Zynga to provide us with a best
estimate of the lives of both consumable and virtual goods to book revenue. As we indicated
in Zyngas First 10K: Zestful Zephyrs, by merely changing the games rules, the
Company can change what it books as revenue! This is all too arbitrary. Are we really
surprised?
So, when it comes to recording revenue, it appears that booking advertising income is
relatively easy, compared to the management estimates needed for multiple deliverables
(Linked In) and virtual good sales (Zynga), or deciding who the primary obligor is (Demand
Media and Groupon). We would not be surprised if some internet companies dont
intentionally complicate their product offerings to make revenue recognition a function of
management guesstimates!
Cost Capitalization
Given that several of these companies are struggling to achieve or maintain profitability, it is
not surprising that they would try to record as an asset what really is an expense. And sure
enough, we find several instances of this. For example, Demand Media capitalizes many
different types of costs including content costs, registration and acquisition costs for
undeveloped websites and internally developed software, as well as intangible assets
acquired in acquisitions. How significant is this? Over 72 percent of the Companys $590.1
million in total assets are intangible in nature! Now that takes cost capitalization to a new
heightwed probably try that too if we were losing as much money every year as they are
(2011s net loss was $18.5 million).
Linked In also plays this game, but with a new twist. The Company does do something
quite interestingit defers expensing $13.6 million in commissions already paid on noncancelable subscription contracts, presumably to match the commission costs with the
related revenue streams. Why stop there? Couldnt you make the same argument for a
whole host of other expenses as well? Maybe they did, but Deloitte didnt buy it.

Groupon and Zynga also have played a slightly different version of the cost capitalization
game, by recording tax assets that presumably will lower future tax liabilities. In recording
these tax assets, the companies reduce income tax expense in the income statement, thus
improving the bottom line. The only problem is that a company must have future taxable
income in order to use these alleged tax assets! Well, if the companies did this to mitigate
their operating losses, the game has ended for Zynga, and soon will end for Groupon.
In 2011 Zynga recorded a $113.4 million allowance against its deferred tax assets, almost
fully reserving these assets, and effectively wiping them off the books. This suggests that
the Company may have had a reality check as to its future prospects, given that it no longer
projects a future that includes profitability, more specifically taxable income.
As for Groupon, we highlighted this same tax issue earlier in Groupons First 10K:
Looking Under the Hood. In 2011, the Company increased its valuation reserve for
deferred tax assets by $72.3 million reducing reported deferred tax assets to $65.3 million.
Although Groupon gave no reason for the increased reserve, it likely was forced to record it
for the same reason as Zynga, i.e., little likelihood of generating taxable income in the
foreseeable future against which deferred tax assets could be used. So, who would have
thoughtthe income tax note might actually shed some light on what a company really
thinks its profit forecast is (as opposed to the press release)!
Other Accounting Issues
Our internet company reviews also turned up a couple of interesting points, which give us
insight into managements attitude toward financial reporting transparencyand believe it
or not, Groupon is NOT involved!
The first involves cash, naturally, and how Demand Media defines cash. You may recall
that we first reported on the increasing trend of companies to manipulate reported cash
balances in Whats Up With Cash Balances? And, yes, Demand Media is overstating its
balance sheet cash by including accounts receivable as cash even though it has yet to
receive the monies. Here is what the Companys accounting policy note says:
The Company considers funds transferred from its credit card service providers but not yet
deposited into its bank accounts at the balance sheet dates, as funds in transit and
these amounts are recorded as unrestricted cash, since the amounts are generally settled
the day after the outstanding date. (emphasis added)
Whats the rush? Why the need to manipulate the balance sheet this way? We dont know
exactly how much in receivables is included in cash, so we cant assess the impact on the
balance sheet or the statement of cash flows. Nevertheless, this is troubling to say the
least. This is exactly the same scam that for which Orbitz was busted and forced to issue a
restatement 8K! SECheads up there!
And then there is the stealth restatement made by Linked In. Accounting errors are
supposed to result in a restatement of financial statements and disclosed by public
companies in an 8K filing. However, stealth restatements occur when a company hides
restated financial figures in a current financial report, say a 10Q or 10K, instead of filing an
8K announcement.
So what was Linked Ins accounting error? In 2010 the Company erroneously reported trade
payable obligations totaling $10.8 million in other accrued expenses within accrued liabilities
instead of accounts payable. So, who cares; after all there is no P&L effect, right? WRONG!

We care because this is just another example of how cavalier internet company managers
are with the rules. It wont surprise you to learn that the Company called this error correction
a reclassification (note 2 of 2011 10K financial statements). Sounds so much better doesnt
it? We are left wondering why Linked In even bothered at all to report this.
And what would a Grumpy Old Accountant blog piece be without us ranting again about nonGAAP pro-forma reporting? Guess what? All five of the internet companies in our sample
report such metrics, and except for Facebook (which reports free cash flow only and whom
we gave an A to earlier), all provide convoluted performance measures that paint a better
operating picture than reported under GAAP. Heres what we mean:

Demand Media uses something called Adjusted OIBDA which adjusts GAAP
operating income by excluding depreciation, amortization, stock-based
compensation, as well as the financial impact of acquisition and realignment costs,
and any gains or losses on certain asset sales or dispositions. Oh, by the way, look at
whats in acquisition and realignment costsnon-cash GAAP purchase accounting
adjustments for certain deferred revenue and costs; legal, accounting and other
professional fees directly attributable to acquisition activity; and integration and
employee severance payments attributable to acquisition or corporate realignment
activities. The Company also has a non-GAAP Revenue metric, ex-TAC, which
measures consolidated revenues net of traffic acquisition costs.

Groupon uses both free cash flow and the now infamous consolidated segment
operating (loss) income, or CSOI, as key non-GAAP financial measures. Free cash flow
is defined as we would expect (operating cash flows less purchases of property and
equipment), but CSOI excludes acquisition-related costs and stock-based
compensation expense from the consolidated operating (loss) income of the
Companys two segments.

Linked In reports Adjusted EBITDA by adding the provision for income taxes, other
(income) expense, net; depreciation and amortization, and stock-based
compensation to net income. By the way, look at whats included in other income
(expense): interest income, foreign exchange gains and losses, investment gains, and
other non-operating expenses.

Zynga uses two pro-forma metrics: bookings and adjusted EBITDA. Bookings is a
non-GAAP revenue measure equal to revenue recognized in the period plus the
change in deferred revenue during the period. The Company also uses adjusted
EBITDA which it defines as net income (loss) plus change in deferred revenue, stock
based compensation, depreciation and amortization, other expenses, and less gains
(losses) from legal settlements, interest income, and provision for taxes.

Now for the big surprise, NOT! All four companies have a history of operating losses under
GAAP during the past four years. During the same period, Facebook reported operating
profits. So, you tell me why the big push to report these metrics. Regardless of what
management tells you about doing so to be transparent, it is exactly the oppositethey
do it to obfuscate!
So, there you have itlots of revenue and asset valuation assumptions in these internet
companies. Do you really believe that these companies with their limited operating
histories, and often inexperienced management, are able to make the kind of assumptions
and judgments that drive their accounting? Scary thought, huh?

What are we left to conclude? Internet company bean counters are not accountants! After
all, its tough to count those virtual beans. If they are not accountants, then what are they?
Artists, of course, and generally bad onesthe paint by numbers type.

Вам также может понравиться