Read and complete the following Case 5-10: Groupon from Mintz & Morris Chapter 5. Address each question in the case. Your submission should be substantive and supported by references. Be sure to include a biblical application concerning the subject matter of your case.
ASSIGNMENT INSTRUCTIONSPost one thread of at least 400 words by 11:59 p.m. (ET) on Thursday of the assigned Module: Week. The student must then post 2 replies of at least 140 words by 11:59 p.m. (ET) on Sunday of the assigned support the assertions with at least 2 scholarly citations in APA format., in addition to the course textbooks, must incorporate at least 1 scholarly citation in APA format. Any sources cited must have been published within the last five years.
Case 5-10 Groupon
Groupon pioneered the use of digital coupons in a way that created an explosive new market or local business. Paper coupon use had been declining for years. But when Groupon made it possible for online individuals to obtain deep discounts on products in local stores using e-mailed coupons, huge numbers of people started buying. Between June 2009 and June 2010, revenues grew to $100 million. Between 2010 and Jun 2011, revenues exploded tenfold, reaching $1 billion. In Aug 2010, Forbes magazine labeled Groupon the world’s fastest growing corporation. And that did not hurt the company’s valuation when it went public in Nov 2011.
On Nov 5, 2011, Groupon took its company public with a buy-in-price of $20 per share. Shares rose from that IPO price of $20 by 40% in early trading on NASDAQ and at the 4pm market close it was $26.11, up by 31%. The closing price valued Groupon at $16.6 billion, making it more valuable than companies such as Adobe system and nearly the size of Yahoo. However, after disclosures of fraud and increased competition from the likes of Amazon local and living social, its valued had dropped to about $6 billion.
Less than five months after its IPO on March 30, 2012, Groupon announced that it had revised its financial results, unexpected restatement that deepened losses and raised questions about its accounting practices. As part of the revision, Groupon disclosed a “material weakness” in its internal control saying that it had failed to set aside enough money to cover customer refunds. The accounting issue increased the company’s losses in the fourth qtr. to $64.9m from $42.3M. These amounts were material based on revenue of $500 million in the prior year. The news that day sent shares of Groupon tumbling to 6%, to $17.27. Shares of groupon had fallen by 30% since it went public.
In its announcement of the restatement, groupon explained that it had encountered problems related to certain assumptions and forecasts that the company used to calculate its result. In particular, the company said that it underestimated customer refunds for higher-priced offers such as laser eye surgery.
Groupon collects more revenue on such deals, but it also carries as higher rate of refunds. The company honors customer refunds for the life of the coupons. So, these payments can affect its financial at various times. Groupon deducts refunds within 60 days from revenue, after that the company has to take an additional accounting charge related to the payments.
Groupon restatement is partially a consequence of the “Groupon promise” feature of its business model. The company pledges to refund deals if customer are not satisfied. Because it had been selling those deals at higher prices-which leads to a higher rate of return-it needed to set aside larger amounts to account for refunds, something it had not been doing.
The financial problems escalated after Groupon released its third-quarter 2012 earnings report, marking its first full-year cycle earnings reports since IPO. While the net operating results showed improvement year to year, the company still showed a net loss for the qtr. Moreover, while its revenue had been increasing in fiscal 2012, its operating profit had decline over 60%. This meant that its operating expenses were growing faster than its revenues, a sign that trouble might be lurking in the background. The company’s stock price on NASDAQ went from $26.11 per share down to $4.14 per share on Nov 30, 2012, a decline of more than 80% in one year. The company did not meet financial analyst expectations for the third qtr. of 2012.
There had been other oddities with Groupon’s accounting that reflected a culture of indifference toward GAAP and its obligations to the investing public.
It reported a 1,367 % increase in revenue for the three months ending March 31, 2011 vs the same period in 2010.
It admitted to recognizing as revenue commissions received on sales of coupon/gift certificates, but also recognized the total value of the coupon and gift certificates at the date of sale.
As Groupon prepared its financial statement for 2011, its independent auditor E.Y. determined that the company did not accurately account for the possibility of higher refunds. By the firm’s assessment, that constituted a “material weakness”. Groupon said in its annual report, “We did not maintain effective controls to provide a reasonable assurance that accounts were complete and accurate. This means that other transactions could be at risk because poor controls in one area tend to cause problems elsewhere. More important, the internal control problems raised questions about the management of the company and its corporate governance. But Groupon blamed E.Y. for the admission of the internal control failure to spot the material weakness.
In a related issue, on Apr 3, 2012, a shareholder lawsuit was brought against Groupon accusing the company of misleading investors about its financial prospects in its IPO and concealing weak internal controls. According to the complaint, the company overstated revenue, issued materially false and misleading financial results, and concealed the fact that its business was not growing as fast and was not nearly as resistant to competition as it had suggested. These claims identified a gap in the sections of SOX that deal with companies’ internal control. There is no requirement to disclose a control weakness in a company’s IPO prospectus.
The red flags had been waving even before the company went public in 2011. In preparing the IPO, the company used a financial metric that it called “Adjusted Consolidated Segment Operating Income”. The problem was that the figure excluding marketing cost, which make up the bulk of the company’s expenses. The net result was to make Groupon’s financial results appear better than they actually were. In fact, a reported $81.6 million profit would have been a $98.3 million loss had the marketing costs been included. After the SEC raised questions about the metric-which the Wall Street Journal called “Financial voodoo”-Groupon downplayed the formulation in its IPO documents.
Groupon reported the weakness in its internal control through s Section 302 provisions in SOX that requires public companies top executives to evaluate each quarter whether their disclosure controls and procedures are effective. The company seems to have concluded that the internal control shortcoming was serious enough to treat as an overall deficiency in disclosure controls rather than pointing it out in its report on internal controls that is required under section 404. EY expressed no opinion on the company’s internal controls in its audit report, which makes us wonder whether it was willing to stand up to Groupon’s management on the shortcomings in its internal controls and governance. In fact, the firm signed clean audit opinions for 4 years.
Questions:
1. Does it matter that Groupon reported its weakness in internal controls as a disclosure control under SOX section 302 rather than pointing it out in its report on internal controls section 404? Explain.
2.Describe the risks of material misstatements in the financial statements that should have raised red flags for EY.
3.According to 2012 survey of 192 U.S executives conducted by Deloitte & Touche, LLP and Forbes Insights, social media was identified as the 4th largest risk on par with financial risk. This ranking derives from social media’s capacity to accelerate to other risks, such as financial risk associated with disclosures in violations of SEC rules, for example. Other risks inherent to social media include information leaks, reputational damage to brand, noncompliance with regulatory requirements, third party and governance risk.
a.Why is it important for a firm such as E&Y in case such as Groupon to fully understand the nature of risk when a company conducts its business on line?
b.What role can internal auditors play in dealing with such risk?
c.How should external auditors adapt their risk assessment procedures for social media/networking clients?
