C6-48 Revenue Recognition and Refunds

Groupon, Inc. is an internet-based marketing company which sells coupons (called Groupons) for products and services sold by other merchants (merchant partners). Groupon offers a daily deal to subscribers. The daily deal provides significant savings on a variety of products and services provided a minimum number of customers purchase the Groupon for each deal offered. This feature guardedness a sufficient volume of customers to ensure that the deal is profitable to the merchant partner.

When a group sells a coupon, it collects the proceeds from the customer (gross billings) and then remits a payment to the merchant partner. These payments are typically paid out over a 60-day period. Groupons revenue recognition policy is described in its 10-K as follows:

Revenue Recognition

The Company recognizes revenue from Groupons when the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred; the selling price is fixed or determinable; and collectability is reasonably assured. These criteria are met when the number of customers who purchase the daily deal exceeds the predetermined threshold, the Groupon has been electronically delivered to the purchaser and a listing of Groupons sold has been made available to the merchant. At that time, the Companys obligations to the merchant, for which it is serving as an agent, are substantially complete. The Companys remaining obligations, which are limited to remitting payment to the merchant and continuing to make available on the Companys website the listing of Groupons previously provided to the merchant, are inconsequential or perfunctory. The Company records the net amount it retains from the sale of Groupons after paying an agreed upon percentage of the purchase price to the featured merchant excluding any applicable taxes. Revenue is recorded on a net basis because the Company is acting as an agent of the merchant in the transaction.

Groupon reported gross billings of $3,985.5 million in 2011, up from $745.3 million in 2010. Its net revenues were $1,610.4 million in 2011 and $312.9 million in 2010. Groupon also reported that it changed its method of revenue recognition during 2011:

The Company restated the Condensed Consolidated Statements of Operations for the three months ended March 31, 2011, included in the Form S-1 filed with the SEC on June 2, 2011, to correct for an error in its presentation of revenue. Most significantly, the Company restated its reporting of revenues from Groupons to be net of the amounts related to merchant fees. Historically, the Company reported the gross amounts billed to its subscribers as revenue. The Condensed Consolidated Statement of Operations for the three months ended March 31, 2011, was restated to show the net amount the Company retains after paying the merchant fees. The effect of the correction resulted in a reduction of previously reported revenues and corresponding reductions in cost of revenue in those periods. The change in presentation had no effect on pre-tax loss, net loss or any per share amounts for the period.

Groupons refund policy is also described in its 2012 10-K report:

Our Groupon Promise states that we will provide our customers with a refund of the purchase price of a Groupon if they believe that we have let them down. . . . Our standard agreements with our merchant partners generally limit the time period during which we may seek reimbursement for customer refunds or claims. Our customers may make claims for refunds with respect to which we are unable to seek reimbursement from our merchant partners.

At the time revenue is recorded, we record an allowance for estimated customer refunds. We accrue costs associated with refunds in accrued expenses on the consolidated balance sheets. The cost of refunds where the amount payable to the merchant is recoverable is recorded in the consolidated statements of operations as a reduction to revenue. The cost of refunds when there is no amount recoverable from the merchant are presented as a cost of revenue.

To determine the amount of our refund reserve, we track refund patterns of prior deals, use that data to build a model and apply that model to current deals. Further analysis of our refund activity into 2012 indicated deviations from modeled refund behavior for deals featured in late 2011, particularly due to a shift in our fourth quarter deal mix and higher price point offers. Accordingly, we updated our refund model to reflect changes in the deal mix and price point of our deals over time and we believe this updated model will enable us to track and anticipate refund behavior more accurately.

Question:

Given the uncertainty surrounding refunds, what alternative accounting approaches might Groupon consider for handling refunds?