Groupon: Financial Fraud Analysis Case Study

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C​‌‍‍‍‌‍‍‍‍‍‌‌‌‌‍‌‍‌‌‌​ase 5-10 Groupon The Groupon case was first discussed in Chapter 3. Here, we expand on the discussion of internal controls and the risk of material misstatement in the financial statements. Groupon is a deal-of-the-day recommendation service for consumers. Launched in 2008, Groupon—a fusion of the words group and coupon—combines social media with collective buying clout to offer daily deals on products, services, and cultural events in local markets. Promotions are activated only after a certain number of people in a given city sign up. Page 335Groupon pioneered the use of digital coupons in a way that created an explosive new market for 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. Then, between June 2010 and June 2011, revenues exploded tenfold, reaching $1 billion. In August 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 November 2011. On November 5, 2011, Groupon took its company public with a buy-in price of $20 per share. Groupon shares rose from that IPO price of $20 by 40 percent in early trading on NASDAQ, and at the 4 p.m. market close, it was $26.11, up 31 percent. The closing price valued Groupon at $16.6 billion, making it more valuable than companies such as Adobe Systems and nearly the size of Yahoo. However, after disclosures of fraud and increased competition from the likes of AmazonLocal and LivingSocial, its value 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, an 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 controls 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 quarter to $64.9 million from $42.3 million. These amounts were material based on revenue of $500 million in the prior year. The news that day sent shares of Groupon tumbling 6 percent, to $17.29. Shares of Groupon had fallen by 30 percent since it went public, and the downward trend continues today. 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 results. 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 a higher rate of refunds. The company honors customer refunds for the life of its coupons, so these payments can affect its financials 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’s restatement is partially a consequence of the “Groupon Promise” feature of its business model. The company pledges to refund deals if customers aren’t satisfied. Because it had been selling those deals at higher prices—which leads to a higher rate of returns—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 of earnings reports since its IPO. While the net operating results showed improvement year-to-year, the company still showed a net loss for the quarter. Moreover, while its revenue had been increasing in fiscal 2012, its operating profit had declined over 60 percent. 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 on November 5, 2011, the end of the IPO day, to $4.14 a share on November 30, 2012, a decline of more than 80 percent in one year. The company did not meet financial analysts’ expectations for the third quarter 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 percent increase in revenue for the three months ending March 31, 2011 versus the same period in 2010 It admitt​‌‍‍‍‌‍‍‍‍‍‌‌‌‌‍‌‍‌‌‌​ed to recognizing as revenue commissions received on sales of coupons/gift certificates, but also recognized the total value of the coupons and gift certificates at the date of sale. As Groupon prepared its financial statements for 2011, its independent auditor, Ernst & Young (EY), 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 reasonable assurance that accounts were complete and accurate.” This meant that other transactions could Page 336be 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 EY for the admission of the internal control failure to spot the material weakness. In a related issue, on April 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 controls. 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 its IPO, the company used a financial metric that it called “Adjusted Consolidated Segment Operating Income.” The problem was that that figure excluded marketing costs, 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 controls through a Section 302 provision 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 four years.

 

In two to three pages, supported by evidence from your text and from other research (at least one resource is required), answer the following questions:

  1. What is the responsibility of management and the auditor with respect to the internal controls of a client?
  2. Groupon disclosed a “material weakness” in its internal controls saying that it had failed to set aside enough money to cover customer refunds. Do you believe the company engaged in fraud with respect to customer refunds? Why or why not?
  3. Groupon blamed EY for the admission of the internal control failure to spot the material weakness. Do you agree that EY should have spotted the internal control weakness earlier and taken appropriate action? Include in your response the role that risk assessment should have played in EY’s actions.

The paper • Must be two to three double-spaced pages in length (not including title and references pages) and formatted according to APA style as outlined in the Ashford Writing Center (Links to an external site.). • Must include a separate title page with the following: o Title of paper o Student’s name o Course name and number o Instructor’s name o Date submitted • Must use at least two scholarly sources in addition to the course text. • Must document all sources in APA style as outlined in the Ashford Writing Center. • Must include a separate references page that is formatted according to APA style as outlined in the Ashford Writing Center. • • Mintz, S. M., & Morris, R. E. (2017). Ethical obligations and decisi​‌‍‍‍‌‍‍‍‍‍‌‌‌‌‍‌‍‌‌‌​on making in accounting: Text and cases (4th ed.). Retrieved from https://www.vitalsource.com

 

 

 

 

 

 

 

 

Groupon: Financial Fraud Analysis Case Study

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Groupon: Financial Fraud Analysis Case Study

Fraud in financial statements is one of the issues that affect companies negatively. Many auditors are keen regarding fraud in financial statements because it negatively affects their careers. This paper is a discussion of Groupon regarding fraud in financial statements.

Management leaders have a significant responsibility to ensure that the internal audit process is effective and adds value to the organization. According to Barišić and Tušek (2016), top managers are tasked with establishing a proper internal audit that aligns with organizational goals. They achieve their responsibilities by designing achievable objectives that do not lead to fraud or illegal financial reporting. Organizational managers help their institutions be effective and grow by ensuring that they control risks that can tempt a company to tempt fraud or illegal actions. For example, the Groupon managers could have avoided fraud reporting if they had established clear and attainable objectives because this criterion could have minimized risks.

Additionally, the managers are supposed to enhance risk response decisions because their organizations operate in a competitive market niche. For instance, organizational managers must understand when to avoid, reduce, share, or accept some risks if they increase their businesses’ value (Mintz & Morris, 2017). Besides, the managers have to establish an organizational culture that reduces operational surprises and losses because that strengthens the internal control processes.

Monitoring the internal control systems is another essential task that managers carry out, which helps institutions establish strong internal control processes. Notably, the policies that managers establish are used to determine how an organization runs its businesses and the appropriate controls. Finally, the managers are responsible for coming up with procedures used to assess and report various issues in an organization.

The responsibility of the auditor is to look for the red flags regarding internal controls in an organization. Additionally, according to Mintz and Morris (2017), an auditor should pass judgments after assessing the internal controls and advise the management team what should be done if they find issues that can negatively affect the company. Additionally, an auditor should communicate in an issue that is identified in an organization’s financial reports to the SEC because that will help make crucial decisions. Therefore, an auditor’s responsibilities are used to establish an ethical business that could survive the challenges in their activities.

Financial fraud is one of the issues that affected Groupon, and I believe it intentionally committed this crime. According to van Driel (2018), many organizations have failed to achieve their visions because they engage in financial frauds and illegal activities. For example, the top managers and financial leaders failed to enter details regarding expenditure in their financial reports. As a result, they convinced the public that they were doing well economically. Many investors rushed to buy the Groupon shares because they believed that company was doing well as the financial reports indicated. However, the financial reports were not based on professional care, and the people who prepared them avoided essential information. Therefore, the managers avoided crucial information, which changed everything about the company, which qualifies their case as fraudulent.

Groupon committed fraud because the top managers had incentives that pressured them to act unethically. The company had grown and attracted many customers quickly, and many more people were willing to join it. The media reported that the company was doing well and was growing at an unprecedented rate. The media reports and the desire for many people to become part of the fastest-growing company globally contributed to the manager’s and employees’ decisions to commit fraud. As a result, they hid critical information regarding their customer refunds because that could negatively affect them. Therefore, I believe that the fear of losing customers and affecting the company brand motivated the managers to lie to the public that they could refund customers.

I also believe that the company committed fraud because it took advantage of the opportunities that arose since its inception. Many reports praised the company’s performance, which could have given the managers a hard time to follow ethical or unethical means to survive in the market. However, the leaders rationalized their actions and realized that they could obtain more benefits compared to losses. As a result, they undervalued the customer refunding process. They realized their mistake when the customer segment increased, and the demand for a refund went up. The company’s operating expense could not meet the customer refund requirements as it was promised during sales promotions. The increment in customer refunds forced the managers to report the “material weakness” concealed from the beginning of the financial reporting before the company went public.

EY is an auditing firm, and I agree that it should have spotted Groupon’s material weakness. An auditing firm should have been careful in identifying the red flags in Groupon. EY could have assessed the top managers and determine their attitudes towards internal controls. Besides, EY could have obtained the internal control policies that Groupon was using. This could have painted a picture of the company’s progress and commitment to achieving its goals in an ethical way.

Additionally, EY failed in its responsibilities because it did not determine its relationship with the managers. For example, Groupon used an unrecognized method when reporting its financial reports and the media pointed it out. However, EY, a qualified financial auditor firm, did not point out these issues until things went wrong, and the public became aware of them.

Additionally, the EY did not evaluate the internal control factors to determine the risks associated with fraud financial reports. Finally, EY failed in its operations as an auditing firm because it did not evaluate the information that was provided in the financial statements (Mintz & Morris, 2017). As a result, EY did not notice the Groupon had avoided including its expenditure in the financial reports. Groupon realized that if it included the operating costs in its financial reports, it was to have a negative figure, which could negatively affect it.

In conclusion, fraud in financial statements is an area that is attracting many auditors. It has negative impacts on an organization. Groupon falls into the temptation of fraud financial reports, and this affected its operations negatively. EY failed to report the financial weaknesses from the start, and that enhanced Groupon’s failures.

 

 

References

Barišić, I., & Tušek, B. (2016). The importance of the supportive control environment for internal audit effectiveness–the case of Croatian companies. Economic Research-Ekonomska Istraživanja29(1), 1021-1037. https://doi.org/10.1080/1331677X.2016.1211954

Mintz, S. M., & Morris, R. E. (2017). Ethical obligations and decision making in accounting: Text and cases, Fourth Edition. McGraw-Hill Education

van Driel, H. (2018). Financial fraud, scandals, and regulation: A conceptual framework and literature review. Business History, 61(8), 1259-1299. https://doi.org/10.1080/00076791.2018.1519026

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