Well, it’s happened yet again. Groupon is making these two Grumpy Old Accountants look like prophets of financial reporting transparency. Last August we warned you of revenue recognition problems and internal control weaknesses at Groupon (Trust No One, Particularly Not Groupon’s Accountants). Both predictions have since proven to be fact.
And in April of this year, we alerted you to another new potential problem at Groupon: income tax accounting. Remember these words from Groupon’s First 10-K: Looking Under the Hood?
Next, we turn our attention to the Company’s income tax accounting. We find it very curious that Groupon pumped up its valuation reserve for deferred tax assets by $72.3 million (actual expense was $92 million according to Schedule II-Valuation and Qualifying Accounts) in 2011 with little or no discussion as to why in either the MD&A or the financial statement notes. We know why! This is the first of two earnings charges the Company will be forced to take since it is losing money, with no foreseeable prospects of generating taxable income against which deferred tax assets can be used (emphasis added). To discuss the current year income tax charge, the Company would have had to admit how bleak its future prospects are! Ceteris paribus, next year’s income tax asset valuation adjustment will be $112.9 million, i.e., 2011’s net deferred tax assets.
Guess what? According to Groupon’s March 31, 2012 10-Q (note 11 on page 20), the Company recorded $34.6 million of income tax expense on only $31 million of pretax book income (an effective tax rate of 111.6 percent) due principally to increased valuation allowances for deferred tax assets. Told you so! Now granted, the number was not the full amount we predicted, but it’s only the first quarter.
To Groupon’s credit, however, management’s discussion of this significant addition to the deferred tax asset valuation allowance is getting better. Page 32 of the 10-Q attributes the jump in the effective tax rate to:
“the impact of foreign losses where we cannot take a benefit and it reflects the amortization of prepaid taxes recognized on profits from the taxable sale of certain intellectual property rights within our international structure in previous periods.”
And finally, the Company is opening the door to the possibility of future tax charges with the following language:
“the Company’s effective tax rate could be adversely affected by greater earnings in countries with higher statutory rates, changes in the valuation of the Company’s deferred tax assets and liabilities (emphases added), additional losses in countries where the Company cannot recognize the tax benefit and changes in the relevant tax laws, regulations, or accounting principles.”
The rest of the March 31, 2012 10-Q continues to evoke financial reporting concerns that we have voiced in the past, namely increasing goodwill and technology intangibles, poorly performing equity interests, a growing merchant payable, operating cash flow classification issues, and non-GAAP financial metrics.
Perhaps this increase in Groupon’s deferred tax asset valuation allowance account will be an omen for Groupon’s future disclosures. We hope so. It appears that the Company is trying to tighten up its financial reporting practices since being forced to restate and admit to internal control weaknesses. If so, this will make Groupon’s financial reports stronger and more credible.
This essay reflects the opinion of the authors and not necessarily the opinions of The Pennsylvania State University, The American College, or Villanova University.