E-Commerce Companies Characteristics and Unique Accounting Methods

1. E-Commerce CompaniesCharacteristics and Unique Accounting Methods Professor Joshua Livnat, Ph.D., CPA 311 Tisch Hall New York University 40 W. 4th St. NY NY 10012 Tel. (212) 998-0022 Fax (212) 995-4230 jlivnat@stern.nyu.edu Web page: www.stern.nyu.edu/~jlivnat

2. Overview • Financial characteristics of E-Commerce companies • Accounting consequences • Unique accounting aspects

3. Financial Characteristics of E-Commerce Companies • Large expenditures on site development • Large expenditures on customer acquisition or traffic acquisition • Low levels of revenues • Fast growth in revenues • High levels of losses • Initial stages of the business growth

4. Comparison with Brick and Mortar Companies • Lower levels of fixed assets • Higher levels of intangible assets: • Customers • Systems • Content • Employees • Low marginal costs of a marginal customer • Higher operating uncertainty • Rapidly changing environment

5. Financial Characteristics • Large cumulative losses • Start-up costs • Negative operating cash flows • Using liquid resources to finance operations • Negative free cash flows • Operating cash flows are not sufficient to cover capital expenditures

6. Financial Characteristics • High growth rates in revenues • Working capital should grow at a high rate to keep pace with revenue growth • Large fluctuations in operating results due to environmental changes • At the initial stages, firms do not have good managerial controls: • Unnecessary expenses • Investments in projects that do not bear fruit and need to be abandoned

7. Financial Characteristics • Financing opportunities: • Can typically not borrow funds • Can issue equity, but dilutes the founders and prior investors • Can finance some operations through issuance of contingent claims • Stock options to employees • Warrants to suppliers (rent, referring sites, etc.) • Convertible preferred stock and convertible bonds

8. Financial Characteristics • Large differences between firms that issued stock to the public and those that did not: • Cash reserves • Book value of equity • Can use cash in agreements instead of using equity or contingent equity • Can use cash to acquire new customers • Can use the cash to build physical operations

9. Accounting Consequences • Intangible assets cannot be recorded in many cases, and are immediately expensed. • Intangible assets that are recorded have shorter useful lives than tangible assets • Depreciation of equipment versus amortization of software development costs • Some contingent claims will not be recorded as an expense.

10. Unique Accounting Aspects • Disclosure of various revenue sources • Sale of products or services • Advertising • Leveraging customers • Disclosure of various expenses • Product or service cost • Selling and marketing cost • System development cost • Content cost

11. Unique Accounting Aspects • Barter revenues - See Appendix D • Can account for a significant proportion of all revenues • What is the economic cost of bartered advertising? • Can you rely on non-bartered revenues to determine revenues and costs of bartered advertising?

12. Unique Accounting Aspects • Stock options awarded to: - See Appendix E • Employees • Usually not recorded as an expense • Suppliers and service providers • Shown as an expense, but not necessarily matched properly with revenues • Customers • Should be shown as a selling expense, but sometimes shown separately

13. Other Unique Accounting Aspects • Gross or net revenues • Record commission revenues or total revenues • Tickets for a performance. Price is $50, processing fee of $5, customer pays $55. • Should you show revenue of $55 and cost of goods sold $50? Or revenues of $5? • Why does it matter? • Rebates for complementary service • 36 months Internet connection • Can you show it as revenue and selling expense?

14. Other Unique Accounting Aspects • Shipping and handling expenses included in revenues (and selling expenses). • Customer pays $10 for a book, plus $4 for shipping. Assume the book costs $8 and shipping is $5. How do you show it on the income statement? • Free or introductory offer is recorded as revenue and selling expense.

15. Other Unique Accounting Aspects • How is self-developed software accounted for? Over what period is it amortized? • When can an auction site recognize revenues? • Sometimes needs to list an item for a specified period. • How should rewards be accounted for? • Current expenses or capitalized acquisition costs?