E-Commerce Companies Characteristics and Unique Accounting Methods

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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. [phone] Fax [phone]
• jlivnat_at_stern.nyu.edu
• Web page www.stern.nyu.edu/jlivnat

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Overview

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

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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

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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

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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

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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

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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

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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

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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.

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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

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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?

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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

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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?

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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.

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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?