Ethical Obligations and Decision Making in Accounting, 4/e 1
Case 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.
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.
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.
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.
There had been other oddities with Groupon’s accounting that reflected a culture of indifference
toward GAAP and its obligations to the investing public.
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 be 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.
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
$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
Questions
1. Prompted by frauds such as at Groupon, which was carried out in part by creating
a metric that is not recognized in the accounting literature, although not specifically
prohibited either, the PCAOB has issued a release requesting comments on a
proposal to include either in the audit report or as a separate document an Auditor’s
Discussion and Analysis (AD&A). It would be an analog of the management’s
discussion and analysis (MD&A) currently required in certain filings under the
federal securities laws. The idea is to give users a more detailed view both of the
auditor’s work and impressions and concerns about the entity being audited.
Do you think the AD&A is a good idea? Should it comment on the audit, the
company’s financial statements, or both? Should it comment on any other
information? Explain.
The PCAOB issued a concept release back in 2011 to solicit comments on an “Auditor’s
Discussion and Analysis.” Initially, it was not met with a great deal of enthusiasm from
the accounting profession. One example is PwC that issued a document explaining its
point of view.
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The following discussion incorporates the PCAOB’s views, that of PwC,
and your authors.
PCAOB View
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PwC view
The AD&A would result in unintended consequences. The firm believes that while the
auditing model should be enhanced, any effort to change the auditor’s role from
objectively validating management provided information to subjectively reporting the
auditor’s views would be detrimental to audit and financial reporting quality. While the
firm supports providing additional information to serve investors’ needs it must be done
in the context of evaluating rather than generating information that the company provides
to investors. To remain objective, both in fact and appearance, the auditor’s role in
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2. The role of Ernst & Young in the Groupon fraud is somewhat unclear. The firm did
render unmodified opinions for four years. Do you believe it is possible that an audit
firm can render an unmodified opinion and have no responsibility for detecting and
reporting a financial fraud? Explain in general and specifically with reference to the
fraud at Groupon.
A firm can render an unmodified opinion for a number of years and not be held
responsible for detecting and reporting fraud. Auditors are not guarantors that fraud will
be discovered. Auditors are required to assess the risk of material misstatements due to
fraud, look for the red flags that fraud may exist (i.e., apply the fraud triangle), maintain a
healthy dose of professional skepticism in gathering and evaluating audit evidence, and
probing management’s representations to ensure they can be independently verified.
Auditors should take care not to accept management-provided evidence when external
sources can confirm the existence of transactions and financial statement valuation.
3. According to a 2012 survey of 192 U.S. executives conducted by Deloitte & Touche
LLP and Forbes Insights, social media was identified as the fourth-largest risk on
par with financial risk. This ranking derives from social media’s capacity to
accelerate to other risks, such as financial risk associated with disclosures in
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violation of SEC rules, for example. Other risks inherent to social media include
information leaks, reputational damage to brand, noncompliance with regulatory
requirements, third-party, and governance risks.
1. Why is it important for a firm such as EY, in a case such as Groupon, to fully
understand the nature of risk when a company conducts its business online?
Auditors need to carefully assess the business model of clients and evaluating the unique
aspects of it that may require additional auditing or a different kind of auditing. Consider
that Groupon sells discounted coupons online, keeping part of the money that customers
pay for the coupons, with the rest going to participating merchants. Is EY familiar with
2. What role can internal auditors play in dealing with such risks?
Internal auditors can serve as the eyes and ears for the external auditors. They are in the
thick of it from the beginning and have a better opportunity to identify fraud and help the
external auditors to fully understand the risks of a business model such as Groupon.
3. How should internal auditors adapt their risk assessment procedures for
social media/networking companies?
A top priority for chief audit executives (CAEs) and internal auditors has been preventing
risks – such as hits to the bottom line and a loss of productivity – that could result from
social media use within their organizations, according to a survey released by global
consulting firm Protiviti.
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1. Financial loss (7.3 on a 10-point scale, with 10 representing the highest risk level
and 1 indicating the lowest)
3. Loss of intellectual property (6.6)
5. Viruses and malware (5.6)
But even though CAEs have had minimizing these risks on their radar screens, not even
half of those surveyed (47 percent) are including social media risk in their current year
audit plans. According to the report, only 25 percent have social media risk included in
their plans this year, up from 20 percent last year, while 31 percent noted they will
include social media risk in next year’s audit plan, down from 35 percent in 2013.
What factors inhibit internal audit’s involvement in assessing social media risk?
According to the survey, the top five factors include:
1. Perceived risk (29 percent)
3. Lack of management support (23 percent)
5. Lack of IT support (15 percent)
For organizations that do have social media policies, significant concerns remain as many
still fail to address critical issues. For example, in cases where respondents said a social
media policy is in place, nearly 30 percent fail to address disclosure of employee
information, and only 66 percent address information security, according to the survey.
For the survey, internal audit professionals were also asked to assess their competency in
49 areas of technical knowledge and then indicate whether they believe their knowledge
is adequate or needs improvement. Based on the findings, the top five areas for technical
knowledge improvement are:
1. Mobile applications
3. Social media applications
5. Data analysis technologies
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1. Computer-assisted audit tools
3. Data analysis tools for statistical analysis
5. Data analysis tools for sampling