E-Commerce Companies

Characteristics 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

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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 4
 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?
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