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Facebook’s Anti-Groupon Accounting

Tuesday, 15 May 2012 | 12:26 PM ET
Facebook IPO Coffee cup
Photo by Jodi Gralnick for CNBC.com
Facebook IPO Coffee cup

Facebook’s payment network is its largest source of revenue after advertising. Primarily through selling credits for virtual goods for use in social games like Farmville, Facebook earned $557 million last year through its payments network.

What’s most surprising to a cynic like me is how honestly Facebook accounts for revenues from the payment network. There’s no accounting trickery going on in that $557 million figure.

Payment networks provide easy opportunities for abuse, especially when they are configured like Facebook’s. On Facebook, users purchase credits that can later be redeemed for virtual goods, like a cow in Farmville. This creates the opportunity to book revenues from the initial purchase—even though much of the initial purchase price will later have to be handed over to the merchant of the virtual goods.

Groupon was doing something like this. If it sold a $50 coupon for $100 of services, it booked the entire $50 as revenue—even though it would have to remit much of that to the merchant actually providing the goods and services.

I’m not an expert in accounting rules but that strikes me as at least a bit questionable.

Groupon was able to count the entire purchase price of the coupon as revenue because it considered itself the “primary obligor” in the coupon purchases. This struck me—and many others—as a bit of a stretch. Weren’t the companies that provided the services the primary obligors?

Facebook is the anti-Groupon when it comes to accounting for its payment network. When a user purchases a credit, Facebook doesn’t recognize any revenue at all. It considers the funds used to buy the credit as a “deposit.” Revenue is only recognized when the credit is cashed in for a virtual good. And even then, Facebook only includes the amount it gets to keep after the company selling the virtual good gets its share.

That produces a good clean number on the revenue line. And it speaks well for Facebook’s desire to be upfront with investors about its earnings.

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