Click online for revenue clarity

E-commerce and Internet companies are becoming increasingly relevant and popular in India. They can be broadly classified into online content companies, which focus on Internet sites that provide news and information, and rely on revenue from advertisements on their Web sites; and Internet commerce companies, which sell products and services over the Internet.

As the business model is different from brick-and-mortar companies, several unique accounting issues have emerged in this sector. As these companies increasingly access the capital markets, their accounting policies and practices will assume greater importance for all stakeholders.

advertising revenue

Online advertising is a unique feature of the e-commerce industry ranging from display banners on Web sites, clicks generated from banners or e-mails sent. Companies generally receive consideration upfront for such services. However, revenue from such advertisements should be recorded only when the company has fulfilled its obligation to provide services — that is, over the period the banner is displayed or based on clicks generated or e-mails sent.

barter transactions

E-commerce companies exchange rights to place advertisements on each other’s Web sites. In some cases, no cash or other payment is involved. Indian GAAP (generally accepted accounting principles) has limited guidance for such transactions, and there is no uniformity in whether the barter is recorded in the books and at what value. Internationally, there is detailed guidance under which revenue from all advertising barter transactions should be recorded based on the fair value of the advertising services provided, unless it is an exchange of similar services. The exchange is not considered similar if the target group, platform, format, and frequency of advertisements are different (for example, an advertising barter between a travel site and an online retailer).

revenue recognition

Generally, companies recognise revenue when the goods are delivered to customers. However, careful evaluation is needed where the customer has a right to return the goods for a specific period. Here, revenue is recognised on delivery only when the company has sufficient historical experience to estimate a provision for sales return; otherwise, revenue can be recognised only after the return period. As new business models evolve, it may be a challenge for companies to have sufficient historical experience to estimate sales returns.

Gross vs. net report

This is a critical issue for an e-commerce company as revenue is a key performance indicator during the initial stages. For companies selling goods and services, gross reporting of revenue is appropriate where a company is a principal in a transaction. However, if a company acts as an agent — that is, provides services on commission basis — revenue should be recorded net even if the company collects money for the entire service or product. Whether a company acts as a principal or agent is determined based on the substance of the transaction, and not merely the legal form.

The accounting treatment of discounts and other sales incentives depends on their nature. Generally, where discounts are offered to specific customers linked to a sale transaction, they are reported as a reduction from revenue.

Where the discounts and other sales incentives are in kind, such as free products with purchases, the cost of the free products are generally recorded as expense.

Capital structuring

E-commerce and Internet companies have been raising capital from investors during the start-up and growth stages. Often, a part of the capital is raised through complex financial instruments, such as convertible debentures and instruments with put options, to provide liquidity to the investor. Accounting practice varies significantly for such complex instruments in the absence of specific guidance. If companies in this sector attempt to raise capital in international markets, the international guidance would require treating many of these instruments as debt, with the related returns to investors reflected as interest cost. This treatment would apply even if the funding instrument is legally structured as equity.

Many e-commerce and Internet companies use share-based payments to incentivise employees. Accounting guidance requires recognising the compensation cost for those stock options that have an exercise price lower than the fair value of the share on the date of grant. As many companies in this sector are unlisted, the determination of the fair value becomes a challenge. Companies may need to consider the value at which private funding was raised close to the grant date or obtain independent valuation reports to determine the compensation cost.

As the e-commerce and Internet industry in India is still evolving, more complex transactions and business models are likely to emerge. The standard setters would need to issue appropriate guidance to ensure consistency in accounting practices and comparability with international practices.

The author is Global Head of Accounting Advisory Services, KPMG in India

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