[patio11]

This is an artifact of a longstanding issue that they've had with GAAP. They sell non-cancelable non-refundable multi-year services (like domain registrations) and receive cash up front for them. GAAP requires that they book that revenue on a pro-rata basis over time.

This means that if it costs them $200 to acquire a new customer and that customer immediately whips out their CC and buys $1k of domains spread over ten years then, at the end of the year, they "lost" $100 on that customer and have to console themselves by drying their tears on $800 in cash.

It also makes their balance sheet look over leveraged due to the $900 in unearned revenue booked as a liability.

[fookyong]

Fascinating - thanks for the explanation on this. I'm often surprised at how slow accounting practices are to catch up on business models that we see as commonplace in the tech world.

[patio11]

I'm of two minds on it. On the one hand, revenue recognition rules seem to lag common practices in our industry. They're wacky for domain registrations and absolutely insane for e.g. virtual currencies used to purchase improvements in video games. (If I sell you four dragon eggs for $10 and you spend 1 dragon egg on a Sword of Dragonslaying, do you know how much revenue I can recognize? Make a guess. Answer: I have to estimate your lifetime as a player given my best data of player behavior, subtract the age of your account, and pro-rate $2.50 over the remaining days of your estimated life.)

On the other hand, most time when tech companies chafe under GAAP restrictions, it is because they're trying "creative accounting" in the abusive rather than the creative senses of the term. Salesforce, for example, is periodically annoyed that they have to account for stock-based compensation to employees. Well, yeah, you can't simultaneously say "Equity grants are why people work for startups" and also say "But on the other hand they're totally free." They also have some other things which are apparently allowed in their GAAP accounting but... are rather aggressive, like $3.5 billion in goodwill on the balance sheet.

Disclaimer: I have in the past held, and currently hold, options positions which express the opinion that CRM is far overvalued and which profit if the market decides to agree with me.

[mrfusion]

Why is it a liability? I'm thoroughly confused.

[patio11]

So if I promise to pay you money in the future, that is clearly a liability, right? Same if I sell you a chicken today for $25 and promise delivery next year. My assets increase by $25 cash and my liabilities increase by 1 chicken, which I'd probably record at $25.

This makes a lot of sense for chickens. It feels to me like it makes a lot less sense when I'm selling you something with a COGS which is too cheap to meter and where there is essentially no meaningful risk to delivery.

[mrfusion]

Thanks for explaining. So why would your liability for the chicken be $25, the retail price? Why wouldn't it be what a chicken costs to you?

[mechanical_fish]

Accounting isn't always intuitive, but in this case I believe it is: His liability for the chicken is $25, because what he owes you is not "a chicken", but "$25 worth of chicken".

To see this, imagine what happens if he has to break his promise to deliver, perhaps because all his chickens get swept out to sea and there are no substitute chickens available in time. He owes you a refund. How much does he owe you? Having spent our lives doing deals like this, we intuitively know the answer: $25. He has to give back all the money you paid. That's why the liability is $25.

Now, once an actual chicken gets handed over to you, and you agree that it satisfies the chicken contract, things are different. Now the $25 liability changes into a $5 cost-of-goods-sold (assuming that wholesale chickens cost $5) and a $20 increase in equity (aka "profit").

(More or less, I think. I'm not an accountant.)

[mrfusion]

that makes sense. Thanks.