There's been a lot of business at the Fogdog sporting goods web site as customers are rewarded for making purchases with a plethora of free offers. And the Fogdog income statement looked great - all of the company's promotional items and shipping expenses were categorized as marketing expense, making the gross margin at Fogdog look pretty appealing.
Apparently the practice is pretty widespread among start-up Internet companies trying to boost profit margins to attract investors. But the spoilsport accounting profession says companies need to reclassify these costs as part of the cost of the product sold.
If you give a discount or a prize as part of the purchase, the cost to the company becomes a cost of sales, thus reducing the margin on the sale of the product. The same theory applies to shipping costs that are a direct cost of making a sale.
A new accounting rule is about to force companies to include the cost of free items as part of the cost of sales, and the Securities & Exchange Commission is leaning toward issuing a similar rule specifically aimed at classification of shipping costs.
In Fogdog's situation, the company made a reclassification of expenses last winter and their stock price, which had been in the $10 per share range last February has plummeted to $1 per share.