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Unconventional Transactions Boosted Sales

Enter EBay

On July 25, 2001, AOL found another way to generate ad dollars, this time through an agreement with eBay, the giant online auction site.

AOL was not only an advertising medium for other companies, it also served as an advertising broker, selling ads for other companies that lacked AOL's expertise and sales force. AOL agreed to serve in this capacity for eBay, hoping to sell a big chunk of the auction site's ad space, according to AOL's confidential executive summary of the deal. AOL said it was able to bundle advertising for different Web sites and offer package deals to advertisers.

AOL Time Warner directors are scheduled to approve the name change at a meeting on Thursday in New York, according to people close to the board. (File Photo - Associated Press)

_____AOL Responds_____
AOL Says Accounting 'Was Appropriate' (The Washington Post, Jul 18, 2002)
_____AOL Series_____
Part II: Creative Transactions Earned Team Rewards (July 19, 2002)
Sidebar: Unorthodox Partnership Produced Financial Gains (July 19, 2002)
_____Graphics_____
The Heart of a Deal: How America Online Brings Advertising Deals to Fruition
Excerpt of AOL E-mail
A Rocky Road: Graphical Timeline Tracks AOL Stock Price
AOL Documents and Deals Reviewed by The Washington Post
_____Time Warner_____
Stock Quote and News
Historical Chart
Company Description
Analyst Ratings
Timeline: Time Warner Highlights
Company Downsizing Actions
_____Time Warner News_____
Former AOL Chairman Heads Luxury Travel Firm (The Washington Post, Nov 23, 2004)
Time Warner Nears Deal Over AOL Accounting (The Washington Post, Nov 23, 2004)
AOL Concentrates On Security Issues With New Software (The Washington Post, Nov 18, 2004)
More AOL Time Warner News

In the eBay deal, AOL did not simply take the customary commission of an ad rep. AOL counted all of the eBay revenue as if it were AOL's own.

"AOL recognizes all revenue generated from eBay inventory sales on a topline basis," AOL said in its internal documents.

When asked about the financial arrangement, AOL declined to make any documents available but confirmed that it booked the sale of eBay's ads as AOL's own revenue, which it maintained is the proper accounting method. AOL said it booked $80 million in revenue in 2000 and 2001 and $15 million in the first quarter of 2002, the gross amounts from selling eBay's ads.

With this accounting, AOL was able to report a larger amount of ad and commerce revenue. (The gross sales didn't change AOL's net income, because AOL counted the payments it forwarded to eBay -- minus its broker's fee -- as an expense elsewhere in its books.)

Under accounting standards, there are several factors to consider in determining which party can book the gross revenue from a transaction.

One way an agent can book the gross amount of revenue from the sale of a merchant's goods is if the agent first acquires the goods and then resells them to another party, accounting experts said.

Such is the case with Priceline.com Inc., for example, which buys airline tickets from the airlines before reselling them to customers. But AOL did not buy eBay's advertising inventory.

AOL said it was appropriate for it to book eBay's revenue as AOL's own in part because the advertiser contracted directly with AOL, AOL set the price and received payment directly from the advertiser. AOL said eBay's accounting for the deal -- booking only the net payments -- shows that the company also viewed AOL as a principal.

Several accounting experts, however, said that those factors may not be sufficient for AOL to properly book eBay's ad sales as AOL's own ad revenue. They said the appropriate accounting largely hinged on the amount of financial risk AOL assumed in the transaction.

An internal company document shows that AOL carried no financial penalty if it did not sell eBay's ads, and AOL confirmed this. According to the document, AOL had a nonbinding, informal commitment to reach certain ad sales targets for eBay over two quarters.

In the document, AOL projected it might have to pay eBay $40 million to $45 million in the second half of 2001 "if AOL makes ad purchases on eBay to reach the targets." AOL did not respond to The Post's question about how much of that amount it paid eBay. AOL said that another factor that showed it was the principal in the deal was that it shared "credit risk" with eBay. AOL would not explain how it shared that risk.

Several experts said that sharing the credit risk may not be enough for AOL to be considered the principal in the transaction and properly book all of eBay's revenue as its own.

If AOL had been contractually obligated to pay eBay for the full price of the ads when an advertiser failed to pay, then AOL could have been considered the principal and booked eBay's revenue, these experts said. But in its letter, AOL said it was not contractually obligated in this way.

"It seems to me AOL is not taking any of the normal risks of a merchant and, therefore, the situation seems more similar to the agent model where you should only book the margin or the net rather than the gross," said Bala Dharan, a Rice University accounting professor.

Michael Sutton, the SEC's chief accountant from 1995 to 1998, said, "This sounds more like an agency relationship than a principal relationship." An agent should book a commission, he said, not the gross sale, as AOL did.

O'Connor, the AOL executive who left the company in March, said he told company officials he was concerned that the accounting might lead to an SEC investigation.

AOL, however, said that taking all the aspects of the deal into consideration, it was reasonable to conclude that it was the principal in the transaction and it rejected the experts' opinions, saying they didn't have all the information to make the proper determination. Ernst & Young, AOL's outside auditor, reviewed the transaction and confirmed its accounting.

The company also said the amounts of money involved were a fraction of the total ad and commerce revenue and not material to the company's business.

AOL's ad-repping deal continued into 2002. In exchange for the arrangement, according to sources and documents, eBay also agreed to extend from four to five years an agreement to buy ad space on AOL's service, a deal worth an additional $18.8 million, AOL confidential documents show. EBay declined to comment on the specifics of its business dealings with AOL.

Several accounting and legal experts said the way AOL treated the eBay deal and other transactions raised broader questions about how the company was explaining its business to the public.

As with other conglomerates, AOL has been under mounting scrutiny as investors have lost confidence in corporate America's books. AOL is now being pushed by Wall Street to disclose more about how it earns its revenue and accounts for its expenses.

Accounting experts said a public company has a fundamental obligation to do its best to offer a fully formed picture of its operations. Did AOL provide enough information when it began to identify weakness in its dot-com advertising business?

Dharan, the Rice University professor, said the company did not. "They were representing something to investors," he said, "that was different from what was going on inside."


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