| Summary of Significant Accounting Policies | 2. Summary of significant accounting policies
Basis of presentation
The accompanying unaudited interim condensed consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP) and include the accounts of the Company and its controlled subsidiaries. These interim condensed consolidated financial statements are stated in U.S. dollars, except for amounts otherwise indicated . Intercompany transactions and balances with subsidiaries have been eliminated for consolidation purposes.
Substantially all net revenues, cost of net revenues and operating expenses, are generated in the Company’s foreign operations. Operating (loss) income of foreign operations amounted to 98.7% and 98.8% of the con solidated amounts during the three -month periods ende d March 31 , 201 8 and 201 7, respectively . Long-lived assets, i ntangible assets and g oodwill located in the foreign jurisdictions totaled $233,096 thousands and $ 223,134 thousands as of March 31 , 201 8 and December 31, 201 7 , respectively.
These interim condensed consolidated financial statements reflect the Company’s consolidat ed financial position as of March 31 , 201 8 and December 31, 201 7 . These financial statements include the Company’s consolidated statements of income and comprehensive income for the three-month periods ended March 31 , 201 8 and 201 7 and sta tement of cash flows for the three-month periods ended March 31 , 201 8 and 201 7 . These interim condensed consolidated financial statements include all normal recurring adjustments that management believes are necessary to fairly state the Company’s financial position, operating results and cash flows.
Because all of the disclosures required by U.S. GAAP for annual consolidated financial statements are not included herein, these unaudited interim condensed financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto for the year ended December 31, 201 7 , contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”). The condensed consolidated statements of income, of comprehensive income and of cash flows for the periods presented herein are not necessarily indicative of results expected for any future period. For a more detailed discussion of the Company’s significant accounting policies, see note 2 to the financial statements in the Company ’s Form 10-K for the year ended December 31, 2017 . During the three-month period ended March 31, 2018, there were no material updates made to the Company’s significant accounting policies , except for the adoption of ASC 606 and ASU 2016-16- Income taxes (Topic 740) as of January 1, 2018. S ee Note 2 of these interim condensed consolidated financial statements for more details.
Revenue recognition
Revenues are recognized when control of the promised services is transferred to customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those services.
Contracts with customers may include promises to transfer multiple services including discounts on future services. Determining whether services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment.
Revenues are recognized when each performance obligation is satisfied by transferring the promised service to the customer according to the following criteria described for each type of service:
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Revenues from the Enhanced Marketplace service, include the final value fees and shipping fees charged to the Company’s customers. Because the Company acts as an agent, revenues derived from the shipping services are presented net of the respective transportation costs charged by third-party carriers and paid by the Company. As part of the Company ’s b usiness strategy, shipping costs may be fully or partially subsidized at the Company’s option.
·
Revenues from the Non-Marketplace services are generated from payments fees, classifieds fees, ad sales up-front fees; and fees from other ancillary businesses.
Revenue recognition criteria for the services mentioned above are decribed in note 2 to the consolidated financial statements in the Company’s Form 10-K for the year ended December 31, 2017.
Contract Balances
Timing of revenue recognition may differ from the timing of invoicing to customers. Receivables represent amounts invoiced and revenue recognized prior to invoicing when the Company has satisfied the performance obligation and ha s the unconditional right to payment. The allowance for doubtful accounts, loan receivables and chargebacks is estimated based upon our assessment of various factors including historical experience, the age of the accounts receivable balances, current economic conditions and other factors that may affect our customers’ ability to pay. The allowance for doubtful accounts, loan receivables and chargebacks was $27,644 thousands and $19,734 thousands as of March 31, 2018 and December 31, 2017, respectively.
Deferred revenue consists of fees received related to unsatisfied performance obligations at the end of the period in accordance with ASC 606 (as defined below). Due to the generally short-term duration of contracts, the majority of the performance obligations are satisfied in the following reporting period. Deferred revenue as of December 31, 2017 and 2016 was $6,116 thousands and $1,955 thousands, respectively, of which $4,316 thousands and $1,911 thousands were recognized as revenue during the three-months periods ended March 31, 2018 and 2017, respectively.
As of March 31, 2018, total deferred revenue was $7,546 thousands, mainly due to fees related to listing and optional feature services billed and loyalty programs that are expected to be recognized as revenue in the coming months.
Foreign currency translation
All of the Company’s consolidated foreign operations have determined the local currency to be their functional currency. Accordingly, these foreign subsidiaries translate assets and liabilities from their local currencies into U.S. dollars by using period-end exchange rates while income and expense accounts are translated at the average rates in effect during the period, unless exchange rates fluctuate significantly during the period, in which case the exchange rates at the date of the transaction are used. The resulting translation adjustment is recorded as a component of other comprehensive (loss) income.
Venezuelan deconsolidation
Effective December 1, 2017, the Company determined that deteriorating conditions in Venezuela had led the Company to no longer meet the accounting criteria for control over its Venezuelan subsidiaries. Venezuela’s recent selective default determination, restrictive exchange controls and suspension of foreign exchange market in Venezuela, the lack of access to U.S. dollars through official currency exchange mechanisms together with the worsening in Venezuela macroeconomic environment resulted in other-than-temporary lack of exchangeability between the Venezuela bolivar and the U.S. dollar, and restricted the Company’s ability to pay dividends and its ability to satisfy other obligations denominated in U.S. dollars. Therefore, in accordance with the applicable accounting standards, as of December 1, 2017, the Company deconsolidated the financial statements of its subsidiaries in Venezuela and began reporting the results under the cost method of accounting.
Beginning December 1, 2017, the Company no longer includes the results of the Venezuelan subsidiaries in its consolidated financial statements.
Income tax
The Company is subject to U.S. and foreign income taxes. The Company accounts for income taxes following the liability method of accounting which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Deferred tax assets are also recognized for tax loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets or liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded when, based on the available evidence, it is more likely than not that all or a portion of the Company’s deferred tax assets will not be realized. The Company’s income tax expense consists of taxes currently payable, if any, plus the change during the period in the Company’s deferred tax assets and liabilities.
On August 17, 2011, the Argentine government issued a new software development law and on September 9, 2013 a regulatory decree was issued that established new requirement s to benefit from the new software development law. The decree establishes requirements to comply with annual incremental ratios related to exports of services and research and development expenses that must be achieved to remain within the tax holiday. The Company’s Argentine subsidiary has to achieve certain required ratios annually under the software development law in order to be eligible for the benefits mentioned below.
On September 17, 2015, the Argentine Industry Secretary issued Resolution 1041/2015 approving the Company’s application for eligibility under the new software development law for the Company’s Argentine subsidiary, Mercadolibre S.R.L. As a result, the Company’s Argentine subsidiar y ha s been granted a tax holiday retroactive from September 18, 2014. A portion of the benefits obtained is a 60% relief of total income tax related to software development activities and a 70% relief of payroll taxes related to software development activities.
The benefits to the Company under the software development law will expire on December 31, 2019. As a result of the Company’s eligibility under the new law, it recorded an income tax benefit of $7,299 thousands and $5,097 thousands during the three-month periods ended March 31, 2018 and 2017, respectively. Aggregate per share effect of the Argentine tax holiday amounted to $0.17 and $0.12 for the three -month periods ended March 31, 2018 and 2017, respectively. Furthermore, the Company recorded a labor cost benefit of $2,016 thousands and $1,991 thousands during the three-month periods ended March 31 , 201 8 and 2017 , respectively. Additionally, $652 thousands and $496 thousands were accrued to pay software developme nt law audit fees during the first quarter of 2018 and 2017, respectively.
Tax reform
Argentina
On December 27, 2017, the Argentine Senate approved a comprehensive income tax reform effective since January 1, 2018. The Argentine tax reform, among other things, reduced the prior 35 percent income tax rate applicable to the Argentine entities to 30 percent for 2018 and 2019 and to 25 percent for 2020 and thereafter. The new regulation imposes a withholding income tax on dividends paid by Argentine entities of 7 percent for 2018 and 2019, increasing to 13 percent from 2020 forward. The new regulation also repeals the “equalization tax” (i.e., the prior 35 percent withholding tax applicable to dividends distributed in excess of the accumulated taxable income) for income accrued from January 1, 2018 forward.
USA
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act made broad and complex changes to the U.S. tax code, including, but not limited to, (1) requiring a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries that is payable over eight years and (2) bonus depreciation that will allow for full expensing of qualified property.
The Tax Act also established new tax laws that came into effect on January 1, 2018, including, but not limited to: (a) the elimination of the corporate alternative minimum tax (AMT); (b) the creation of the base erosion anti-abuse tax (BEAT), a new minimum tax; (c) a general elimination of U.S. federal income taxes on dividends from foreign subsidiaries; (d) a new provision designed to tax global intangible low-taxed income (GILTI), which allows for the possibility of using foreign tax credits (FTCs) and a deduction of up to 50 percent to offset income tax liability (subject to some limitations); (e) a new limitation on deductible interest expense; (f) the repeal of the domestic production activity deduction; (g) limitations on the deductibility of certain executive compensation; (h) limitations on the use of FTCs to reduce the U.S. income tax liability; and (i) limitations on net operating losses (NOLs) generated after December 31, 2017, to 80 percent of taxable income.
The Deemed Repatriation Transition Tax (Transition Tax) is a tax on previously untaxed accumulated and current earnings and profits (E&P) of certain of our foreign subsidiaries. To determine the amount of the Transition Tax, the Company must determine, in addition to other factors, the amount of post-1986 E&P of the relevant subsidiaries, as well as the amount of non-U.S. income taxes paid on such earnings. The company was able to make a reasonable estimate of the Transition Tax and determine that no tax duty related to the Transition Tax is expected to be due because the estimated tax is expected to be offset with available foreign tax credits as of December 31, 2017. Accordingly, no adjustments have been made to income tax expense in 2017. The Transition Tax calculation will not be finalized until the MercadoLibre Inc. Federal Income Tax return is filed.
The Company assessed whether its valuation allowance analysis is affected by various aspects of the Tax Act (including the deemed repatriation of deferred foreign income, GILTI inclusions and new categories of FTCs). As a consequence of such analysis, the Company recorded an increase in valuation allowance of $12,097 thousands to fully reserve the outstanding foreign tax credits as of December 31, 2017.
The Tax Act created a new requirement that certain income (i.e., GILTI) earned by controlled foreign corporations (CFCs) must be included in the gross income of the CFCs’ U.S. shareholder. GILTI is the excess of the shareholder’s “net CFC tested income” over the net deemed tangible income return, which is currently defined as the excess of (1) 10 percent of the aggregate of the U.S. shareholder’s pro rata share of the qualified business asset investment of each CFC with respect to which it is a U.S. shareholder over (2) the amount of certain interest expenses taken into account in the determination of net CFC-tested income.
Under U.S. GAAP, the Company was allowed to make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (the “period cost method”) or (2) factoring such amounts into a company’s measurement of its deferred taxes (the “deferred method”). The Company selected the period cost method. Accordingly, the Company has not recorded any impact in connection with the potential GILTI tax as of March 31, 2018 and December 31, 2017.
The Company’s management considers the earnings of our foreign subsidiaries to be indefinitely reinvested, other than certain earnings the distributions of which do not imply withholdings, exchange rate differences or state income taxes, and for that reason has not recorded a deferred tax liability.
As of March 31 , 201 8 and December 31, 201 7 , the Company had included under non-current deferred tax assets the foreign tax credits related to the dividend distributions received from its subsidiaries for a total amount of $12,117 thousands and $12,097 thousands, respectively. As of March 31, 2018 and December 31, 2017, the Company recorded a valuation allowance of $12,117 thousands and $12,097 thousands, respectively, to fully impair the outstanding foreign tax credits.
Accumulated other comprehensive loss
The following table sets forth the Company’s accumulated oth er comprehensive loss as of March 3 1 , 201 8 and December 31, 201 7 :
March 31,
December 31,
2018
2017
(In thousands)
Accumulated other comprehensive loss:
Foreign currency translation
$ (299,220)
$ (283,647)
Unrealized losses (gains) on investments
(24)
1,211
Estimated tax loss on unrealized gains on investments
—
(415)
$ (299,244)
$ (282,851)
The following tables summarize the changes in accumulated balances of other comprehensive loss for the three-month period ended March 3 1 , 201 8 :
Unrealized
Foreign
Estimated tax
(Losses) Gains on
Currency
(expense)
Investments
Translation
benefit
Total
(In thousands)
Balances as of December 31, 2017
$ 1,211
$ (283,647)
$ (415)
$ (282,851)
Other comprehensive loss before reclassifications adjustments for losses on available for sale investments
(24)
(15,573)
—
(15,597)
Amount of loss (gain) reclassified from accumulated other comprehensive loss
(1,211)
—
415
(796)
Net current period other comprehensive loss / income
(1,235)
(15,573)
415
(16,393)
Ending balance
$ (24)
$ (299,220)
$ —
$ (299,244)
Amount of (Loss) Gain
Reclassified from
Details about Accumulated
Accumulated Other
Other Comprehensive Loss
Comprehensive
Affected Line Item
Components
Loss
in the Statement of Income
(In thousands)
Unrealized gains on investments
$ 1,211
Interest expense and other financial gains
Estimated tax gain on unrealized losses on investments
(415)
Income tax loss
Total reclassifications for the period
$ 796
Total, net of income taxes
Use of estimates
The preparation of interim condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates are used for, but not limited to accounting for allowance s for doubtful accounts , loan receivables and chargebacks , recoverability of goodwill and intangible assets with indefinite useful life, useful life of long-lived assets and intangible assets, impairment of short-term and long-term investments, impairment of long-lived assets, compensation costs relating to the Company’s long term retention plan, fair value of convertible note debt, fair value of investments, recognition of income taxes and contingencies. Actual results could differ from those estimates.
Recently Adopted Accounting Standards
Effective January 1, 2018, the Company adopted ASC 606 – Revenue from Contract s with Customers related to revenue recognition (“ ASC 606 ”) issued by the Financial Accounting Standards Board (“FASB”) in 2014. ASC 606 provides a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. The Company adopted ASC 606 using the full retrospective transition method and recast the prior reporting period presented.
In connection with the MercadoEnvios service the Company ha s identified a performance obligation with the seller to arrange for the transportation of the merchandise sold to the buyer using third-party carriers. As the Company act s as agent, upon adoption of ASC 606 , the revenues derived from the shipping services are presented net of the respective transportation costs charged by third-party carriers and paid by the Company. As part of the business strategy, the Company may fully or partially subsidize the cost of shipping at the Company’s option. Under the current guidance the Company must account for the subsidized cost of shipping netting of revenues rather than as cost of net sales. For the three - month periods ended March 31, 2018 and 2017, the Company incurred $112,497 thousands and $4,251 thousands , respectively, of subsidized shipping costs that have been incurred and included as a reduction of revenues.
Under the full retrospective method, the Company retrospectively applied ASC 606 to the three-month period ended March 31, 2017. The total impact resulting from the change in presentation of shipping subsidies was a decrease in Net revenues and Cost of net revenues of $4 ,251 thousands in the Interim Condensed Consolidated Statement of Income for the three-m onth period ended March 31, 2017 . Additionally, the adoption of ASC 606 did not modify the carrying amount of assets or liabilities as of the beginning of the first period presented, thus, there was no effect on the opening balance of retained earnings as of January 1, 2017.
Furthermore, the adoption did not have a material impact on the Consolidated Balance Sheets as of March 31, 2018 and December 31, 2017 , on Net (loss) income and on the Statements of Cash Flows for the three-month periods ended March 31, 2018 and 2017.
In October 2016, the FASB issued Accounting Standards Update No. 2016-16 (ASU 2016-16) "Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other than Inventory." ASU 2016-16 generally accelerates the recognition of income tax consequences for asset transfers between entities under common control. The Company adopted ASU 2016-16 as of January 1, 2018 using a modified retrospective transition method, resulting in a $2,092 thousands increase to the opening balance of retained earnings .
Recently issued accounting pronouncements not yet adopted
On February 25, 2016 the FASB issued ASU 2016-02. The amendments in this update create Topic 842, Leases, which supersedes Topic 840, Leases. The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. Previous GAAP did not require lease assets and lease liabilities to be recognized for most leases. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. Topic 842 retains a distinction between finance leases and operating leases. The classification criteria for distinguishing between finance leases and operating leases are substantially similar to the classification criteria for distinguishing between capital leases and operating leases in the previous leases guidance. The result of retaining a distinction between finance leases and operating leases is that under the lessee accounting model in Topic 842, the effect of leases in the statement of comprehensive income and the statement of cash flows is largely unchanged from previous GAAP. Based on existing leases currently classified as operating leases, the Company expects to recognize on the statements of financial position right-of-use assets and lease liabilities. The amendments in this update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is assessing the effects that the adoption of this accounting pronouncement may have on the Company’s financial statements and expects the ASU will have a material impact, primarily to the consolidated balance sheets and related disclosures.
On June 16, 2016 the FASB issued the ASU 2016-13 “Financial Instruments-Credit Losses (Topic 326): Measurement of credit losses on financial instruments”. This update amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. For assets held at amortized cost basis, this update eliminates the probable initial recognition threshold in current GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses. For available for sale debt securities, credit losses should be measured in a manner similar to current GAAP, however this topic will require that credit losses be presented as an allowance rather than as a write-down. The new standard is effective for fiscal years beginning after December 1 5, 2019. The Company is assessing the effects that the adoption of this accounting pronouncement may have on its financial statements.
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