When Should Advertising Be Capitalized?

Article excerpt

The IRS and FASB have specific guidelines companies should follow.

EXECUTIVE SUMMARY

* THE QUESTION OF WHEN TO CAPITALIZE ADVERTISING costs has long presented a problem for CPAs. While the easy solution is for companies to expense advertising as it is incurred, both the IRS and FASB say in some circumstances it should be capitalized.

* THE MOST FORMIDABLE BARRIER A COMPANY FACES to taking a tax deduction for advertising expenditures is the 1992 Indopco decision. The IRS has not, however, been very aggressive in applying Indopco to advertising, announcing in revenue ruling 92-80 that the decision would not affect a company's ability to deduct advertising under IRC section 162(a).

* IN THE 1998 RJR NABISCO CASE, THE IRS distinguished between the costs of developing advertising campaigns and the costs of executing them. The IRS argued that campaign development costs created long-term benefits for a particular brand of cigarettes. The Tax Court found the position in conflict with several Treasury regulations.

* FOR FINANCIAL REPORTING PURPOSES, THE PROBLEM CPAs face with advertising expenditures is whether a future economic benefit exists. SOP 93-7 provides guidance on how to account for advertising expenditures and says costs should generally be expensed either as they are incurred or the first time the advertising takes place.

* SOME FASB PRONOUNCEMENTS GIVE CPAs GUIDANCE on reporting advertising costs for specific items or industries. Some of the affected industries include cable television, lenders, insurance companies and real estate entities.

Should you or shouldn't you? Tax and accounting authorities acknowledge that it is difficult for CPAs to establish criteria about when a company should capitalize advertising costs. Many suggest that the reasonable solution is for a company to expense advertising as it is incurred. Despite this, both the IRS and FASB believe it is possible to identify circumstances in which companies should capitalize advertising. Complicating the tax picture, recent IRS rulings and court briefs send conflicting signals. For financial reporting purposes, FASB generally sets limited criteria for capitalization but allows some exceptions for specific industries. CPAs responsible for deciding how to handle a particular advertising expenditure may find this review of the current tax and accounting rules will help them make choices in the gray areas.

MEASURING INTANGIBLES

The most formidable barrier a company faces to taking a tax deduction for advertising expenditures is the significant long-term benefit criterion, a qualifier round an the Indopco decision (503 U.S. 79, 87 [1992]). Some advertising undoubtedly creates for a company significant benefits that extend beyond the current tax year, so the crucial issue CPAs face is not whether long-term benefits exist but how to measure them. Although the IRS has not been shy about using Indopco to require a company to capitalize expenditures in some areas, it also has sought to allay fears in the business community that Indopco will lead to increased scrutiny of advertising expenditures.

In revenue ruling 92-80, 1992-2 C.B. 57, the IRS announced that Indopco would not affect a company's ability to deduct advertising under IRC section 162(a). So even if a company's advertising has a future impact, as is the case with institutional or goodwill advertising, the IRS has elected not to use Indopco as a precedent. The IRS has not said it is allowing a deduction because of the difficulty of separating current from future benefits. Even if advertising is directed solely at future patronage or goodwill, a company can still deduct the cost, unless the future benefits are significantly beyond those of normal advertising.

The U.S. Supreme Court previously held in Lincoln Savings and Loan Association (71-1 USTC 9476, 403 U.S. 345,554 [1971]) that businesses must capitalize expenditures that create or enhance a separate and distinct asset. …