Advertising Expenditures Can Be Capitalized ... Well at Least Sometimes
Kreuze, Jerry G., Pung, Joseph G., The National Public Accountant
The tobacco industry presently is under attack for its influence on youth. Advertising plays a vital role in that influence. In fact, the tobacco industry is second only to the automobile industry in annual spending on advertising. And it is this advertising, contend opponents, that is especially enticing to youth. The tobacco industry advertising debate acknowledges that advertising can be very effective in enhancing sales levels, both in current and future periods. The fact that annually more than $100 billion is spent by corporations on advertising seems to indicate that the benefits are real. Information Resources, Inc., a Chicago-based market research firm, believes that "you can an quantify with a 90% confidence level that certain sales increments are attributable to specific investments in advertising."(1)
Considerable debate among the accounting profession has ensued regarding the propriety of capitalizing advertising expenditures. Proponents argue that advertising expenditures create probable future economic benefits that are controlled by the enterprise, and thus those expenditures meet the definition of an asset, as contained in Statement of Financial Accounting Concepts No.6, "Elements of Financial Statements." Opponents argue that the benefits from advertising are uncertain, are not measurable with reasonable accuracy, and therefore should be expensed as incurred.
The purpose of this paper is not to discuss the propriety of selected advertising nor to rehash the capitalization versus expensing arguments. Rather the paper summarizes existing pronouncements dealing with the accounting for advertising expenditures and highlights their inconsistencies. In general, the form of advertising and the specific industry doing the advertising determine the proper method of accounting for these expenditures.
Form of Advertising
AICPA Statement of Position (SOP) No. 93-7, "Reporting on Advertising Costs," issued in December 1993, provides broad accounting guidance for advertising expenditures. With SOP 93-7, the form of the advertising is the determining factor in its prop.er accounting. That is, SOP 93-7 segregates all advertising into two forms: direct-response advertising and all others.
With direct-response advertising, the incremental direct costs of the advertising incurred are capitalized if the primary purpose of the advertising was to elicit sales to customers who specifically responded to the advertising and the advertising resulted in probable future benefits.
The amount capitalized includes the incremental direct cost of the advertising incurred in transactions with third parties (e.g., costs of idea development, writing advertising copy, artwork, printing, magazine space and mailing) and the portion of employees' total compensation and payroll-related fringe benefits for the time spent performing direct response advertising activities. To satisfy the requirements of linking customers and probable economic benefits to specific direct-response advertising, a means of documenting that response is required. Customers, for example, can be matched to the advertising campaign through files containing customer names; coded order forms, coupons, or response cards; and a log of customers who made phone calls to a number appearing in an advertisement, linking those calls to the advertisement. Probable future benefits requires persuasive evidence verifying that this advertising campaign is similar to past campaigns of the entity which resulted in future benefits.
Once the advertising cost has met the capitalization criteria, it must be amortized over the estimated period benefited on a cost-pool-by-cost-pool basis. The amortization amount is the ratio that the current period revenues for the direct-response advertising cost-pool bear to the total of current and estimated future period revenues for that direct-response advertising cost-pool. …