Question

ETHICAL DILEMMA

You have recently been employed by a large retail chain that sells sporting goods. One of your tasks is to help prepare financial statements for external distribution. The chain's largest creditor, National Savings & Loan, requires that financial statements be prepared according to generally accepted accounting principles (GAAP). During the months of November and December 2012, the company spent $1 million on a major TV advertising campaign. The $1 million included the costs of producing the commercials as well as the broadcast time purchased to run them. Because the advertising will be aired in 2012 only, you decide to charge all the costs to adver- tising expense in 2012, in accordance with requirements of GAAP The company's chief financial officer (CFO), who hired you, asks you for a favor. Instead of charging the costs to advertising expense, he asks you to set up an asset called prepaid advertising and to wait until 2013 to record any expense. The CFO explains, "This ad campaign has produced significant sales in 2012; but I think it will continue to bring in customers throughout 2013. By recording the ad costs as an asset, we can match the cost of the advertis- ing with the additional sales in 2013. Besides, if we expense the advertising in 2012, we will show an operating loss in our income statement. The bank requires that we continue to show profits in order to maintain our loan in good standing. Failure to remain in good standing could mean we'd have fire some of our recent hires." What should you do?

Answer 1

Advertising is any communications with a target audience that is designed to persuade that audience to take some type of action, such as buying a product or service. Advertising can also be intended to build awareness of an industry or brand.

You can record an advertising expense as an asset when there is a reliable and demonstrated relationship between total costs and future benefits resulting directly from the incurrence of those costs.

For example, an entity has evidence that, if it sends out 20,000 pieces of direct-mail advertising, it will receive 250 responses. Thus, the cost of obtaining 250 responses is the cost incurred to send out the 20,000 mailings. With such information, an entity can use historical information to make reliable predictions about the relationship between current expenditures required to obtain future revenue.

If such historical information is available, then accrue advertising costs and charge them to expense when you recognize the related revenue.

If the advertising expenditures are for direct-response advertising, record the expenditures as an asset only if the situation meets both of the following criteria:

1. The primary purpose of the advertising is to generate sales from customers who can be shown to have responded specifically to the advertising. You must be able to document customer responses, specifying the name of the customer and the advertising that elicited the response (such as a coded order form or response card).

2. The advertising activity results in probable future revenues that exceed future costs incurred to realize the revenues, which can be proven with verifiable historical patterns of results for the entity. If there is no operating history for a new product or service, an entity can use as proof statistics for other products and services for which statistics can be highly correlated. Industry statistics are not considered sufficiently objective evidence.

In the given case, there is no such records available which shows the direct relationship between advertisement expenses & the revenue. It is just an assumption of the CFO that the revenue will be generated in 2013 from the advertisement aired in 2012.

Therefore, as per GAAP, I will record whole advertisement expenditure in 2012.