With the end of another year approaching, businesses are busy focusing on their new goals for the coming New Year, and are often spending on items that will help them kick off next year with a bang.
As a result, accounting professionals are confronted with making decisions to determine the period in which expenses are to be included in the profit and loss statement. For example, if a company incurs marketing costs in designing a marketing promotion in December, 2011, but the actual marketing program does not kick off until March, 2012, when should the costs be included in the P&L as expenses?
Accountants look to the guidance that comprises Generally Accepted Accounting Principles (“GAAP”) to make that decision. Under GAAP, the marketing expenses described above are considered to be “other expenses”.
The GAAP literature speaks specifically to advertising expenses, which are considered to be a subset of marketing. The guidance speaks to two kinds of advertising. First is the cost of producing advertising (designing the campaign, the collateral material, the media storyboard, etc.), and the second type is the actual cost of communicating or distributing the advertising. In the marketing example above, the costs that we are discussing are the costs of producing the marketing.
The business should charge cost of producing the marketing to expense as it is incurred, no matter when the actual marketing campaign with which it is associated occurs.
Under GAAP, a company should treat sales materials as prepaid supplies. The business would record the costs as an asset and subsequently charge the costs to expense as the company uses them. When the business stops distributing sales materials, they charge the remainder to the P&L as an expense. This is very cumbersome, and generally, small businesses don’t really do this. Why? Because no one keeps a good count as to how many brochures and catalogs are in stock. To do so would require someone to stop whatever they’re doing in the middle of a monthly close and do a physical count of these items. Sometimes sales material and brochures hang around for years, so what should the small business do?
The best advice is to just charge the materials to expense as soon as the company buys them, unless the business is spending a massive amount on these materials.
Regarding the cost of communicating the advertising, a business can charge it to an expense account as the costs are incurred, or the company can post it as an asset (prepaid advertising) and expense the amount when the first advertising takes place. Either way, the company needs to be consistent in which method is used.
Many small businesses rely on direct mail advertising campaigns. With these campaigns, the business contacts carefully targeted prospects with custom tailored offers or promotional material (such as brochures, circulars, letters, newsletters) on a one-to-one basis via ordinary mail or email. In the US, direct mail advertising is one of the largest advertising mediums, totaling over $50 billion spent per year.
A small business using a direct mail campaign can record this as an asset, but only if the company can prove the relationship between the costs incurred and the future benefits to be derived from the particular mailing. To prove it, the business would have to use historical results from the products or similar products. If the company can’t prove that it can specifically generate revenue, then the business must record the cost to expense right away.
If the company can prove a relationship, they would record the direct campaign costs as an asset and then charge it to expense as revenue comes from the campaign. To do so, they should include something like an offer code or a coupon code to track the revenue. This calls for more paperwork and effort.
This all leads to the question as to whether it’s worth all that grief to defer the cost of a direct mail campaign by a month or two. Of course, as in many judgment decisions in accounting, it depends. The obvious and simple reaction is that it is not worth the aggravation. The business should just charge the cost to expense when incurred (especially if the cost isn’t that high). However, if the company is in the direct mail business, or if not following the GAAP rules could have a material effect on income statements, by all means they should follow the methodology. Also, if a business is already following this rule, then they should continue to do so to be consistent with their methodology.Written by: Steve Arman TGG Accounting