Question

John is a CPA employed with a retail firm. He is currently preparing the firm’s quarterly financial statements for the three month period ending September 30th 2017.

"During the months of July and August, the firm spent millions of dollars on advertising. These costs have been debited to advertising expense. The company’s chief financial officer asks John to prepare a September 30th adjusting entry to credit advertising expense and debit an account called prepaid advertising for the amount of money spent on advertising during the quarter. The CFO explains:

“Money spent on advertising is an asset because it boosts future revenue, and therefore matching expenses to revenues (the matching principle) requires that advertising expenditure be expensed in a future period when the relevant future revenues are recognized. If we expense advertising expenditure in the same period as it is incurred, we will show an operating loss on our income statement for the quarter. Our bonuses are at stake.”

Provide your responses to the following questions.

1. When are expenditures on advertising to be expensed, per GAAP?

2. Is the CFO’s position consistent with GAAP?

3. Who will be hurt if John accepts the CFO’s position?

4. Who will benefit if John accepts the CFO’s position?

5. What should John do?

Answer 1

1. As per matching principle of GAAP, expenses are to be matched with the period in which the corresponding revenue is earned. However, it is not possible to attribute the benefit of advertising to the future period. Therefore, the advertising expense should be written down completely in the period in which it is incurred. Hence , the CFO is not correct is treating unamortized advertising expense as a fictitious asset.

2. No, CFO's position is not consistent with GAAP.

3. GAAP principles and investors will be hurt if John accepts CFO's position since the accounts will not present true and fair position of the entity.

4. CFO and John himself will benefit in terms of bonus and presenting better profits and position of the Company.

5. John should follow GAAP and write off the advertising expenditure in the period in which it is incurred.