Page/Link:Page URL:HTML link:The Free Library. Retrieved Sep 01 2019 fromThe IRS and FASB have specific guidelines companies should follow.EXECUTIVE SUMMARY. THE QUESTION OF WHEN TO CAPITALIZE ADVERTISING costs has longpresented a problem for CPAs. While the easy solution is for companiesto expense advertising as it is incurred, both the IRS and FASB say insome circumstances it should be capitalized. THE MOST FORMIDABLE BARRIER A COMPANY FACES to taking a taxdeduction for advertising expenditures is the 1992 Indopco decision. TheIRS has not, however, been very aggressive in applying Indopco toadvertising, announcing in revenue ruling 92-80 that the decision wouldnot affect a company's ability to deduct advertising under IRC section 162(a). IN THE 1998 RJR NABISCO CASE, THE IRS distinguished between thecosts of developing advertising campaigns and the costs of executingthem.
The IRS argued that campaign development costs created long-termbenefits for a particular brand of cigarettes. The Tax Court found theposition in conflict with several Treasury regulations.
FOR FINANCIAL REPORTING PURPOSES, THE PROBLEM CPAs face withadvertising expenditures is whether a future economic benefit exists.SOP 93-7 provides guidance on how to account for advertisingexpenditures and says costs should generally be expensed either as theyare incurred or the first time the advertising takes place. SOME FASB PRONOUNCEMENTS GIVE CPAs GUIDANCE on reportingadvertising costs for specific items or industries. Some of the affectedindustries include cable television, lenders, insurance companies andreal estate entities. Should you or shouldn't you? Tax and accounting authoritiesacknowledge that it is difficult for CPAs to establish criteria aboutwhen a company should capitalize advertising costs.
Many suggest thatthe reasonable solution is for a company to expense advertising as it isincurred. Despite this, both the IRS and FASB believe it is possible toidentify circumstances in which companies should capitalize advertising.Complicating the tax picture, recent IRS rulings and court briefs sendconflicting signals. For financial reporting purposes, FASB generallysets limited criteria for capitalization but allows some exceptions forspecific industries. CPAs responsible for deciding how to handle aparticular advertising expenditure may find this review of the currenttax and accounting rules will help them make choices in the gray areas.MEASURING INTANGIBLESThe most formidable barrier a company faces to taking a taxdeduction for advertising expenditures is the significant long-termbenefit criterion, a qualifier round an the Indopco decision (503 U.S.79, 87 1992). Some advertising undoubtedly creates for a companysignificant benefits that extend beyond the current tax year, so thecrucial issue CPAs face is not whether long-term benefits exist but howto measure them. Although the IRS has not been shy about using Indopcoto require a company to capitalize expenditures in some areas, it alsohas sought to allay fears in the business community that Indopco willlead to increased scrutiny of advertising expenditures.In revenue ruling 92-80, 1992-2 C.B.
57, the IRS announced thatIndopco would not affect a company's ability to deduct advertisingunder IRC section 162(a). So even if a company's advertising has afuture impact, as is the case with institutional or goodwilladvertising, the IRS has elected not to use Indopco as a precedent. TheIRS has not said it is allowing a deduction because of the difficulty ofseparating current from future benefits. Even if advertising is directedsolely at future patronage or goodwill, a company can still deduct thecost, unless the future benefits are significantly beyond those ofnormal advertising.The U.S. Supreme Court previously held in Lincoln Savings and LoanAssociation (71-1 USTC 9476, 403 U.S. 345,554 1971) that businessesmust capitalize expenditures that create or enhance a separate anddistinct asset. The Court strengthened this standard in Indopco, when itsaid the separate-and-distinct-asset standard is a sufficient though nota necessary condition for capitalization.
Interestingly, the IRS appearsto be reaching back to the earlier and weaker standard in the positionsit has taken recently. The likely reason is that it is easier to draw aline in the sand using the separate and distinct test than it isapplying the significant long-term benefit test. Despite its apparentretreat, the IRS has not been very successful in sustaining thisposition in the courts. EXECUTIONIn a recent case, RJR Nabisco (76 TCM 71 1998), the IRSdistinguished between the costs of developing ad campaigns and the costsof executing them.
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In effect, the IRS argued that campaign developmentcosts (the image and message to be conveyed) created long-term benefitsfor a particular brand of cigarettes. In contrast, the costs ofexecuting the campaign, such as specific magazine ads to implement atheme, for example, should be currently deductible, according to theIRS. The commissioner's position was that developing a packagingdesign campaign enhanced a separate and distinct asset-brand equity.The Tax Court agreed that campaign development costs 'createdintangible assets that are inseparable from brand equity andgoodwill.' But the creation of such intangibles does not result ina deduction, because goodwill is traditionally a benefit associated withordinary business advertising.The primary problem the Tax Court had with the IRS position wasthat it conflicted with Treasury regulations sections 1.162-1(a) and1.162-20(a)(2) and revenue ruling 92-80. Goodwill, understood as'the expectancy of continued patronage,' is a traditionalbenefit of ordinary business advertising according to the IRS. Thus, theTax Court felt the IRS should be precluded from advancing a position inconflict with a recent revenue ruling.It appears the IRS might have been able to prevail without thoseself-imposed restrictions.
In an earlier case, the IRS convinced the TaxCourt that marketing costs a company incurs to create an intangibleasset should be capitalized. In Briarchiff Candy Corp. (31 TCM 1711972), the Tax Court held that the company's expenses to developsuburban markets for its products were 'not advertising directed atthe promotion of its product but advertising directed at establishingnew channels of distribution.' Thus, they should be capitalized.
Revenue Ruling 99-23,14 a ruling under Code Section 195. Code Section 195 allows amortization of start-up expenditures that “if paid or incurred in connection with the operation of an existing active trade or business. Would be allowable as a deduction for the taxable year in which paid or incurred.” The IRS, with support from.
Onappeal, however, the Second Circuit Court of Appeals found no authorityfor capitalizing a self-developed intangible asset. Developing newdistribution channels would not qualify under theseparate-and-distinct-asset test. The Second Circuit conceded that afuture benefit was created, but said the question was academic becausethe IRS was on record as saying creation of a marketing intangible was anormal benefit of product advertising.OUTSIDE THE ORDINARYThe IRS has ruled that advertising must be capitalized only inunusual circumstances where it is directed at obtaining future benefitsgreater than those associated with ordinary product advertising orinstitutional or goodwill advertising. The only example the IRS providedwas a claims court decision involving an electric company'sadvertising to allay public fears about nuclear power (ClevelandElectric Illuminating Co., 85-1 USTC 9128, 7 Cls Ct 220). The courtrequired the company to capitalize the expenditure because it believedCleveland Electric intended to obtain future benefits significantlybeyond normal product or goodwill advertising. Such a campaign is notproduct advertising and may not even represent goodwill advertising ifthat term is narrowly defined.
But it is difficult to see a meaningfuldistinction between promotions that tout a company's name and thosethat make the market friendlier for one of its products. It does nottake much imagination to see the IRS requiring companies to capitalizeany advertising directed at improving the bottom line but not directlyconnected to product promotion. Consider, for example, the currentcampaign major tobacco companies are waging to convince the public tooppose increased cigarette taxes.Tangible assets.
Expenses for advertising that produces tangibleassets are subject to capitalization. In Best Lock Corp. (31 TC 12171959), billboards, signs, display cabinets and a collage the companycreated to advertise building materials had to be capitalized. But thecourts have differed on whether a company must capitalize the costs ofdeveloping a sales catalog.
For more insight, CPAs can compare Best LockCorp. Sheldon and Co. (214 F.2d 655 CA-6.1954).ADVERTISING AS A START-UP COSTTo the extent advertising is classified as a start-up expenditure,companies are required to capitalize it. For example, a new businessthat buys ads to promote its opening should clearly capitalize the cost.However, an established company may find it difficult to distinguishexpanding the business from starting a new trade or business.In NCNB Corp. (1982-2 USTC 9469 CA-4, 1982) expenses the bankincurred to develop branch bank facilities were considered expendituresto expand an existing business. Another bank's advertising andstart-up costs related to handling MasterCard accounts were deductiblebecause the new system allowed the bank to carry on its old business ofmaking loans in a new way (Colorado Springs National Bank, 74-2 USTC9809 CA-10, 1974).
In the same vein, advertising and other costsassociated with expanding a line of restaurants through a preexisting subsidiary were deductible. (See LTR 8423005.) However, the IRS said amanufacturer of fragrances, cosmetics, clothing and accessories began anew trade or business when it opened its first retail outlet. The IRSrequired capitalization only on the company's first store, however,because the opening of subsequent retail stores was considered anexpansion of the company's existing business. (See LTR 9331001.)More recent developments indicate a changed mood. The IRS convincedthe Tax Court that mutual fund giant Fidelity should not be allowed todeduct initial costs, including marketing, of launching a new group offunds (FMR Corp.
And Subsidiaries v. Commissioner, 110 TC 30 1998;also see TAM 9825005).
A mutual fund opening more funds can clearly beconstrued as expanding an existing business under earlier reasoning.However, using the wide Indopco net, the Tax Court concluded thatcapitalization was proper because Fidelity's expenditures produceda significant future benefit. The IRS actions in the Fidelity case showit is not reluctant to use Indopco to force capitalization ofadvertising in a start-up context, although based on other cases it hasapparently decided to forego using the ruling to analyze otheradvertising expenditures. (For a summary of tax cases dealing withadvertising costs, see exhibit 1, page 51.)Exhibit 1: Tax Conflicts in Advertising CostsType of Expense/Advertising Capitalize Deciding FactorsFree samples Expense Court refused to allocateexpenditures between those tobuild up future business andthose to maintain currentbusiness.Free samples Capitalize Indecisive about whetherexpenditures were for goodwillor research/experimentation;expenditures had indeterminateuseful life.Catalog Expense Ordinary and necessarybusiness expense. Future benefitscould not be determined precisely.Indefinite useful life.Catalog Capitalize Taxpayer deducted preparationcosts incurred during thetwo tax years precedingpublication.
THE QUESTIONOF WHEN TO CAPITALIZE ADVERTISING costs has longpresented a problem for CPAs. While the easy solution is forcompanies to expense advertising as it is incurred, both theIRS and FASB say in some circumstances it should becapitalized.THE MOST FORMIDABLE BARRIER A COMPANY FACES to takinga tax deduction for advertising expenditures is the 1992Indopco decision.
The IRS has not, however, been veryaggressive in applying Indopco to advertising, announcing inrevenue ruling 92-80 that the decision would not affect acompany’s ability to deduct advertising under IRC section162(a).IN THE 1998 RJR NABISCO CASE, THE IRS distinguishedbetween the costs of developing advertising campaigns andthe costs of executing them. The IRS argued that campaigndevelopment costs created long-term benefits for aparticular brand of cigarettes. The Tax Court found theposition in conflict with several Treasury regulations.FOR FINANCIAL REPORTING PURPOSES,THE PROBLEM CPAs face with advertising expenditures iswhether a future economic benefit exists. SOP 93-7 providesguidance on how to account for advertising expenditures andsays costs should generally be expensed either as they areincurred or the first time the advertising takes place.SOME FASB PRONOUNCEMENTS GIVE CPAs GUIDANCE onreporting advertising costs for specific items orindustries. Some of the affected industries include cabletelevision, lenders, insurance companies and real estateentities.LARRY MAPLES,CPA, DBA, is professor of accounting at TennesseeTechnological University, Cookeville.
His e-mail address is.MELANIE EARLES, CPA, DBA, is assistant professor of accountingat Tennessee Technological University. Her e-mail address is.S hould you or shouldn't you?
Taxand accounting authorities acknowledge that it is difficult for CPAsto establish criteria about when a company should capitalizeadvertising costs. Many suggest that the reasonable solution is fora company to expense advertising as it is incurred. Despite this,both the IRS and FASB believe it is possible to identifycircumstances in which companies should capitalize advertising.Complicating the tax picture, recent IRS rulings and court briefssend conflicting signals. For financial reporting purposes, FASBgenerally sets limited criteria for capitalization but allows someexceptions for specific industries. CPAs responsible for decidinghow to handle a particular advertising expenditure may find thisreview of the current tax and accounting rules will help them makechoices in the gray areas.MEASURING INTANGIBLESThe most formidable barrier a company faces to taking a taxdeduction for advertising expenditures is the significant long-termbenefit criterion, a qualifier found in the Indopco decision(503 U.S. 79, 87 1992).
Some advertising undoubtedly creates for acompany significant benefits that extend beyond the current tax year,so the crucial issue CPAs face is not whether long-term benefits existbut how to measure them. Although the IRS has not been shyabout using Indopco to require a company to capitalizeexpenditures in some areas, it also has sought to allay fears in thebusiness community that Indopco will lead to increasedscrutiny of advertising expenditures.In revenue ruling 92-80, 1992-2 C.B. 57, the IRS announced thatIndopco would not affect a company's ability to deductadvertising under IRC section 162(a).
So even if a company'sadvertising has a future impact, as is the case with institutional orgoodwill advertising, the IRS has elected not to use Indopcoas a precedent. The IRS has not said it is allowing a deductionbecause of the difficulty of separating current from future benefits.Even if advertising is directed solely at future patronage orgoodwill, a company can still deduct the cost, unless the futurebenefits are significantly beyond those of normal advertising.The U.S. Supreme Court previously held in Lincoln Savings andLoan Association (71-1 USTC 9476, 403 U.S. 345,554 1971) thatbusinesses must capitalize expenditures that create or enhance aseparate and distinct asset.
The Court strengthened this standard inIndopco, when it said the separate-and-distinct-assetstandard is a sufficient though not a necessary condition forcapitalization. Interestingly, the IRS appears to be reaching back tothe earlier and weaker standard in the positions it has takenrecently. The likely reason is that it is easier to draw a line in thesand using the separate and distinct test than it is applying thesignificant long-term benefit test. Despite its apparent retreat, theIRS has not been very successful in sustaining this position in thecourts.DESIGN VS.
EXECUTIONIn a recent case, RJR Nabisco (76 TCM 71 1998), the IRSdistinguished between the costs of developing ad campaigns and thecosts of executing them. In effect, the IRS argued that campaigndevelopment costs (the image and message to be conveyed) createdlong-term benefits for a particular brand of cigarettes. In contrast,the costs of executing the campaign, such as specific magazine ads toimplement a theme, for example, should be currently deductible,according to the IRS.
The commissioner's position was that developinga packaging design campaign enhanced a separate and distinct asset—brand equity. The Tax Court agreed that campaign development costs'created intangible assets that are inseparable from brand equityand goodwill.' But the creation of such intangibles does notresult in a deduction, because goodwill is traditionally a benefitassociated with ordinary business advertising.The primary problem the Tax Court had with the IRS position was thatit conflicted with Treasury regulations sections 1.162-1(a) and1.162-20(a)(2) and revenue ruling 92-80.
Goodwill, understood as'the expectancy of continued patronage,' is a traditionalbenefit of ordinary business advertising according to the IRS. Thus,the Tax Court felt the IRS should be precluded from advancing aposition in conflict with a recent revenue ruling.It appears the IRS might have been able to prevail without thoseself-imposed restrictions.
In an earlier case, the IRS convinced theTax Court that marketing costs a company incurs to create anintangible asset should be capitalized. In Briarcliff Candy Corp.(31 TCM 171 1972), the Tax Court held that the company'sexpenses to develop suburban markets for its products were 'notadvertising directed at the promotion of its product but advertisingdirected at establishing new channels of distribution.' Thus,they should be capitalized. On appeal, however, the Second CircuitCourt of Appeals found no authority for capitalizing a self-developedintangible asset. Developing new distribution channels would notqualify under the separate-and-distinct-asset test. The Second Circuitconceded that a future benefit was created, but said the question wasacademic because the IRS was on record as saying creation of amarketing intangible was a normal benefit of product advertising.OUTSIDE THE ORDINARYThe IRS has ruled that advertising must be capitalized only inunusual circumstances where it is directed at obtaining futurebenefits greater than those associated with ordinary productadvertising or institutional or goodwill advertising.
The only examplethe IRS provided was a claims court decision involving an electriccompany's advertising to allay public fears about nuclear power (Cleveland Electric Illuminating Co., 85-1 USTC 9128, 7 ClsCt 220). The court required the company to capitalize the expenditurebecause it believed Cleveland Electric intended to obtain futurebenefits significantly beyond normal product or goodwill advertising.Such a campaign is not product advertising and may not even representgoodwill advertising if that term is narrowly defined. But it isdifficult to see a meaningful distinction between promotions that touta company's name and those that make the market friendlier for one ofits products. It does not take much imagination to see the IRSrequiring companies to capitalize any advertising directed atimproving the bottom line but not directly connected to productpromotion. Consider, for example, the current campaign major tobaccocompanies are waging to convince the public to oppose increasedcigarette taxes.Tangible assets.
Expenses for advertising that producestangible assets are subject to capitalization. In Best Lock Corp.(31 TC 1217 1959), billboards, signs, display cabinets and acollage the company created to advertise building materials had to becapitalized. But the courts have differed on whether a company mustcapitalize the costs of developing a sales catalog. For more insight,CPAs can compare Best Lock Corp. Sheldon andCo. (214 F.2d 655 CA-6.1954).Exhibit 1: Tax Conflicts in Advertising Costs.
Type of AdvertisingExpense/CapitalizeDeciding FactorsCase/RulingFreesamplesExpenseCourt refused to allocateexpenditures between those to build up future business andthose to maintain current business.NorthwesternYeast 5 BTA 232, 237 (1926)FreesamplesCapitalizeIndecisive aboutwhether expenditures were for goodwill orresearch/experimentation; expenditures had indeterminateuseful life.Marko Durovic 76-2 USTC&9732 542 F.2d 1328 (1976)CatalogExpenseOrdinary and necessary businessexpense. Future benefits could not be determined precisely.Indefinite useful life.E. Sheldon & Co.214 F.2d 655, 659 (1954)CatalogCapitalizeTaxpayer deducted preparationcosts incurred during the two tax years preceding publication.Court said the costs had no effect on earning income for thosetwo years but would best benefit several years in the future.Best Lock Corp. 31 TC 1217, 123 (1959)CatalogCapitalizeBenefits derived from costs of trade catalog were notfully realized and were exhausted in year of payment.Revenue ruling 68-360Package designExpenseFuture benefits obtained were notsignificantly beyond those traditionally associated withinstitutional goodwill advertising.RJR Nabisco,Inc.
76 TCM 71 (1998)PackagedesignCapitalizePackage design costscreate an asset with either no ascertainable useful life or anascertainable useful life that extends beyond the tax year inwhich they are incurred.Revenue procedure 97-35New channels of distributionExpenseExpenditures were ordinary and necessary to preserveand continue existing business.Briarcliff CandyCorp. 73-1 USTC &9288Newchannels of distributionCapitalizeAdvertising directed at new outlets for the sale of anentity's products are not 'ordinary' within IRCsection 162(a).
Acquired contracts had indefinite life;capitalized with no amortization allowed.Briarcliff Candy Corp. 31 TCM 171 (1972)ADVERTISING AS A START-UP COSTTo the extent advertising is classified as a start-up expenditure,companies are required to capitalize it. For example, a new businessthat buys ads to promote its opening should clearly capitalize thecost. However, an established company may find it difficult todistinguish expanding the business from starting a new trade orbusiness.In NCNB Corp. (1982-2 USTC 9469 CA-4, 1982) expenses thebank incurred to develop branch bank facilities were consideredexpenditures to expand an existing business. Another bank'sadvertising and start-up costs related to handling MasterCard accountswere deductible because the new system allowed the bank to carry onits old business of making loans in a new way ( Colorado SpringsNational Bank, 74-2 USTC 9809 CA-10, 1974). In the samevein, advertising and other costs associated with expanding a line ofrestaurants through a preexisting subsidiary were deductible.
(See LTR8423005.) However, the IRS said a manufacturer of fragrances,cosmetics, clothing and accessories began a new trade or business whenit opened its first retail outlet. The IRS required capitalizationonly on the company's first store, however, because the opening ofsubsequent retail stores was considered an expansion of the company'sexisting business. (See LTR 9331001.)More recent developments indicate a changed mood. The IRS convincedthe Tax Court that mutual fund giant Fidelity should not be allowed todeduct initial costs, including marketing, of launching a new group offunds ( FMR Corp. And Subsidiaries v.
Commissioner,110 TC 30 1998; also see TAM 9825005). A mutual fund opening morefunds can clearly be construed as expanding an existing business underearlier reasoning. However, using the wide Indopco net, theTax Court concluded that capitalization was proper because Fidelity'sexpenditures produced a significant future benefit. The IRS actions inthe Fidelity case show it is not reluctant to use Indopco toforce capitalization of advertising in a start-up context, althoughbased on other cases it has apparently decided to forego using theruling to analyze other advertising expenditures.
(For a summary oftax cases dealing with advertising costs, see exhibit 1.)RELATIONSHIP PROBLEMSFor financial reporting purposes, the practical problem CPAs facewith advertising expenditures is not only one of measurement but alsoof uncertainty about whether an actual future economic benefit exists.FASB Concepts Statement no. 6, Elements of Financial Statements, defines assets as probable future economic benefits obtained orcontrolled by a particular entity as a result of past transactions orevents. Paragraphs 175 and 176 discuss the concept of future economicbenefits, including those that may arise from advertising:'Uncertainty about business and economic outcomes often cloudswhether.particular items that might be assets have the capacity toprovide future economic benefits to the entity. For example,business enterprises.advertise, develop markets.and spendsignificant funds to do so. The uncertainty is not about the intent toincrease future economic benefits but about whether and, if so, towhat extent they succeed in doing so.
Certain expendituresfor.advertising.are examples of the kinds of items for whichassessments of future economic benefits may be especiallyuncertain.' Arguably, advertising expenditures have the same problem as researchand development costs, which FASB addressed in Statement no. 2,Accounting for Research and Development Costs. That is, acompany charges research and development costs to expense as they areincurred because it is uncertain about the amount of future benefitsand the time period over which they will be realized.Statement of Position 93-7, Reporting on Advertising Costs, provides CPAs with broad guidance on advertising expenditures.It says advertising costs should be expensed, either as they areincurred or the first time the advertising takes place.
The twoprimary costs of advertising are production and communication.Advertising production costs include idea development, advertisingcopywriting, artwork, printing, audio and video crews, actors andother related costs. Communication costs are those for magazine space,television airtime and billboard space. SOP 93-7 provides twoexceptions:1.
Direct response advertising that meets certain criteriashould be capitalized.2. A company's obligation for advertising expenditures it willmake subsequent to recognizing revenues related to those costs shouldbe accrued and the costs expensed when the company recognizes therelated revenues.An example of the latter is cooperative advertising, where an entityagrees to reimburse customers for some or all of their advertisingcosts. This might apply to an appliance manufacturer that reimbursesretailers for newspaper advertising that features its products.
Inthese situations, the company should accrue the advertising costs andexpense them as related revenue is recognized.A company should capitalize and amortize direct response advertisingif. Its primary purpose is to elicit sales from customers who can beshown to have responded specifically to the advertising. It results in probable future economic benefits.To meet the first requirement, companies must have a way to documentthat customers have responded to specific advertising. This mightinclude coded order forms, coupons or response cards; files indicatingcustomer names and the advertisement; or a log of customers who calleda particular phone number appearing in an ad. To meet the secondrequirement, companies must present documentation of benefits fromprevious direct response advertising campaigns. Industry statisticswill not suffice in the absence of a specific entity's operatinghistory.Some FASB pronouncements and audit guides provide CPAs with guidanceon reporting advertising for specific items or industries.
There is,however, some inconsistency between these sources. Pronouncements thatallow capitalization seem to do so because there is a clear,demonstrable cause and effect relationship between the assets acquiredand the costs incurred.
Pronouncements that prohibit capitalizationappear to do so because there is no demonstrable causalrelationship—the amounts capitalized would be immaterial or the costof obtaining the information would outweigh the benefits of reportingit.GUIDELINES BY INDUSTRYCPAs should be aware that in several industries companies mayexpense advertising costs when they are incurred, even direct responseadvertising. A company may expense advertising done in connection withextended warranty and product maintenance contracts when it isincurred, according to FASB Technical Bulletin 90-1, Accountingfor Separately Priced Extended Warranty and Product MaintenanceContracts. FASB Statement no. 51, Financial Reporting byCable Television Companies, says all advertising related toacquiring new cable television subscribers should be expensed when itis incurred, regardless of its form.
Under FASB Statement no. 91, onleases and loans, all advertising costs an entity incurs related tosoliciting potential borrowers should be expensed when incurred.Under FASB Statement no. 60, Accounting and Reporting byInsurance Enterprises, stock life and property and liabilityinsurance companies should capitalize policy acquisition activities.Statement no. 60 is unclear about whether advertising is a policyacquisition activity, but the industry audit guide Audits of StockLife Insurance Companies says it is.
Costs a company incurs torent or sell real estate projects should be capitalized if they willbe realized when the project is sold or rented. FASB Statement no. 67,Accounting for Costs and Initial Rental Operations of RealEstate Projects, says companies should expense the capitalizedcosts in the period revenue is recognized. The flowchart in exhibit 2,above, summarizes the accounting treatment of advertising costs forfinancial reporting purposes.Exhibit 2: Financial Reporting Treatment of AdvertisingExpendituresDON'T TAKE THE EASY WAY OUTIn deciding how to handle advertising expenditures, CPAs shouldbeware the easy assumption that advertising is always expensed. Whileexpensing is the norm for tax and financial reporting purposes, boththe tax and accounting authorities have created a number of exceptionsthat cloud the issue. Although the IRS has eschewed the use of thebroad power granted it by the Indopco case as it applies toadvertising costs, it continues to push for capitalization in somesituations. The accounting authorities have also adopted a seeminglystraightforward rule that companies must expense advertising unless itis direct response advertising.
CPAs should, however, keep a watchfuleye on specific industry exceptions to that rule.