New accounting rules for advertising conflict with tax treatment.

• Author: Moore, Daniel J.

The AICPA's Accounting Standards Executive Committee has issued Statement of Position (SOP) 93-7, Reporting on Advertising Costs, which will be a change in accounting method for many companies. Tax practitioners need to understand these new rules and how they differ from the tax law governing the time for deducting advertising costs. This article summarizes financial and tax accounting for advertising costs and highlights how to avoid potential pitfalls in obtaining Federal income tax deductions.

The SOP is effective for years beginning on or after June 15, 1994. Therefore, these rules will first apply for calendar-year 1995, but could apply to calendar-year 1994 if adopted early. The statement provides that the costs of all advertising should be expensed either as incurred, or the first time the advertising takes place, with two exceptions.

The first exception is direct response advertising. If the primary purpose of the direct response advertising is to elicit sales from customers who could be shown to have responded to such advertising, and it results in probable future economic benefits (i.e., future sales), direct response advertising should be capitalized. If direct response advertising is capitalized, it will be amortized over the estimated period of the benefits, based on the proportion of current period revenue from the advertisement to probable future revenue, and the asset will be reported at its net realizable value.

The second exception relates to advertising costs paid in a period later than the one in which the revenues are recognized from those costs. These expenditures should be accrued and the advertising costs expensed when the related revenues are recognized. For example, in a cooperative advertising agreement, entities assume an obligation to reimburse their customers for some or all of the customer's advertising costs.

Prior to adopting these rules, companies had used diverse methods of expensing and capitalizing advertising expenses. The objective of SOP 93-7 is to standardize the practices of recognizing advertising expenses by various reporting entities, and to reduce the amount of "soft" assets reported by these entities. The new accounting rules have accomplished this by accelerating the expensing of these costs in most cases.

Although companies will be required to change their method of accounting for advertising costs for financial reporting and disclosure purposes, SOP 93-7 will not require companies to apply...