Reporting on advertising costs.

Statement on Auditing Standards no. 69, The Meaning of "Present Fairly in Conformity With Generally Accepted Accounting Principles" in the Independent Auditor's Report, identifies American Institute of CPAs statements of position as sources of established GAAP. This month's column summarizes a proposed SOP on advertising costs that was approved by the accounting standards executive committee (AcSEC) subject to Financial Accounting Standards Board review.

The proposed SOP titled Reporting on Advertising Costs applies to all entities and all advertising except that for which guidance is provided in FASB statements, interpretations and technical bulletins; Accounting Principles Board opinions; and AICPA accounting research bulletins. The proposed SOP would replace the advertising guidance contained in existing audit and accounting guides and SOPs.

The proposed SOP is the first step in a multistep AcSEC project on reporting the costs of advertising activities and certain other activities to create future economic benefits through the development of intangible assets (for example, preopening and startup costs). The project was initiated in 1986 with the expectation it would result in guidance and a conceptual framework for resolving issues concerning financial reporting on the costs of such activities.

The guidance in the proposed SOP is based on the premise that most advertising may result in future economic benefits that meet the definition of an asset in FASB Concepts Statement no. 6, Elements of Financial Statements. However, AcSEC concluded advertising assets other than those resulting from certain direct-response advertising do not meet the recognition criteria of reliability in FASB Concepts Statement no. 5, Recognition and Measurement in Financial Statements of Business Enterprises, which says that in order to be reliable, the information must be representationally faithful, verifiable and neutral.

AcSEC concluded the future economic benefits of most advertising cannot be measured with the degree of precision required to report an asset in the financial statements. These measurement difficulties were underscored by a recent Wall Street Journal article citing a study that measured sales gains by Super Bowl advertisers during the six-week periods following the January 1992 and 1991 games, respectively. The gains varied widely, and advertisers themselves admitted the difficulty of attributing sales gains directly to advertising efforts.

The proposed SOP requires the accounting treatment described as follows.

EXPENSING OR CAPITALIZING ADVERTISING COSTS

All advertising costs must be expensed in the periods they are incurred or the first time the advertising takes place, unless it is direct-response advertising that results in probable future economic benefits (future benefits).

Future benefits. The future benefits are probable future revenues in excess of the costs incurred to earn them.

Capitalizing direct-response advertising. Demonstrating that direct-response advertising will result in future benefits requires persuasive evidence that its effects will be similar to those of past direct-response advertising that resulted in future benefits.

Industry statistics are not considered objective evidence that direct-response advertising will result in future benefits in the absence of the specific entity's operating history.

Reporting costs of advertising that has not taken place. Costs incurred for advertising that has not taken place (such as the costs of unpublished magazine space and unaired television or radio advertising) should not be reported as expenses before the service has been received.

Measuring costs of direct-response advertising. The costs of the advertising directed to all prospective customers, not only costs relating to the customers that are expected to respond to the advertising, should be used to report such assets initially.

The costs eligible for capitalization include only incremental direct costs of the direct-response advertising.

AMORTIZATION

The amounts reported as assets should be amortized over the estimated benefit period based on the proportion of current-period revenue from the advertising to probable remaining future revenue, subject to a test of net realizable values.

DISCLOSURES

The accounting policy, the amount of capitalized direct-response advertising, total advertising expense and other information should be disclosed.

UNCERTAIN FUTURE

The proposed SOP is contentious and AcSEC's approval came after extensive deliberations. The Institute's accounting standards division expects to send the proposed SOP to the FASB for clearance during the second quarter of 1993. Final issuance of the SOP will be announced in The CPA Letter. * THE ACCOUNTING standards executive committee (AcSEC) approved a proposed Statement of Position, Reporting on Advertising Costs, subject to Financial Accounting Standards Board review.

EXECUTIVE SUMMARY

* THIS CONTROVERSIAL proposal requires

* Expensing all advertising costs in the periods they are incurred or the first time the advertising takes place, unless it is direct-response advertising that results in probable future economic benefits.

* Reporting the costs of the future benefits of direct-response advertising as assets.

* Amortizing the amounts reported as assets over the estimated benefit period based on the proportion of current-period revenue from the advertising to probable remaining future revenue, subject to a net realizable value test.

* The proposed SOP has not yet been sent to the FASB for clearance.