Seattle FilmWorks capitalizes the costs of its direct mailings to prospective customers, expensing them over three years rather than in the year they’re incurred. There’s nothing wrong with this practice per se. If the customers netted by mailing come back with repeat business year after year, you really have booked an asset. But there is no guarantee that the first-time customer will become a regular. Consequently, large dollar amounts of marketing costs sit on the company’s balance sheet as an asset.

This situation was familiar to America Online shareholders. By spreading its marketing expenses over several years, AOL was able to create artificially high earnings. The company finally changed its accounting policy. Result: A $385 million write-0ff.

REQUIRED:

Discuss the trade-offs involved with capitalizing marketing costs from a matching standpoint and from the perspectives of management, the shareholders, and the auditors.