Situation When asked about a $518 million “prepaid expense and deferred charge” on its balance sheet for 1990, Sears says that about $100 million of the figure—mainly for the catalog— consists of advertising costs whose impact on profit has been deferred. “These costs are paid but aren’t charged against profits” yet, says a spokesman.

Procter and Gamble generally allocates advertising costs based on the number of cases of products it ships. A spokesman for McDonald’s says that a “small portion” of the $108 million in prepaid expenses and other current assets on its balance sheet for 1990 is deferred production costs for certain commercials and creative development. Nike says that it deducts all advertising costs immediately, and calls advertising-cost deferral “a bogus exercise.”

Philip Morris accrued $1.4 billion in marketing costs on the liability side of its balance sheet for 1990. This means that Philip Morris is deducting advertising costs it has not yet paid to help smooth out profits from year to year. An analyst says, “I call such amounts ‘hidden earnings’ for future years when financial results aren’t as good as Philip Morris would like. Then, it could lower its advertising-cost deductions with this accrual.” (Adapted from The Wall Street Journal, 1/8/92).

Directions

1. Research the generally accepted accounting principles and prepare a short memo that summarizes how to report advertising costs. Cite your reference(s) and applicable paragraph numbers.

2. Are each of the companies complying with the policy? Assume that all the companies recognize revenue at the time of sale.