Question

Quick Fix Ltd is a manufacturing company engaged in the production of adhesives. The company has not performed well over the past three financial years.

In order to improve on the poor past profits, the board approved a R1 000 000 advertising promotion during the year ended 31 December 2018 in order to generate increased sales in the future. The advertising promotion took place (and was paid for) during December 2018.

The accountant insists on recognizing the R1 000 000 payment as an asset at 31 December 2018. His reasoning is that future sales will increase as the number of customers grows due to the advertising campaign.

Required:

Discuss whether you agree with the accountant, making reference to the framework. Provide an alternate treatment if you disagree.   (20)

Answer 1

Generally, advertising expenses are revenue in nature and should be charged to profit and loss account. However, if the advertising expenditures are for direct-response advertising, record the expenditures as an asset only if the situation meets both of the following criteria:

1. Primary purpose of the advertising is to generate sales from customers and there must be evidences that sales generated specifically due to that advertisement. You must be able to document customer responses, specifying the name of the customer and the advertising that elicited the response. Example – any unique code or specific response card.
2. The advertising activity results in probable future revenues that exceed future costs incurred to realize the revenues, which can be proven with verifiable historical patterns of results for the entity.

If there is no operating history for a new product or service, an entity can use as proof statistics for other products and services for which statistics can be highly correlated. Industry statistics are not considered sufficiently objective evidence.

In this given problem advertisement was done and paid in Dec 2018 and benefit of which will be enjoyed in future for sure. However I have assumed that there will be system in place to identify sales generated from that campaign.       

However the degree of expense can’t be guessed for that company that means if that company is used to do that kind of campaigns on regular basis and that kind of amount is not a material expenses for them, they should not recognize that as an asset. In the given problem past performance of company is not good and this is a new effort for generating sales so the above mentioned fact can be ignored and recognize it as an asset.