Question

You have recently been employed by a large retail chain that sells sporting goods. One of your tasks is to help prepare periodic financial statements for external distribution. The chain's largest creditor, National Savings & Loan, requires quarterly financial statements, and you are currently working on the statements for the three-month period ending June 30, 2018.

During the months of May and June, the company spent $1,200,000 on a large radio and TV advertising campaign. The $1,200,000 included the costs of producing the commercials as well as the radio and TV time purchased to run the commercials. All of the costs were charged to advertising expense. The company’s chief financial officer (CFO) has asked you to prepare a June 30 adjusting entry to remove the costs from advertising expense and to set up an asset called prepaid advertising that will be expensed in July. The CFO explained that “This advertising campaign has produced significant sales in May and June and I think it will continue to bring in customers through the month of July. By recording the ad costs as an asset, we can match the cost of the advertising with the additional July sales. Besides, if we expense the advertising in May and June, we will show an operating loss on our income statement for the quarter. The bank requires that we continue to show quarterly profits in order to maintain our loan in good standing.”

Post your opinion which should include the ethical issues identified, the values, the alternatives available, your evaluation of the alternative you would choose and the consequences related to the alternative.

Answer 1

As per 'Matching Principle', All expenses should be matched in same Accounting Period in which related income are made.
In this given situation, reports are preparing on Quaterly basis. Hence period ends on June 30.
The Adversiting Exp brings sales revenue in may and June. It is also expected that it will bring sales in July also.

So, Considering the matching principle, The ad expense related to May and June should Record as Advertising exp and Expense related to July should recorded as Prepaid Advertise Expense.

If the whole amount of advertising expense recorded as Prepaid advertising cost, there will be ethical issue for not following the "Matching Principle".
Also,
It will increase profit in current financial statement. Which will reflect wrong Profit balance and will not follow the principle of 'True and Fair' View of Financial statement.

The alternative can be -
The advertising expense should allocate under advertising exp account and Prepaid Advertising Expense Account.
Taking the months, as a base of allocation,
Cost to be charged on Advertise Expense account = $  $1,200,000 x 2/3 = $800,000
And
Cost to be charged on Prepaid Advertise Expense account = $  $1,200,000 x 1/3 = $400,000

By following this alternattive, there won't be any ethical issue
And
Expense will be reduced by $400000 in current income statement which might result in operating profit.