Question

Tokyo AFM immediately expensed incremental insurance contract acquisition costs related directly to the signing of the contract. The company’s accountants argued that this treatment was required in order to be consistent with the company’s premium revenue recognition policy. For example, on June 30, 2001, a policyholder paid an up-front ¥210,000 premium for a two-year property insurance contract for her Tokyo apartment. The contract was based on a product called “Home Umbrella.” It covered a variety of casualty losses, and the company sold it exclusively to individual residential customers.

The principal incremental contract acquisition costs were:
a. A ¥50,000 commission fee paid to the agent who had worked directly with the policyholder.  The fee was due to the agent when the policyholder signed the contract and was paid immediately upon signing.
b. A ¥20,000 cost of marketing efforts incurred over the past six months to promote Home Umbrella through broad-based advertising (50%) and targeted phone calls (50%) to existing Tokyo AFM customers as part of a cross-selling strategy. The policyholder, who had just bought her apartment, was already using Tokyo AFM for her car liability insurance.

Question Would you capitalize any of the above acquisition costs, or would you expense them immediately? If you were to capitalize the costs, over what period would you amortize them?

Answer 1

Capitalisation or not: Based on the given case it appears that the incremental expenses form the part of normal business of the company and is no where related to deferment of any expense. The costs incurred are not in the nature of being capitalised.

Agent commission is a revenue expense hence can not be capitalised. Similarly the advertising expenses are in revenue nature hence should not be capitalized.

Alternatively, it can be argued that targeted phone calls for cross selling is related to ab existing customer, hence this ¥10000 shall be capitalised and be amortised over a period of two years.