Question

ABC Ltd is an Australian mail-order company.

Although the sector in Australia is growing slowly, ABC Ltd has reported significant increases in sales and net income in recent years.

While sales increased from $50 million in 2009 to $120 million in 2018, profit increased from $3 million to $12 million over the same period.

The stock market and analysts believe that the company’s future is very promising. In early 2019, the company was valued at $350 million, which was three times 2018 sales and 26 times estimated 2019 profit.

Company management and many investors attribute the company’s success to its marketing flair and expertise.

Instead of competing on price, ABC Ltd prefers to focus on service and innovation, including:

free delivery
a free gift with orders over $200.
As a result of such innovations, customers accept prices that are 60% above those of competitors, and ABC maintains a gross profit margin of around 40%.

Nevertheless, some investors have doubts about the company as they are uneasy about certain accounting policies the company has adopted.

For example, ABC Ltd capitalises the costs of its direct mailings to prospective customers ($4.2 million at 30 June 2018) and amortises them on a straight-line basis over 3 years.

This practice is considered to be questionable as there is no guarantee that customers will be obtained and retained from direct mailings.

In addition to the mailing lists developed by in-house marketing staff, ABC Ltd purchased a customer list from a competitor for $800 000 on 4 July 2019.

This list is also recognised as a non-current asset.

ABC Ltd estimates that this list will generate sales for at least another 2 years, more likely another 3 years.

The company also plans to add names, obtained from a phone survey conducted in August 2019, to the list.

These extra names are expected to extend the list’s useful life by another year.

ABC Ltd.’s 2018 statement of financial position also reported $7.5 million of marketing costs as non- current assets.

If the company had expensed marketing costs as incurred, 2018 net income would have been $10 million instead of the reported $12 million.

The concerned investors are uneasy about this capitalisation of marketing costs, as they believe that ABC Ltd.’s marketing practices are relatively easy to replicate.

However, ABC Ltd argues that its accounting is appropriate.

Marketing costs are amortised at an accelerated rate (55% in year 1, 29% in year 2, and 16% in year 3), based on 25 years’ knowledge and experience of customer purchasing behaviour.

Question
How ABC Ltd should account for the costs?

(Specify with the numbers of each cost in the question with AASB138/IAS38)

Answer 1

Purchase of Customer List

[IAS 38.8] The three critical attributes of an intangible asset are:

identifiability ,control (power to obtain benefits from the asset), future economic benefits (such as revenues or reduced future costs)

Purchase of Customer List from competitor for $0.8 million is identifiable

Identifiable:--under IAS 38.12, an asset is identifiable if it is separable – so comapny can separate it or detach it from the entity and

comapny can actually sell it, transfer it, license it, rent it or do whatever like

Customer list is identifiable non-monetary asset without physical substance

Control---- company is having the control of the asset, in this case I assume that nothing prevents

the buyer to control the use of purchased customer list.

[IAS 38.21]Future Benefit---Standard does not tell to quantify these benefits or measure the future economic benefits. It’s almost impossible.

So, the comapny expects future economic benefits from the use of the purchased customer list and thus this criterion is met.

[IAS 38.21]Reliable of Cost:-- Company knows how much she paid for the customer list

the cost of the asset can be measured reliably

Purchase of Customer list shoukd be capitalised

Mailing Cost

Intangible assets have three criteria’s to be met in order to be recognised: identifiability, control and future economic benefits.

If these three are not there, then one can not recognise it as an intangible asset.

So when a company spends some money as expenditure on intangible assets internally,

these expenses will either become internally generated goodwill or internally generated intangible assets.

when company spend money $4.2 Million on direct mailing to develop customer relationships to develop future business,

this expenditure does not fall under intangible assets criteria because, the relationships building is not tangible and cannot be measured reliably.

On top of that, one cannot sell the customer relationship development separately

Brands, mastheads, publishing titles, customer lists and items similar in substance that are internally generated should not be recognised as assets. [IAS 38.63]

Cost of $4.2 million should be recognised as an expense

Marketing Cost

Marketing Cost is not identifiable – We can’t separate it and sell it to someone else.

Therefore, Company should recognize the expenditures for marketing in profit or loss