Homework: Ethics Case (10 points) John is a CPA employed with a retail firm. He
ID: 2523780 • Letter: H
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Homework: Ethics Case (10 points) John is a CPA employed with a retail firm. He is currently preparing the firm's quarterly financial statements for the three month period ending September 30th 2017. During the months of July and August, the firm spent millions of dollars on advertising. These costs have been debited to advertising expense. The company's chief financial officer asks John to prepare a September 30th adjusting entry to credit advertising expense and debit an account called prepaid advertising forthe.amount.of money spent on advertising during the quarter. The CFO explains: "Money spent on advertising is an asset because it boosts future revenue, and therefore matching expenses to revenues (the matching principle) requires that advertising expenditure be expensed in a future period when the relevant future revenues are recognized. If we expense advertising expenditure in the same period as it is incurred, we will show an operating loss on our income statement for the quarter. Our bonuses are at stake." Provide your responses to the following questions (2 points each): 1. 2. 3. 4. 5. When are expenditures on advertising to be expensed, per GAAP? Is the CFO's position consistent with GAAP? Who will be hurt if John accepts the CFO's position? Who will benefit if John accepts the CFO's position? What should John do?Explanation / Answer
1. As per GAAP all advertising expenses with regards to cost of communicating and distributing the advertisement has to be charged to an expense account when the costs are incurred. Alternatively, GAAP has a provision which states that the advertisement expenses can be posted as an asset (in the form of prepaid advertising) and expense the amount as and when advertising takes place. The company has to be consistent with the method which it elects to use.
Thus as per GAAP marketing and advertising costs are expenses as incurred. In other words if benefits do not extend beyond the interim period in which the expenditure is made then the advertising costs should be expensed. As per codification topic 34-20 of GAAP advertising costs have to be expensed either when they are incurred or when the advertising takes place for the first time.
2. No, CFO’s statement is not consistent with GAAP as the millions of dollars that have been spend in the form of advertising expenses. As per codification topic 34-20 of GAAP advertising costs have to be expensed either when they are incurred or when the advertising takes place for the first time. Here the expenses have been incurred and paid for. Also it can be safe to assume that the advertising has taken place in the current financial quarter.
3. If CFO’s position is accepted then the company’s shareholders will be hurt as the net income attributable to them will decline. This is because if advertising costs are not expensed then substantial bonuses will be paid and this will lead to fall in net income available for shareholders.
4. If CFO’s position is accepted then employees eligible for bonus will benefit. This is because they would have met the bonus eligibility criteria and hence will earn substantial bonuses.
5. John should adhere to GAAP’s guidelines and should explain to the company’s CFO as to why his suggestion for the adjusting entry is incorrect and hence will not be made.
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