Advertising is an important part of any business, and it's essential to understand when it should be capitalized or expensed. The Internal Revenue Service (IRS) considers all startup costs for a company, including advertising, as capital expenditures that are deducted over time. Generally, advertising costs need to be spent when they are incurred, as it is difficult to quantify its future economic value. This includes media expenses, printing costs, point-of-purchase material and marketing promotions.
Direct response advertising costs with likely future benefits can be capitalized and amortized over the estimated life of future profits. The IRS requires companies to capitalize on any advertising aimed at improving results, but that isn't directly related to product promotion. This may include coded order forms, coupons or response cards; files that indicate the names of customers and the ad; or a record of customers who called a specific phone number that appears in an ad. The Executive Committee on Accounting Standards (ACSec) appointed a working group to study accounting policy issues related to the capitalization of advertising costs.
To effectively implement the practice of capitalizing on certain advertising costs, some implementation issues need to be addressed. The relationship between advertising and sales (or A to S), for example, only takes into account advertising costs divided by total sales for a given period. Findings have suggested that advertising effectiveness decreases at reasonably stable rates within an industry. Several reasons may explain why sales may occur in a future period as a result of advertising in the current period.
Figure 1 shows examples of advertising costs that are currently being capitalized by large public companies. Advertising is a way to increase the sales of a company through brand or product awareness and to inform about new products or features. It is important for businesses to understand when they should capitalize or expense their advertising costs in order to maximize their profits.