Polymedica Case
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In determining the appropriate method PolyMedica should use to account for direct response advertising we concluded that they have an even larger issue that needs to be addressed. PolyMedica needs to address the repercussions of for or against capitalizing advertising expenses we concluded that regardless of the accounting practices on this subject, Polymedica has a larger issue than just accounting related practices. They need to address the repercussions of losing faith in their financial reportings.
Statements that led us to the problem statement:
PolyMedica is potentially overstating revenue by using capitalization method on adversting expenses (SOP 93-7, exception rule)
Shareholders and users of the financial statements are misinformed
Risking bad financial decisions by investors due to inaccurate financial reporting
Investors have lost faith in the integrity of the financial reporting
PolyMedica potentially has an exposure that is not in their favor if they make treat the advertising as an expense
The second alternative would be to record all advertising expenditures as expenses and charge them to earnings in the period they were incurred. PolyMedica would be classifying all ad costs under one umbrella; rather they are direct or nondirect response or for diabetic or respiratory needs. There are many long-term benefits to expensing the direct-response advertising expenditures vs. capitalizing them. Utilizing the expensing method impacts net income, stockholders equity, and cash flow from operations. If PolyMedica were to utilize this method a higher profitability (Net Income) would be realized, than if they capitalized the cost. However, using this method could cause the company to look unstable in the earlier years due to inconsistency in reported income. Expensing can also be beneficial for stockholders equity, by having less profit and smaller retained earnings upfront; stockholders earn more on the back end and watch their investments grow. There is also a tax benefit to expensing, more taxes are paid in the beginning due to higher net profits shown using the accrued asset method, but with expensing you pay less taxes upfront due to lower net income, yet there is really no difference in taxes over a longer period of time. Choosing to capitalize or expense is a choice left up to management, but it is obvious that capitalizing