America Online (AOL) Accounting Scandal

Solution

America Online (AOL) Accounting Scandal

In general, advertising and promotion costs are normally expensed in the period in which they are incurred, even though they are intended to generate future revenues. This is because these costs are considered to be a current period expense and do not provide any future economic benefit. According to the Financial Accounting Standards Board (FASB), these costs should be expensed as soon as they are incurred because they are “associated with the current period’s revenues.”

However, in the case of AOL, the company chose to expense these costs over a two-year period, arguing that this was a justifiable way to match expenses against revenue flows that would emerge later. This accounting method allowed AOL to spread the costs of acquiring new subscribers (such as the expense of sending computer disks to potential customers) over two years, rather than expensing them in the period in which they were incurred. As a result, AOL was able to post a profit for six of eight quarters in 1995 and 1996, even though it would have recorded a loss if it had followed recommended accounting practices.

There are a few possible reasons why AOL chose this different approach to expensing advertising and promotion costs. One reason could be that the company wanted to present a more favorable financial picture to investors and stakeholders. By spreading the costs over a two-year period, AOL was able to show a profit in certain quarters, which may have been more appealing to investors than a loss.

Another possible reason for AOL’s decision could be that the company believed that the benefits of its advertising and promotion efforts would continue to accrue over a longer period of time. By expensing these costs over a two-year period, AOL may have felt that it was more accurately reflecting the long-term nature of the benefits it was receiving from its advertising and promotion efforts.

However, in 2000, the Securities and Exchange Commission (SEC) ruled that AOL’s accounting method was improper and imposed a civil penalty of $3.5 million. The SEC argued that AOL should have expensed these costs in the period in which they were incurred, rather than spreading them over a two-year period. As a result, AOL decided to change its method and begin expensing these costs in the period in which they were incurred.

Overall, it is clear that AOL’s decision to expense advertising and promotion costs over a two-year period was a controversial one that ultimately resulted in a civil penalty from the SEC. The company’s decision may have been motivated by a desire to present a more favorable financial picture to investors, or it may have been based on the belief that the benefits of its advertising and promotion efforts would continue to accrue over a longer period of time. However, the SEC ultimately ruled that this approach was not in line with recommended accounting practices, and AOL was required to change its method and expense these costs in the period in which they were incurred.