SOP 93-7: Accounting for Advertising Costs

The landscape of accounting for advertising costs is governed by principles that have evolved in their codification. Originally, the primary source of guidance was the Statement of Position (SOP) 93-7, “Reporting on Advertising Costs,” issued by the American Institute of Certified Public Accountants (AICPA). Over time, the Financial Accounting Standards Board (FASB) has integrated this guidance into its Accounting Standards Codification (ASC).

The principles of SOP 93-7 are now found within ASC 720-35, Other Expenses—Advertising Costs. The core requirements established in the original SOP have been preserved, ensuring continuity in how companies report these specific costs. Therefore, understanding the tenets of SOP 93-7 remains relevant for comprehending the current standards under U.S. Generally Accepted Accounting Principles (GAAP).

The General Rule for Advertising Costs

The fundamental principle for accounting for advertising costs is to expense them as they are incurred or the first time the advertising takes place, whichever is later. This means that the costs associated with an advertising campaign are recognized on the income statement in the period they are consumed, rather than being treated as a long-term asset on the balance sheet. This approach is based on the premise that while advertising may provide future economic benefits, these benefits are often difficult to measure reliably.

Advertising costs include the costs of creating the content, such as hiring an advertising agency, production costs for commercials, and graphic design fees. They also include the costs of communicating the advertisement, such as purchasing airtime on television or radio, space in print publications, or clicks on a digital platform. The production costs are expensed as they are incurred, while the costs of media placement are expensed the first time the advertisement is shown to the public.

For example, if a company pays for the production of a television commercial in December but the commercial does not air until January, the production costs would be expensed in December. The cost of the airtime, however, would be expensed in January when the advertisement first runs.

The Exception for Direct-Response Advertising

A narrow and specific exception to the general rule of expensing advertising costs exists for direct-response advertising. This type of advertising is unique because it is designed to elicit a direct sale from a specific customer. Unlike general brand advertising, the effectiveness of direct-response campaigns can be directly tracked and measured in terms of the revenue they generate.

To qualify for capitalization, where the costs are recorded as an asset instead of an expense, the direct-response advertising must meet three stringent criteria. The first is that its primary purpose must be to elicit sales from customers who can be shown to have responded specifically to the advertisement. This requires a mechanism for tracking customer responses, such as a unique phone number, a specific web address, or a scannable coupon code.

The second criterion is that the advertising must result in probable future economic benefits. The final requirement is that the company must be able to reliably measure these future benefits.

Accounting for Capitalized Advertising Costs

Once it is determined that direct-response advertising costs meet the criteria for capitalization, they are recorded as an asset on the balance sheet. This asset represents the expected future economic benefits to be derived from the advertising campaign. The costs that can be capitalized include those directly related to the direct-response advertising, such as third-party costs for mailing lists, printing, and postage.

These capitalized costs must be amortized, or systematically expensed, over the period during which the future benefits are expected to be realized. This amortization period should be a reasonable estimate of the time frame over which the advertising will continue to generate revenue. The amortization method used should be systematic and rational, reflecting the pattern in which the future benefits are consumed.

The capitalized advertising asset must also be regularly assessed for impairment. If the expected future net cash flows from the advertising are less than the carrying amount of the asset, an impairment loss must be recognized. This write-down reduces the value of the asset on the balance sheet and is recorded as an expense on the income statement.

Financial Statement Disclosure Requirements

Companies are required to provide specific disclosures in their financial statements regarding their accounting for advertising costs. The information is typically included in the notes to the financial statements. A key disclosure is the company’s accounting policy for advertising costs. This includes whether the company expenses all advertising costs as incurred or capitalizes certain direct-response advertising costs.

The total amount of advertising costs expensed for the period must also be disclosed. For companies that capitalize direct-response advertising, additional disclosures are required. These include:

• A description of the capitalized asset
• Its carrying amount
• The amortization period
• The method of amortization used