America Online Inc Case Study

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3. Was AOL’s policy to capitalize subscriber acquisition costs justified prior to 1995? Ans: AOL’s accounting policy was labeled aggressive and capitalized its subscriber acquisition costs when its archrival CompuServe didn’t.

AOL’s biggest expenditure was the cost of attracting new subscribers and maximizing shareholders’ value: 1. Separate registration numbers and passwords were issued to customers. They cost more than $40 per new subscriber in 1994. 2. AOL aggressively marketed its online service both directly and indirectly. 3. To retain new subscribers and increase customer loyalty & satisfaction, AO

The noteable accounting procedures followed by AOL were as follows: :a. AOL's amortization period for subscriber acquisition costs was about 15 months, such aggressive accounting was attributed to the bundling & direct mail marketing practices b. During September 1995, the company modified the components of subscriber acquisition costs as incurred Analysis

a. It is not advisable for AOL to capitalize the marketing costs because in 1990s Web was being established. This would definitely impact the sales. Instead of amortizing the Acquisition Costs for 15 months, if we treat it as single lumpsum cost, the Income statement shows a loss for the period. Capitalizing the expenditure for 2 years contained an implicit assumption for the coming two years. This was unlikely with the online industry as it had acquired most of its customers in the last 36 months,

If AOL were to write off all capitalized subscriber acquisition costs the effect on the 1995 balance would be a $77,229,000 reduction in other assets and stockholders’ equity. If all the subscriber acquisition costs incurred in fiscal year 1995 were expensed in 1995, the effect on the income statement would be an increase in marketing expense of $50,837,000 and an increase in net loss of $50,837,000
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