DeVos Graduate School of Management
September 17, 2012
PolyMedica’s method of capitalizing direct-response advertising expenditures rather than expensing the cost is under investigation by the U.S. Securities and Exchange Commission (SEC) and has caused concern for investors who are questioning the legitimacy of this practice.
PolyMedica is a leading provider of direct-to-consumer medical products and conducts business through its Liberty Diabetes, Liberty Respiratory, and Pharmaceuticals segments. The issue at hand concerns the divisions of Liberty Diabetes and Liberty Respiratory and the reporting of their advertising expenses. PolyMedica capitalizes and amortizes its direct- response advertising cost, generally over a 2-4 year period, in accordance with American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 93-7. Under the Financial Accounting Standards Board (FASB) guidelines, this rule allows such cost to be capitalized when; (a) the advertising generates sales to customers who respond explicitly to the advertisement and (b) the advertisement results in a likely future benefit. To understand why this circumstance is being challenged, it is important to examine how PolyMedica concluded that the capitalization method was justifiably used for their business.
EXPENSING THE DIRECT-RESPONSE ADVERTISING EXPENDITURES AS INCURRED
In may countries outlays for advertising must be expensed immediately because they are difficult to value objectively. While this eliminates the possibility of management abuse of reporting on the uses of these resources, it makes it more difficult to assess the firm’s profitability by comparing the cost of critical resources with the revenues they generate. (2000, Choudhary and Healy, p.5) If...