Definition of Advertising Expense
Advertising is any communications with a target audience that is designed to persuade that audience to take some type of action, such as buying a product or service. Advertising can also be intended to build aware of an industry or brand. Examples of advertising are billboards, web site banner ads, radio announcements, and podcast sponsorships, as well as the production costs for any of these items.
Accounting for Advertising Expense
In a smaller business, it is important to be mindful of the economic entity principle, where the records of the owner are kept separate from those of the business. This means that any advertising expenses relating more to the owner than the business should not be recorded as expenses of the business.
You can record an advertising expense as an asset when there is a reliable and demonstrated relationship between total costs and future benefits resulting directly from the incurrence of those costs. For example, an entity has reliable evidence that, if it sends out 100,000 pieces of direct-mail advertising, it will receive 2,500 responses. Thus, the cost of obtaining 2,500 responses is the cost incurred to send out the 100,000 mailings. With such information, an entity can use historical information to make reliable predictions about the relationship between current expenditures required to obtain future revenue.
If such historical information is available, then accrue advertising costs and charge them to expense when you recognize the related revenue.
If the advertising expenditures are for direct-response advertising, record the expenditures as an asset only if the situation meets both of the following criteria:
- The primary purpose of the advertising is to generate sales from customers who can be shown to have responded specifically to the advertising. You must be able to document customer responses, specifying the name of the customer and the advertising that elicited the response (such as a coded order form or response card).
- The advertising activity results in probable future revenues that exceed future costs incurred to realize the revenues, which can be proven with verifiable historical patterns of results for the entity. If there is no operating history for a new product or service, an entity can use as proof statistics for other products and services for which statistics can be highly correlated. Industry statistics are not considered sufficiently objective evidence.
Each significant advertising effort is treated as a separate standalone cost pool, where each pool must meet the preceding criteria before it can be recorded as an asset.