Polymedica Case

Q: Explain difference between an asset and an expense
A: Assets are resources controlled by the entity as a result of past events and from which future economic benefits are expected into next accounting periods. Expenses are costs related to running the business, in order to earn revenues. An “expense” is that economic portion of an asset that has been used up within the accounting period.

Q: Explain the role of advertising in the company’s customer acquisition strategy.
A: The role of direct response television was to reach a larger portion of eligible customer, which resulted in a significant increase of sales.

Q: What are the arguments in favor of capitalizing the direct-response expenditures? What are the arguments in favor of expensing the direct-response advertising expenditures as incurred? As a CEO of Polymedica, would you favor capitalizing or expensing the direct response advertising cost?
A: Arguments in favor of capitalizing the direct-response expenditure: * In capitalizing the direct-response advertising, the effectiveness of the advertising is directly related to the amount of sales. * Capitalizing costs and depreciating them over time will show a higher profitability in the early years. Hence, a company who capitalizes cost will show higher profitability ratios in short time and lower ratios in the later periods. * Higher total assets

* Cash flow from operations higher than if the choice is for expensing Arguments in favor of expensing the direct-response advertising expenditures as incurred: * In later years, the company that expenses costs will have a higher profitability than it would have had if it capitalized them. In line with this, it would also show a more realistic picture of income performance

4. Q: Impact ……?
A: PolyMedica understated operating expenses, overstate assets, and create a false impression of operating efficiencies.. The assets will be reduced from US$ 250,969 to US$ 186,908 and US$224,392 to US$ 172,280 in 2003 and 2002, respectively. This will lead to a loss of US$ 38,429 for 2003 and a loss of US$ 21,701 for 2002.

5. A: Due to the fact that direct-response advertising expenditures meet the capitalized direct-response advertising costs definition under the SOP 93-7, these costs are capitalized and amortized to selling, general and administrative expenses over next years.

The capitalized direct-response advertising costs definition under the SOP 93-7: A company should capitalize and amortize direct response advertising if : -Its primary purpose is to elicit sales from customers who can be shown to have responded specifically to the advertising. To satisfy the requirements of linking customers and probable economic benefits to specific direct-response advertising, a means of documenting that response is required. The use of 800 numbers, coded order forms, coupons, or response cards; and a log of customers who made phone calls to a number appearing in an advertisement, linking those calls to the advertisement are examples of this. -It results in probable future economic benefits.