Is Advertising an Investment or Expenditure?
- Under Generally Accepted Accounting Principles (GAAP), advertising is an expenditure. The expense is found on the income statement and is expensed when it is incurred. The reason accountants treat advertising as an expense is that it is hard to measure the future value of the advertisement. One of the core accounting principles is conservatism. For assets, this means that it is better be wrong and understate assets instead of being wrong and overstating assets.
- In reality, advertising is an investment. Advertising has a carryover effect beyond the current year. Just as equipment is depreciated over a certain period to better match revenues with related expenses, advertising expenses in the current year also help sales in future years. Although accounting treatments are important, in this case, a company may be better off thinking about advertising not as an expense but as an investment.
- For modeling purposes, it may make sense to capitalize advertising expense in a similar way that equipment is capitalized. Although it won't be perfect, it will at least give an investor a better sense of the assets of the company and the proper advertising expense amount. It will also better match revenues with expenses for a company. For companies with erratic advertising budgets, the latter may be especially helpful. For companies with steady advertising budgets, the big advantage will come in knowing the assets of the company and calculating more accurate return on equity and return on assets measures.
Accounting Investments and Expenses
- Examples of expenses in accounting are selling, general, and administrative expense, cost of goods sold, and interest expense. These items will not help a company generate revenue in future periods. The inventory sold will not help the company generate revenues in next periods. It already generated revenues for the company. Examples of investments are computer, building, land, or intangible assets such as trademarks and brand names. A company will be able to use these assets for a long time and they will help the company generate revenues.