FRANCISCO, Marvin P. 30 August 2013Assignment (Polymedia Corporation A) Financial AccountingProf. Aaron C. Escartin

1. Explain the difference between an asset and an expense.a. The difference between an asset and an expense is: An asset

generates a future benefit for a company, while an expense is a cost, which will be deducted from revenue. An asset will add more value to a company while an expense is just one of the costs of doing business. An asset on the other hand, will be showed on the balance sheet and on the basis of this, you can determine the value of a company, while an expense is displayed on the income statement helps to portray profitability of the company. A couple examples of an asset are: inventory of a company, cash and accounts receivable. Furthermore, for expense: payment to supplier, employees’ wages and depreciation. AND/OR

b. An asset represents all things that bring value to a corporation. Some examples of assets would include cash, cash balances in banks, money owed to the company from its customers (receivables) etc.   Asset can also include items that would help within the operational scope such as land, factories, equipment and so on.   Other assets may include items from financial activities such as investments and marketable securities.   Assets can be capitalized over the life of the asset and would depreciate over time. This would allow for a slower recognition of cash burn on a balance sheet.

An Expense is a cost that a company uses to generate revenue and is often considered the cost of doing business. Some items that represent an expense would be cash that is paid to its employees in salary or wages. Depreciation of an asset within the company or any future bad debt that may be a part of the revenue process would also be considered an expense. When an expense has occurred is almost always documented on a financial statement immediately. Expenses on a balance sheet or income statement would also show a negative impact on cash balanced or a reduction in owners’ equity and net income.

2. Explain the role of advertising in the company’s customer-acquisition strategy.

a. PolyMedica utilizes a form of advertising called direct response advertizing. This form of advertising is meant to directly advertise to a certain client. The company then uses different measurement tools to prove that when customer signs up it was because of the advertisement. Another important element for PolyMedica customer is the fact they call in using numbers that represent the commercial they viewed. This is exactly how PolyMedica can relate dollars

spent on the commercial to the customer that was attained. The customer would then be considered long term because of the automotive refill process in 120 days.

Since 1996, PolyMedica had reached a larger portion of the Medicare-eligible patient market through   using an ongoing program of direct-response television advertising.   The campaign resulted in a significant increase in sales as the company expanded its active Medicare-eligible diabetes customers from a approximately 17’000 to approximately 545’000 customers in 2003.

As a result of the expansion of its customer base, and emerging ability to leverage the value of its customer base by marketing a range of products to its customers, PolyMedica was considering a number of new marketing initiatives. The company was also considering expanding its customer base by purchasing businesses that provided products to consumers that were complementary to its existing products.

3. a. What are the arguments in favor of capitalizing the direct-response advertising expenditures? b. What are the arguments in favor of expensing the direct-response advertising expenditures as incurred? c. As a CEO of Polymedia, would you favor capitalizing or expensing the direct-response advertising costs?

a. It will keep company’s income from operations and net income remains reasonably constant without causing the significant losses as they occurred. It will increase the company’s corporate income tax provision through the beginning years. It will decrease the company’s Liabilities to Assets Ratio resulted from increasing the total asset. It will also increase the company’s corporate value and stock price through the beginning years due to that increase the net income through the beginning years.

Under the Statement of Position 93-7(exhibit 2), it indicated that the direct-response advertising that may result in probable future economic benefits that are measurable with the degree of reliability required to report an asset in the financial statements with specific requirements, the amounts of direct-response advertising reported, as assets should be amortized over the estimated period of the benefits, based on the proportion of current period revenue from the advertisement to probable future revenue, subject to a net realizable value test.

For the company that has ability to show the reasonable proof that requested by SOP 93-7, it will better to capitalize direct-response advertising costs, and it will keep company’s operation results more sustainable.

b. It will decrease company’s income from operations and net income through the beginning years compare to capitalization, even cause

net losses. It will decrease the company’s corporate income tax provision through the beginning years compare to capitalization. It will increase the company’s Liabilities to Assets Ratio resulted from decreasing the total asset. It will also decrease the company’s corporate value and stock price through the beginning years due to that decrease the net income through the beginning years.

Under the Statement of Position 93-7(exhibit 2), ruled that most advertising should be treated as an expense, and charged against revenue. An exception was direct-response advertising that may result in probable future economic benefits that are measurable with the degree of reliability required to report an asset in the financial statements with specific requirements.

For the company that doesn’t have ability to show the reasonable proof   that requested by SOP, it will better to expenses direct-response advertising costs, and it will avoid more detailed bookkeeping   workload.

c. From the given circumstances of Polymedica’s direct-response advertising and their implementation of the process, they meet all the capitalization requirements under the SOP 93-7. Therefore we would favor capitalizing the direct-response advertising costs due to that it has positive effects on company’s business operation due to the same reason indicated above (answer for 3a).

4. What would be the impact on the company’s financial statement if Polymedia had expensed the costs as incurred in 2003 and 2002? Calculate key balances that highlight any major differences.

One of the arguments for capitalizing the direct response advertising is that is allows the company to have more cash on hand to operate and invest in the future. If they were to book it as an expense it would have an impact on PolyMedica’s financial statements, which can potentially lower the shareholders confidence. Polymedica’s advertising costs were $64,061 in March 2003 and $52,112 in March 2002 (Hawkins & Cohen, 2003). The company spent an additional $11,949 on advertising in a 12-month period. Selling, general, and administrative expenses were $163,758 in March 2003 and $133,609 in March 2002. By calculating the advertisement as an expense, “advertising expense” increased to $212,177 in 2003 and to $176,107 in 2002. Because total advertising expense is allocated in the expense section on the income statement, if PolyMedica had expensed their advertising there would have been a negative net income in 2003 of $8,162 and $12,087 in 2002. By capitalizing the direct response advertising, it allows PolyMedica to write-off the expense over four years, which gives them a greater net income for each of those years. These will decrees the initial expenses and increase net

income. It will also gradually affect the cash flow of the company.

Impact on BS – Total assets decreased due to the impacts from direct-response advertising, net and cash, and cash equivalents. Shareholder’s equity decreased due to the decrease in retained earnings.

Impact on IS – SG&A increased due to that expensed all the direct-response advertising incurred during the year. Income from operation, tax provision and net income decreased due to the increased of SG&A cost.

Impact on CF - Cash from net income and amortization of direct-response decreased due to that expensed all the direct-response advertising incurred during the year. Direct-response advertising increased due to that expensed all the direct-response advertising incurred during the year. Net cash flows from operating activities, cash and cash equivalents at end of year changed due to the impacts from above reasons.

5. As CEO of Polymedia, how might you respond to this direct-response advertising accounting issue raised by the SEC and short sellers?

Given the PolyMedica’s current business model, the current accounting approach is completely in compliance with SOP 93-7 under GAAP. The external auditors PricewaterhouseCoopers LLP, approved of the company’s treatment of direct-response advertising expenditures.

Recommendation: that the CEO should write a letter to the shareholders expressing on why the management at PolyMedica decided to capitalize the direct-response advertising. The following letter was a template given to the CEO by the 4 consultants.

As CEO, I issue the following statement:This letter is to be served as my respond to the criticism.

PolyMedica Corporation has recently been questioned by the SEC for the method used to capitalize the direct-response advertising. As CEO, I stand firm with the company’s decision to have capitalized direct-response advertising and book it as an asset, although most advertising should be treated as an expense. Through a thorough analysis, we have been able to show that we took the appropriate steps to meet the accounting conditions established by the AICPA.

In view of the criticism, the company has brought external auditors like for example: Price Water House Coopers LLP, to   look at the method used by PolyMedica and they came to the conclusion

that PolyMedica followed all the requirements.   As I express this message to you, I like to make it clear that

this situation does not have any influence in the way this company operates. As well as the decisions made in the past. As head of the company, it take full-responsibility of action and will make everything in my power to prove to you that PolyMedica is a leading company in the world, and that your investment is manage appropriately. The honesty of the management at PolyMedica will not be limited; this company looks at growth and contribution. By using this method, we have seen growth and the demand of our product. Furthermore, this company has goals to meet; the support of you is key to the operation. Do not feel discourage about the situation, but rather look at it as a tool to create more business.

Additional Recommendations:That the CEO, should to write a letter to the (SEC) expressing that

the method used by PolyMedica was effective and created growth for the company. Also, that he (CEO) could add the analysis used by the external auditors to his letter.

That PolyMedica, should explain better to the SEC that PolyMedica is using direct-response advertising, instead of regular advertising. By showing them proof/records, that they meet the requirements needed for recording the direct-response advertising as an asset.

That PolyMedica should estimate and create future financial statements that include net income as well distribute it to shareholders to explain why PolyMedica chose to capitalize the direct-response advertising.