FRANCISCO, Marvin P.

30 August 2013
Assignment (Polymedia Corporation A) Financial Accounting
Prof. 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 companys 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 17000 to approximately 545000 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 companys income from operations and net income
remains reasonably constant without causing the significant losses
as they occurred. It will increase the companys corporate income
tax provision through the beginning years. It will decrease the
companys Liabilities to Assets Ratio resulted from increasing the
total asset. It will also increase the companys 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 companys operation
results more sustainable.

b. It will decrease companys income from operations and net income
through the beginning years compare to capitalization, even cause
net losses. It will decrease the companys corporate income tax
provision through the beginning years compare to capitalization. It
will increase the companys Liabilities to Assets Ratio resulted from
decreasing the total asset. It will also decrease the companys
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 doesnt 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 Polymedicas 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 companys business operation due to
the same reason indicated above (answer for 3a).

4. What would be the impact on the companys 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 PolyMedicas financial
statements, which can potentially lower the shareholders
confidence. Polymedicas 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.
Shareholders 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 PolyMedicas 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 companys 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 companys 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.