Many small-business owners are justifiably perplexed about how to treat advertising costs on their financial statements. Industry professionals often refer to advertising as an "investment" on a par with building and equipment. Buildings and equipment are reported on financial statements as depreciated capitalized assets, but advertising costs are generally not assets for financial reporting purposes. They must be expensed according to guidelines from the Internal Revenue Service and the Financial Standards Accounting Board, barring certain well-defined exclusions.
When you report advertising expenditures as expenses, they appear on your income statement as "fixed" or indirect costs in the cost grouping that includes rent, utilities, telephone and administrative salaries. These are fixed costs because they exist independent of sales. You have these costs whether or not you're generating sales. Expensed advertising expenditures reduce profits, thereby reducing your tax liability.
Except for current period amortized costs, advertising as capitalized assets appear mainly on your balance sheet where the impact on profits is reduced. Capitalized advertising costs are amortized on the balance sheet as intangible assets and expensed on the income statement in the way patents and other intangible assets are reduced in value over time.
Direct response advertising is an exception to expensing advertising costs. It can be capitalized if you can prove that new customers responded specifically to your advertising. Other instances where advertising might be capitalized remain cloudy. These include production costs associated with advertising, advertising costs associated with a new business startup, catalog production and printing, package design and advertising to open new channels of distribution.
The IRS has either lost court cases or conceded court cases in recent years involving these kinds of advertising expenditures. As a small-business owner, it would be safer for you to view these exceptions as "outliers" litigated by deep-pocket large corporations that can afford to take on the IRS, as they did in RJR Nabisco, Inc. v. Commissioner of Internal Revenue, 76 TCM 71 (1998).
Capitalized assets generally have predictable future values that can be quantified over the useful lives of the assets. Most advertising is expensed rather than capitalized, precisely because it is difficult, if not impossible, to quantify its future economic value. Consequently, the IRS requires that you expense advertising as the costs are incurred. For advertising expensing purposes, the IRS currently includes media expenditures, print costs, point-of-purchase material and marketing promotions. You can expense costs related to the production of television advertising over the life of the campaign.
The justification for expensing advertising costs is predicated on the uncertainty of the future value of advertising. However, quantifying and measuring the return on advertising investment, or ROI, have become increasingly more sophisticated with the growing use of the Internet and digital marketing practices. One of the allures of digital marketing is the ability to calculate advertising's ROI with greater precision, which the Internet makes possible. Consequently, the financial reporting of advertising expenditures could remain an evolving issue. You can avoid possible costly errors on your tax returns by having your tax adviser inform you of changes to IRS advertising reporting guidelines. Always get professional help when in doubt.