AOL INC (originally known as America Online)

COMPANY OVERVIEW

AOL INC (simply known as AOL) is a mass media corporation based out of New York,
a subsidiary of Verizon Communications. The company own and operates websites
such as The Huffington Post, TechCrunch and Engadget, and spans digital
distribution of content, products, and services, which it offers to consumers,
publishers, and advertisers. It has also positioned itself as major player in the Ad
Tech business. Through its Ad platform business, it caters to both the sell side and
the buy side. Thus placing itself both as a B2B and B2C player.
Aol generates a majority of revenue from its Advertising business. The other sources
of revenue for it are the subscription revenue and the revenue generated from
leasing its intellectual property rights. In this case we study the 2014 annual report
of Aol and answer important questions related to deferred costs.
Q1. What do AOLs Deferred subscriber acquisition costs, net represent?
does AOL account for these costs?

How

AOLs Deferred subscriber acquisition costs, net represents the amount of money
AOL spends on direct response advertising. This does not include any indirect costs
associated with acquiring customers. Direct response advertising consists solely of
the costs of marketing programs which result in subscriber registrations without
further effort required by AOL. These costs relate directly to the solicitation of
specifically identifiable prospects and include the printing, production and shipping
of starter kits and the costs of obtaining qualified prospects by various targeted
direct marketing programs and third parties.

AOL accounts for its subscriber acquisition costs by deferring them in order to
match the associated online services revenue. The deferred costs are amortized
over a period and are determined by calculating the ratio of current revenues
related to direct response advertising versus the total expected revenues related to
this advertising, or twenty-four months, whichever is shorter. All other costs related
to the acquisition of subscribers, as well as general marketing costs, are expensed
as incurred
Q2. How much money did AOL spend on Deferred subscriber acquisition costs" in
1996? How much of this was expensed?
AOL spent $314,181 thousand on Deferred subscriber acquisition costs in 1996. It
expensed $126,072 thousand of it toward amortization of subscriber acquisition
costs.
Q3. According to Note 2, AOL changed the amortization period over which Deferred
subscriber acquisition costs are charged. What effect did this change have on 1996
Net income?

The net income increased by $48.106 million in the year ended June 30, 1996.
According to note 2, AOL modified the components of subscriber acquisition costs
deferred and changed the period over which it amortizes the cost. The company
changed the method from 12 and 18 months to

1. Period determined by calculating the ratio;

Current Revenue relating to direct response advertising Total expected revenues
relating to this advertising Or
2. 24 months, whichever is shorter.
Q4. Refer to the appropriate authoritative literature to determine how AOL should
account for the costs and provide arguments both for and against AOLs treatment
of the costs.
The below is the appropriate authoritative literature to determine how AOL should
account for the costs and provide arguments both for and against AOLs treatment
of the costs.
FASB guideline, SOP 93-7 allows companies to classify the cost of certain types of
direct response advertising as the acquisition of an asset that will provide a future
benefit in the form of increased revenue. In 1994, AOL used this clause to justify
deferring the cost of their direct mailing to potential customers over the following
24 months. However, according to SEC Administrative Proceeding, File No. 3-10203,
AOL misclassified these customer acquisition costs as a capital expenditure rather
than an expense. Paragraph 48 of SOP 93-7 only allows for the capitalization of
customer acquisition costs if the future revenue brought in by these activities can
be directly and reliably measured. This wasnt the case for AOL because it did not
meet the requirements that the cost be amortized on a cost-pool by cost-pool basis
which measures the revenue brought in by the customers who signed up as a result
of the acquisition activity. Another complication was the revenue over following
months was not consistent because of pricing changes and the pressures of a
competitive market.