America online

Objective

Q1. Prior to 1995 why was AOL so successful in the commercial online industry relative to its competitors CompuServe and Prodigy?

Ans : It was because of these factors : 1. Cost leadership :a.) Rate structure was easiest to understand. b.)No additional charges were charged for premium services and downloads unlike their peers.

2.)Promotion and customer acquisition plan

a) Direct mail packets with AOL software disks b) Television and print advertising featuring a toll free number for ordering the AOL software c) Co-marketing efforts with computer magazine publishers and personal computer hardware and software producers. d) First 10 hours of access were free.

3.)Joint ventures :a.) With America Express, ABC, Reuters, Shoppers Express, Business Week, Fidelity and National Education Association. b.)Also created special interest sites like Motley Fool and Follywood c.)These kept customers online and increased metered time and revenue.

Q.2 As of 1995, what are the key changes taking place in the commercial online industry? How are they likely to affect AOLs future prospects?

 Key changes: a.)Entry of MSN It offered content providers a larger share of revenues and greater control over their own products. b.)Introduction of World Wide Web WWW shrunk the role of middleman as anyone can publish their own content. Thus, content providers got full control over their content.

 Effects on AOL: a.) Content providers shifted from AOL as they were getting less revenue even with a high customer base. b.)Thus, there was reduction in the number of subscribers of AOL which subsequently reduced their revenue.

Q.3 Was AOLs policy to capitalize subscriber acquisition costs justified in 1995?

Prior to 1995, AOL was the market leader, thus it was justified to capitalize the subscriber acquisition costs because they forecasted that they will have a sustainable customer base implying a long term investment

Q.4 Given the changes discussed in question 2, do you think AOL should change it accounting policy as of 1995? Is the companys response consistent with your view?

 Yes, there should be a change in the accounting policy of AOL because of the introduction of new competitors in the form of MSN and WWW, which led to the creation of a competitive market and the reduction of revenue of AOL. So, the amortisation period should be reduced to show the clearer picture of the company.

 But the companys response is not consistent with our view as it amortised over a longer period of time, thus depicting a rosy picture on the Wall Street and instilled a false faith in investors.

Q. What would be the affect on AOLs 1994 and 1995 ending balance sheets if the company had followed the policy of expensing subscriber acquisition outlays instead of capitalizing them? What would be the effect of expensing subscriber acquisition costs on AOLs 1995 income statement?

a.)For fiscal years 1994 and 1995, AOL capitalized most of the costs of acquiring new subscribers as "deferred membership acquisition costs" ("DMAC") -- including the costs associated with sending disks to potential customers and the fees paid to computer equipment manufacturers who bundled AOL software onto their equipment -and reported those costs as an asset on its balance sheet, instead of expensing those costs as incurred. Substantially all customers were derived from the above direct marketing program.

b.) For fiscal years 1993, 1994 and 1995, AOL (generally) amortized DMAC on a straight-line basis over a 12 month period. Beginning July 1, 1995, the company increased that amortization period to 24 months

c.)At July 1, 1994, the beginning of AOL's 1995 fiscal year and June 30, 1995, the DMAC on AOL's balance sheets were $26 million and $77 million respectively, or 17% and 19% of total assets, and 26% and 35% of shareholders' equity. Had these costs been properly expensed as incurred, AOL's 1995 reported pre-tax loss would have been increased from $21 million to $98 million (including the write-off of DMAC that existed as of the end of fiscal year 1994).