Aol Case Study Essay

1227 Words5 Pages
AOL Case Study

1. What accounting approach has AOL used in the past that it is now changing (related to the $385 million)?
Prior to October 1, 1996, AOL accounted for the cost of direct response advertising as "Deferred Subscriber Acquisition Costs," i.e., it recognized (reported) the costs of mailing out diskettes allowing you to sign-on to AOL for 100 free minutes as an asset on its Balance Sheet. In accounting, we say that the costs were "capitalized," meaning reported on the Balance Sheet as an asset. This is in contrast to the costs being "expensed," flowing to the Income Statement immediately as an expense.

The asset, Deferred Subscriber Acquisition Costs was amortized, beginning the month after such costs were incurred,
…show more content…
Thus the Current Ratio would decrease as a result of the write-off. The Debt/Equity ratio will increase as a result of the write off, since Retained Earnings will reflect the expense. All profitability ratios, Return on Sales, Return on Assets, Return on Equity and EPS, will decline as a result of the lower net income.

6. What was the cash impact of the charge?

As noted in the journal entry in (4) above, there is no cash impact of the charge. (The cash was spent back when the mailing campaign was conducted - a couple of years ago.)

7. Why does Mr. Vohra, an analyst say that "The earnings numbers were meaningless - they were a house of cards"?

Reporting subscriber acquisition costs as an asset allowed AOL's management lots of discretion in determining net income because the amount capitalized and the level of the amortization expense are both determined by managers. As a result, it was not clear whether AOL's income number is a good measure of the economic performance of the firm. Managers could have taken advantage of this situation, distorting the income number in order to get some personal benefits (e.g., higher bonuses, a higher stock price which would add to their personal wealth, etc.).

8. What was "aggressive" about AOL's accounting approach

Reporting subscriber acquisition costs as an asset rather than an expense is "aggressive" (as opposed to "conservative"). As noted above, capitalizing costs as

More about Aol Case Study Essay

Get Access