If your business involves door-to-door summer sales, an arcane accounting method known as capitalized creation costs could provide a great opportunity.
Capitalized Creation Costs
Capitalized creation costs are the incremental direct costs a business incurs to obtain a customer contract that it intends to hold and not sell. The intent to hold the contract obtained is critical to capitalizing creation costs related to obtaining the contract. For instance If you’re an alarm company that generates 10,000 sales in a summer and you sell all of those contracts off to Monitronics, ADT or another buyer, then you cannot capitalize incremental direct costs incurred in obtaining the contract. On the other hand, if you’re an alarm company that generates 10,000 sales in a summer and you have the financial backing to hold onto all those contracts, then you can capitalize your incremental direct costs incurred to obtain those contracts. There are big potential benefits in the alarm industry, for example, where costs generally include equipment costs, sales representative commissions, as well as costs associated with technicians that install the equipment. It is recommended that you track all of these direct costs on a contract by contract basis, and U.S. generally accepted accounting principles (GAAP) requires that these costs be amortized over the expected life of the customer regardless of the contract term. The reason for this requirement is this results in revenues and expenses being properly matched in the correct period.
No Definitive Guidance from the FASB
The Financial Accounting Standards Board (FASB) has not issued definitive guidance forbidding or requiring companies to defer costs directly related to acquiring a customer contract. An updated Revenue Recognition Exposure Draft (November 14, 2011) makes it clear that companies are to capitalize incremental costs in obtaining a contract, but it is unclear when that will be effective. Yet authoritative guidance already exists that supports the capitalization of incremental direct costs.
FASB ASC 605-20-25-4 (revenue recognition for services) states the following:
Costs that are directly related to the acquisition of a contract and that would have not been incurred but for the acquisition of that contract (incremental direct acquisition costs) should be deferred and charged to expense in proportion to the revenue recognized.
FASB ASC 310-20 deals with accounting for nonrefundable fees and other costs. As outlined in this subtopic, costs eligible for deferral are those that relate directly to a specific loan and are either (1) incremental direct costs incurred with third parties or (2) certain internal direct costs related to origination activities.
The guidance in the accounting standards codification (ASC) above presently support capitalizing creation costs related to obtaining a contract.
Why Is This Important to Your Business?
If you’re a company that obtains customer contracts and then delivers the services under those contracts over an extended period of time (beyond 1 year), then to misunderstand this concept puts your business at risk of presenting a financial picture that appears to be far worse than it really is.
Failing to capitalize direct costs results in a very poor picture of the company’s operations, which can have negative consequences when seeking additional financing from banks or private equity investors. Also be aware that IRS rulings exist that still allow you to expense these costs as incurred while capitalizing them on your books for financial statement purposes.