Financial Analysis: Debate ensues over estimating ad figures

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When some big marketers deduct advertising expenses to calculate quarterly earnings, they're not really reporting what they spent on ads. Instead, they use sales-based estimates sanctioned by a 1970s standard that one accounting professor sees as outdated and that one marketer, Clorox Co., recently stopped using.

The estimates can smooth swings in ad spending and earnings during the first three quarters of the year-a potentially big advantage given that companies can earn a share-price premium for delivering consistent quarterly results. Companies that use estimates ultimately report actual incurred advertising costs with their full-year results. But they're never required to restate ad spending as it actually was incurred for the prior quarters.

not widely used

While estimating quarterly ad spending complies with U.S. generally accepted accounting principles (GAAP), it isn't used by most major U.S.-based marketers whose financial statements were reviewed by Advertising Age. The practice appears limited mainly to a few household and personal-products marketers, including Colgate-Palmolive Co., Gillette Co. and Kimberly-Clark Corp., plus Yum Brands, owner of Taco Bell, Pizza Hut and KFC.

Clorox, which had used estimates to report quarterly ad spending, shifted to the more common method of recording quarterly ad expenses as incurred starting with fiscal 2003, which began July 1.

"In the past we have had decentralized accounting of our media purchases and less sophisticated tools to forecast our business," a Clorox spokeswoman said. "The prior practice helped us manage that properly, and it's been an industry practice as I understand it for decades. It was consistent with the accounting principle of matching expenses to revenue. We now have more sophisticated tools and processes that allow us to forecast better."

Gillette, however, continues to use the estimates. A spokesman said the practice "smoothes out what would otherwise be undue peaks and valleys during the year, but it's all totaled out at the end of the year."

Colgate and Kimberly-Clark declined to comment. Yum Brands did not respond to repeated inquiries.

"It's really a loophole in the current accounting standards," said Douglas Carmichael, accounting professor and director of the Center for Financial Integrity at Baruch College in New York. He said estimation of quarterly ad spending was permitted by a 1970s Accounting Principles Board opinion that he believes has become an anachronism. "Certainly quarterly reporting was important [in the 1970s]," he said. "But the emphasis that [later] was placed on quarterly earnings and earnings growth by quarter just didn't exist back then."

A 1993 opinion by the American Institute of Certified Public Accountants said companies should report ad spending as it's incurred for annual reports. But the newer opinion didn't affect the higher-ranking APB's opinion on quarterly reporting.

Mr. Carmichael believes accounting-standards bodies eventually may close the loophole, but added: "There are so many other things, like Enron, calling attention to special-purpose entities and a lot of revenue-manipulation issues that are big issues. So this particular"-and entirely legal-"loophole they're not likely to get around to for a while."

A substantial minority of public companies use estimates for some quarterly selling, general and administrative expenses not tied directly to revenue, according to Ed Ketz, professor of accounting at Pennsylvania State University. He sees no problem with estimating quarterly expenses as long as the goal is to reflect accurately what spending will be for the full year.

no big difference

The practice often doesn't produce big directional differences between companies' reported ad spending and U.S. spending numbers reported by Taylor Nelson Sofres' CMR. But sometimes the gap can appear large.

Gillette, for instance, reported a 17% increase in ad spending in the first quarter to $137 million, even as CMR numbers showed a 26% decline in U.S. media spending to $15 million. By the second quarter, however, the numbers jibed better. Gillette reported a 17% increase for the first six months and CMR figures showed a 27% U.S. increase to $108 million.

Besides possible differences in overseas and U.S. ad spending, timing of ad campaigns also could have affected the numbers. Gillette spent heavily on launching its Venus women's razor starting in the first quarter of 2001, but didn't launch big 2002 campaigns for a Venus extension and Gillette Turbo Mach 3 until the second quarter of 2002.

Since advertising's impact extends well beyond one quarter, estimating ad spending based on sales follows the principle of matching earnings to revenue, said Bill Steele, analyst with Banc of America Securities. Although estimating quarterly ad spending opens the door for companies to cut ad budgets without telling investors until year-end, Mr. Steele said: "They'll eventually be found out." For companies that estimate quarterly ad spending, shifts in accrued ad expenses and liabilities are among red flags that can give analysts and investors warning of ad cuts before fourth-quarter results are released.

contributing: kate macarthur

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