Advertising is the promotion of a company, brand, or specific products or services to create a positive image or to create desire to buy a company’s products or services. While advertising historically relied on broad-reach media like mail, TV, and print, the shift toward digital advertising allows companies to leverage precise targeting and measurability. Through promoting products/services through online channels like sponsored search engines searches, social media, websites, and apps, organizations are able to reach specific audiences and drive buyer actions quickly. As such, organizations may have a large volume of prepaid or accrued advertising costs to account for.
Accrued and prepaid expenses
Accrued expenses, also known as accruals, are expenses for goods or services an organization has used or received that they pay for at a later date. For example, a business might incur an expense for advertising services that accrues over the period when they’re gaining the benefit but they don’t receive an invoice until after the service period has ended.
When a business establishes an accrual, they recognize a journal entry which includes a debit to the expense for the good/service used and a credit to an accrued liability.
The opposite of an accrued expense is a prepaid expense, also known as a deferred expense. Prepaid expenses are paid in advance of receipt of the good/service rather than after, and are therefore treated as an asset rather than a liability.
While accrued and prepaid expenses are the opposites of one another based on the timing of the payment in relation to the expense/service period, they are similar in that they are often expensed over multiple periods using the accrual basis of accounting, and in both cases, the expenses would be recognized over the full usage period and not necessarily when they are actually paid.
The concept of accrual accounting differs with that of the cash basis of accounting:
- Cash Basis Accounting: Under the cash basis of accounting, revenues and expenses are recorded only when cash physically changes hands.
- Accrual Basis Accounting: Under the accrual basis of accounting, revenues are recorded when they’re earned and expenses when they’re incurred, regardless of when cash is paid.
For a full explanation of the difference between the Cash Basis and the Accrual Basis of Accounting, read more here. Additional specific guidance around how to account for advertising expenses under US GAAP is in ASC 720-35.
Example: Accrued digital advertising with Google Ads
Assume your organization’s marketing department runs monthly Google Ads to advertise your company’s product or services. Google allows most organizations using Google Ads to run advertising campaigns with a credit card, debit card, or e-wallet as the primary payment method, which makes paying for services simple.
However, for some advertisers, Google may decide to assign your account to either their Large Customer Sales (LCS) or Google Customer Solutions (GCS) High Touch sales teams. When you’re assigned one of these sales teams, Google also requires that the payment method for the customer’s account be switched over to either monthly invoicing or automatic payments via direct debit. Many advertisers choose monthly invoicing, but the charges for pay-per-impression or pay-per-click (PPC) advertising on Google are usage-based, so this creates a type of accrual.
The vendor typically sends the invoice after the month ends based on the volume of activity and it is received and paid within 30 days after the service period. During the month-end close process, accounting must estimate the accrual based on various factors, such as historical performance, estimated activity, etc. (for more information on estimated accruals, click here). Assume the company estimates that the performance of the ad would cost $80,000. At the end of the month, despite not having received an invoice yet, accounting makes the following entry:
After receiving the invoice for $83,500, accounting realizes that the cost of the ad exceeded the original $80,000 estimate and makes the appropriate entry in the current period to adjust for the additional accrual:
Once the payment is finally made and processed through AP, the entry is made to reduce the accrued liability and to send the cash out the door. (The entry below and immediately above could potentially be combined depending on the timing).
Example: Prepaid digital advertising
Let’s look at a real-world example of a company’s prepaid advertising expense. Your company’s marketing department purchases 12 months of banner advertising on a website. You prepay for the entire year, up front, for ads starting in January of the following year, but pay for it in December in advance.
The entry that accounting would make when the payment is made in December is the following:
At the end of January-December of the following year, as your company uses the banner advertising space, the prepaid advertising is converted to advertising expense. The cost of the straight-line expense each month is $2,000 ($24,000/12 months).
The following entry is made in January-December of the period of usage:
Accurate accounting for advertising costs, including digital advertising, requires organizations to identify the service period and recognize either an accrued advertising liability or a prepaid advertising asset based whether the service period comes before or after the invoice and subsequent payment. As companies move more and more into the digital advertising space, keeping track of the various advertising accruals and expenses can be difficult to do without a dedicated system. Automating the process with a dedicated system like FinQuery can help remove the manual steps and lessen the workload. Schedule a demo today!
