AOL was simply attempting to follow the matching principle. If AOL's management had been correct in its estimate of the number of customers it would get as a result of the mailing campaign and the length of time these customers would remain with the Company, then AOL's accounting treatment (capitalizing the costs as an asset) would have been appropriate. However, because the number of customers and the average subscription time were different than anticipated, AOL's accounting treatment turned out to be wrong - booking these charges as assets for a two-year period violated the matching principle.
3. What do you think is meant by the term the "quality of earnings" (see page two of article, top paragraph). What, in your opinion, would constitute "high" quality earnings?.
"Quality of earnings" refers to the extent to which the income number describes the economic reality of the company. A "high" earnings quality is obtained if the accounting rules selected by a firm generate an income number that closely relates to its economic performance (as measured, for example, by its stock price performance). "Low" earnings quality results if the company produces financial reports that make the company appear to be far more profitable than it actually is. .
4. Which financial statements were affected by the charge? How?.
The Balance Sheet and the Income Statement were affected. When AOL elected to write off the "Deferred Subscriber Acquisition Costs" asset from the Balance Sheet, it recorded an expense of $385,221,000 ($4.03 per share). This reduced both asset account and net income.
Journal Entry: Subscriber Acquisition Cost Expense (an expense) $385.2 million.
Deferred Subscriber Acquisitions Costs (the asset) $385.2 million.
5. Which financial ratios will be affected by the charge?.
Any ratios that involve assets, Retained Earnings and Net Income will be affected. Since some of the "Deferred Subscriber Acquisitions Costs" will presumably reverse within a year, they would have been held as current assets.