164 ShowMetheMoney
portion of loans deemed uncollectible is recorded as an expense (a
debit). The credit is to an account called Allowance for Doubtful
Receivables.
Instea dof treating all ba dloans as expenses, Mercury Finance
apparently decided that even if a borrower was not going to pay,
somehow the company woul drecover the money (by repossessing
the borrower’s car, for example). In the bookkeeping, a debit was
made to an asset account called Other Assets to reflect the right to
repossess rather than to an expense account to reflect that the loan
probably was never going to be paid. With fewer reported expenses,
Mercury Finance reporte dfar higher earnings.
A bright re dflag flew over Mercury Finance’s financial state-
ments. The Other Assets account on its balance sheet rockete dfrom
$24.6 million at the en dof 1994 to $121 million a year later. Even if
the account included other assets besides repossession rights, the
striking increase shoul dhave seeme dpeculiar to anyone with a little
accounting sense (or even common sense).
America Online
America Online’s asset- an dexpense-flipping imbroglio resulte dfrom
treating disbursements for developing a subscriber base not as a cost
of doing business (an expense) but as an investment in the business
(an asset). While this is exactly what was done in the National Stu-
dent Marketing scandal of the late 1960s and early 1970s, there was
a judgment to make here.
One coul dliken on-line services to newspapers an dfollow that
industry’s practice of expensing these costs, or one could analogize
to direct mail order companies and follow that industry’s practice of
capitalizing them—treating them as assets whose cost is allocated
over future accounting periods.
In choosing between these treatments, the accounting issue is
whether the disbursements will contribute reliably to revenue gen-
eration in future periods. As it turned out, America Online could
not gauge for how long its new subscribers woul dremain customers,
an dso there was no basis for saying the disbursements woul din-
crease future revenue.
Maybe it was reasonable for AOL’s managers an dau ditors to
make the judgment they made. After the horrible press coverage and
class action shareholder lawsuit that resulted, however, you can be
sure they regret it.