Aol Case Study Essay examples

1203 Words May 20th, 2009 5 Pages
AOL Case Study

1. What accounting approach has AOL used in the past that it is now changing (related to the $385 million)?
Prior to October 1, 1996, AOL accounted for the cost of direct response advertising as "Deferred Subscriber Acquisition Costs," i.e., it recognized (reported) the costs of mailing out diskettes allowing you to sign-on to AOL for 100 free minutes as an asset on its Balance Sheet. In accounting, we say that the costs were "capitalized," meaning reported on the Balance Sheet as an asset. This is in contrast to the costs being "expensed," flowing to the Income Statement immediately as an expense.

The asset, Deferred Subscriber Acquisition Costs was amortized, beginning the month after such costs were incurred,
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9. It is reported (paragraph 3) that AOL's share price rose on the news of the accounting change.

(a) Do you think that accounting changes drive stock prices? Comment.

In a rational market, stock prices are determined by the ability of the firm to generate cash flows in the future. Accounting changes that do not affect future cash flows should not affect stock prices.

(b) What else might have caused AOL's share price to move upward?

Many reasons might explain the change in the stock price, including:

(i). Investors interpret this change as a sign that management's view about the prospects of the firm have improved; consequently they revise their expectations upward, bidding up the stock price.

(ii). Investors believe that this is the appropriate manner to report these costs. Switching to this new procedure thus reduces expected litigation costs.

(iii). This improved disclosure increases the informativeness of earnings, which allows investors to predict future cash flows more accurately. Investors, disliking uncertainty, are now willing to invest in AOL for a lower (expected) return and thus bid up the stock price.

10. AOL mentions a charge of $75 million. Explain the nature of this charge and how it will affect the financial statements.

The $75 mil. consists of two components:

(1) $48,627,000 is restructuring charge whose components are: Write-off of impaired assets and discontinued businesses $31,215,000, Severance and

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