SafeCard Services Inc. Case Study

SAFECARD SERVICES, INC. CASE STUDY

I. FACTS/GIVEN DATA SafeCard Services Inc. had a credit card loss notification service called Hot-Line. For an annual fee, SafeCard would notify the customer’s credit card issuers if the credit cards were stolen or lost. The Hot-Line service was marketed through direct-mail advertising campaigns. The customer of a credit card issuer would be sent a description of the Hot-Line service. This explains that the Hot-Line service customer would give SafeCard the information of all the customer’s credit card issuers. SafeCard will then give a toll free number to the customer. SafeCard will assist the customer in case of loss or theft and they will also automatically notify the credit card issuer to cease honoring it. The customers were offered a six month free period and if the customer accepts, at the end of the period, the customer could cancel or continue the service. The credit card company would automatically bill the customer $12 for the annual fee. SafeCard incurred substantial costs for obtaining new customers mainly because of the direct mail descriptive materials and postage. Until fiscal year 1980. SafeCard capitalized these costs of obtaining new customers and amortized them over three years. Beginning fiscal year 1980, SafeCard extended amortization period to 10 years. When a new subscriber would sign up for a year’s paid Hot-Line service, SafeCard debited Accounts Receivable for $12, credited about 80% of this amount to Customers’ Advance Payments and credited the remainder to Allowance for Cancellations. Also, SafeCard paid an annual commission to the credit issuers through which the subscription was acquired. The commission was deducted by the credit card company from the subscription revenues it remitted to SafeCard. SafeCard then debits Cash for the actual cash payment and debited Prepaid Direct Marketing Costs for the commission. The $12 was credited to Accounts Receivable. These commissions and the prepaid revenues credited to Customers’ Advance Payments were amortized on a straight line basis over 12 months. SafeCard’s accounting practices were criticized by Professor Abraham J. Briloff. The professor pointed out that the costs incurred for the direct marketing to obtain new subscribers were incurred for tax purposes. SafeCard reported a loss to the IRS but reported a profit to the shareholders. The professor also stated that there were inconsistencies with the company’s financial accounting practices. Although there were great losses to the company, it reported substantial profits to its shareholders.

II. STATEMENT OF THE PROBLEM

What steps can the management of SafeCard undertake to amend their financial statements and correct the figures of their profits or losses? III. OBJECTIVE  Change the category of their marketing costs. Alternatives: 1. Capitalize the marketing costs during the free trial period of six months and amortize evenly over the next twelve months, as Professor Briloff suggested. 2. Write off the marketing costs as expenses as they are incurred. 3. Capitalize the marketing costs during the free trial period of six months and write off as expense at the end of the trial period.

IV. EVALUATION OF ALTERNATIVES 1. When the advertising campaigns are mailed to the customer, the costs for the material and postage are capitalized during the free trial period. It can be counted as an asset because the customers to whom the mail were sent are potential subscribers. As the period ends, the customer might avail of the service. At this time, the asset can now be written off evenly as an expense throughout the period of the subscription which is twelve months. This approach is less complicated than having to capitalize the cost over a few years. 2. Writing off the cost as expense directly could acknowledge directly the cash used in the marketing of the service. The expense was already incurred whether the customers subscribe or not. 3. This is a combination of the first and second alternative. The costs are capitalized during the trial period where there is a possibility of gaining new subscribers and written off as an expense after the period. V. CONCLUSION/RECOMMENDATION Since the accounting practice of SafeCard Services made them commit mistakes and suffer from losses, the alternatives might make the situation better. It makes the process less complicated and it shows directly how the company’s assets stand.