Protectomatic, Inc., (PI) ran a credit card loss notification service called Loss-Link. For an annual fee of $12, PI would immediately notify a subscriber’s credit card issuers (such as American Express, Master Card, Visa, oil companies, department stores, and so on) if the subscriber’s credit cards had been stolen or lost. Loss-Link was marketed through direct-mail advertising campaigns in conjunction with several credit card issuers.
PI's marketing approach was as follows. First, a credit card issuer sent a description of the Loss-Link service to its customers, all of whom were considered potential Loss-Link subscribers. At this point, the potential subscribers were called “prospects.”
The description explained that PI would keep a list of each subscriber’s credit cards on file. The subscriber would be given a toll-free number to call to inform PI if his or her credit cards had been lost or stolen. Once notified, PI would immediately contact the relevant credit card issuers and tell them to cease honoring the cards. PI also would assist its subscribers to obtain replacement cards.
Second, each prospect was offered six months of free service. At the end of the six months, the credit card issuer through which PI had reached the prospect initially would bill him or her $12 to continue the service for a year. At this point, the prospect could either cancel the service or pay the $12 to continue it.
About 50 percent of the prospects paid to continue the service after their six-month free trial. Those who subscribed in this way were automatically billed by the credit card issuer every 12 months to renew the service for another year. According to PI, although a subscriber could cancel when the bill was received, about 80 percent of the paid subscribers renewed the service for the following year.
PI incurred substantial costs in obtaining new subscribers, primarily for direct-mail materials and postage. PI capitalized these costs as a noncurrent asset, called “deferred marketing costs.” Until fiscal year 2000, PI had amortized these costs over three years, with the unamortized portion of the costs remaining in the “deferred marketing costs” account on the balance sheet. . . .
- Identify two accounting issues that you think have a significant effect on the information presented in Protectomatic’s financial statements. Explain the importance each and its potential impact on any ratio or other analysis you might do of the financial statements.
- Identify two issues associated with the financial management of Protectomatic that you think are important for individuals considering a purchase of the company’s stock. Explain why you believe each is significant and what it means to a potential investor.
- Make one recommendation to PI’s senior management for a way that the company’s accountants might improve the presentation of the company’s accounting information so as to better inform readers of the company’s financial performance. Explain your rationale for this recommendation and how it would affect the information reported on the financial statements.
* Some suggestions for how to go about answering these questions are contained in Exhibit 4.