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Marketing Definition and Operation of Advertising Expenses

What Are Advertising Costs?

Advertising costs are a type of financial accounting that covers expenses associated with promoting an industry, entity, brand, product, or service. They cover ads in print media and online venues, broadcast time, radio time, and direct mail advertising.

Key Takeaways

  • Advertising costs are categorized as those expenses associated with marketing a company's brand, product, or service via media outlets.
  • Advertising is defined as the paid distribution of a controlled marketing message found in print ads, radio or TV broadcast, online, or via direct mail.
  • Advertising costs are sometimes recorded as a prepaid expense on the balance sheet and then moved to the income statement when sales relate to those costs come in.

Understanding Advertising Costs

Advertising costs will in most cases fall under sales, general, and administrative (SG&A) expenses on a company's income statement. They are sometimes recorded as prepaid expenses on the balance sheet and then moved to the income statement when sales that are directly related to those costs come in.

For a company to record advertising expenses as an asset, it must have reason to believe those specific expenses are tied to specific future sales. Then, as those sales occur, those advertising expenses are moved from the balance sheet (prepaid expenses) to the income statement (SG&A).

Advertising costs are typically not a surprise to a business owner. In fact, many will have budgeted for a certain amount of advertising costs. The U.S. Small Business Administration notes that most companies set their marketing budget based on revenues.

Many small business owners report spending as little as 1% of their annual business income on advertising. If you single out manufacturers and wholesalers specifically, the number is closer to around 0.7% of annual revenues spent on advertising as of 2020.

Simply spending the money is no guarantee, of course, that a business will get the return on investment they want with their ad expenditures. As such, business owners need to make sure they're spending their advertising budget in the right places, where the audience is likely to include potential buyers of their product or service. Some media outlets offer a 40%–50% discount for running ads in slots left open due to cancellations.

Whatever a business spends on advertising, the point is to maximize the ROI of advertising costs. This can be difficult because there is no shortage of advertising opportunities out there to consider. The best bet is to settle on a set of business goals and build a program around those.

The U.S. Small Business Administration notes that many businesses set their marketing budget as a percent of revenue. Business to consumer (B2C) companies generally spend more than business to business (B2B) and service companies spend more than product companies.

Example of Advertising Costs

For example, if a company launches a direct mail campaign and it knows that future sales are due to that campaign, it will record the cost of the campaign on its balance sheet as an asset, a prepaid expense. Over time, as customers respond to the campaign, those direct mail expenses will be moved from the prepaid expense category to the advertising cost category.

The company must be able to demonstrate that those advertising expenses are directly related to those sales. It may use historical data as evidence to do so. That is, if the company knows, for example, that in the past when it sent out 1 million pieces of direct mail, it received 100,000 responses, it may apply this ratio to future sales coming from a future direct mail campaign.

Promotion expenses, while related to advertising expenses, are far more generalized and generic measures meant to increase brand awareness. A promotion may include product samples, giveaways, or sweepstakes. Expenses devoted to promotion and for advertising are accounted for as separate items.

Why do companies spend money on advertising?

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Advertising is a way to increase a company's sales through brand or product awareness and to inform about new products or features. Several studies show that advertising does, generally speaking, work to boost revenues

How do companies measure how effective their advertising dollars are being spent?

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There are several metrics of advertising cost efficiency. The advertising-to-sales ratio (or "A to S"), for instance, simply looks at advertising costs divided by overall sales for a given period.

How much should a company spend on advertising costs?

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Companies should develop an advertising budget that maximizes the return on advertising dollars. This budget should be made with target customers in mind and with a message that will resonate with those individuals.


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