Until now, AOL has been deferring the cost of a portion of its marketing activities, such as mass-mailing diskettes to prospective customers. The company would then amortize these costs over a period of time, rather than accounting for the full amount during a single quarter, a technique that appears to boost earnings for the current quarter.
While this is perfectly legal, it has made it difficult for investors to assess the real level of the company's earnings. It also made Wall Street feel like AOL was hiding something.
But today AOL said it will bite the bullet and take a charge of approximately $385 million when it reports its first-quarter results for the period ending September 30. The company said it will also immediately begin to take any future expenses as they occur.
"This does away with Wall Street's criticism about their accounting practice," said Paul Saunders, an analyst with Van Kasper & Company. "It wasn't illegal but it wasn't the most conservative. Their method would show much higher earnings than what they actually had.
"This charge will have a substantial impact on their earnings, but on the whole it's a positive move for the company," Saunders added. "This action may help their stock. There's been the perception that this accounting method has been a continual drag on their stock because the income statement didn't fully reflect the reality of their business."
Abhishek Gami, an analyst with Nesbitt Burns Securities in Chicago, estimated that 25 percent of AOL's stock is sold short because of its accounting methods. Today's announcement may boost the AOL stock, which has been trading near a 52-week low.
"All the investors who had been nervous about trusting the numbers may buy the stock," Gemi said.
AOL's decision is a change from what has been a traditional practice among online service companies, which rely almost exclusively on their subscriber base for revenues. CompuServe, for example, has a similar method of accounting for marketing costs associated with attracting new subscribers, according to a CompuServe spokeswoman.
But CompuServe isn't sure yet if it will follow AOL's example. "We'll probably ask our auditors and accountants who have recommended this practice if this is the way we need to report it as a result of AOL's announcement," she said.