Are deferred charges of poor quality?
Deferred expenses depend to a greater extent on estimates of future probabilities than do other assets. The estimates may be overly optimistic. Is the company deferring an item having no future benefit only to defer costs in order not to burden net income? Deferred charges are not cash realizable assets and cannot be used to meet creditor claims.
EXAMPLES: Questionable deferred charges are:
o Deferred exploration costs under the full cost method
o Deferred interest on borrowed funds for self-constructed assets
The higher ratios of deferred charges to total assets, to sales, and to net income indicate more realization risk in assets. Furthermore, 20X5's earnings quality may be lower because deferred costs may include in it items that should have been expensed.
A high ratio of intangible assets and deferred charges to total assets points to an asset structure of greater realization risk. Overstated assets in terms of realizability may necessitate later write-off.
Do off-balance sheet assets exist?
Unrecorded assets are positive aspects of financial position even though they are not shown on the balance sheet.
EXAMPLE: Unrecorded assets include tax loss carryforward benefit and a purchase commitment where the company has a contract to buy an item at a price materially less than the going rate.
RECOMMENDATION Note the existence of unrecorded assets representing resources of the business or items expected to have future economic benefit.
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