Prepaid expenses and their treatment in the balance sheet;

              26 HASKINS & SELLS April
Prepaid Expenses and Their Treatment in the Balance Sheet
By L. E. PALMER, Assistant Manager, New York 39th Street Office
APROPOS of the present interest in
the relations among bankers, bor­rowers,
and accountants, the considera­tion
of prepaid expenses and other de­ferred
charges and their treatment in the
balance sheet may be worthy of attention.
Accounting generally takes cognizance of
such items and they are usually included
in balance sheets properly drawn up.
There is ample precedent for such proce­dure
in the rulings of the Interstate Com­merce
Commission and other govern­mental
bureaus and boards. The ques­tion
is perhaps one of where they should
be set forth in the balance sheet, rather
than one of whether or not they should be
included. The question bears partly on
their value as quick assets, or the bearing
which they have on the liquid condition
of a given organization.
In respect of this group of accounts,
comprising prepaid insurance, rent, taxes,
etc., there is often a marked difference of
opinion as between the manufacturer and
the banker. The manufacturer frequently
considers all expenses of this nature to be
a part of cost. The banker generally
holds all such items to be intangible, not
possible of realization in cash, and there­fore
not properly included among the
quick assets. There is an obvious incon­sistency
in the policy of the manufacturer
who contends that insurance, rent, taxes,
etc., constitute a part of his manufacturing
cost, and at the same time, classifies a
portion of such expenses under deferred
assets, whereas another portion has been
included in the value of inventories of
work-in-progress and finished goods.
Excepting there be need to compare
production cost of factories owned and
factories rented, the writer can see no
great harm in the inclusion in operations
of items of this nature, so long as they
apply directly to property used for manu­facturing
purposes. He is of the opinion,
however, that to conform strictly with
economic theory they should be excluded
from manufacturing costs and included
in general expenses or deductions from
income. In any event, the point is again
made that if certain expenses are compre­hended
in manufacturing costs, any de­ferred
portions of these expenses should
be carried in the same section of the
balance sheet as inventories. It is gener­ally
necessary to convert raw materials into
finished stock, and finished stock into
accounts receivable, before it is possible
to realize any cash. It is necessary to do
no more than this in the case of prepaid
operating expenses.
The banker's attitude in the matter is
generally opposed to the inclusion of such
items. He casts them aside immediately
in making his calculations. If they are
set out separately, his work in this respect
is facilitated. If they are merged with
other items so as not to be readily recog­nized,
the banker, through analysis, pur­sues
them, so to speak, until they are
identified and extricated from their con-