Accumulated Earnings and Deferred Compensation

Application problems of the Bardahl formula

There are 3 problems that should be considered when applying the Bardahl formula:

• Imprecision. The formula is imprecise. Results depend on how data is used in the formula. This can lead to contrary interpretations of the company’s true situation.
• Cash flow. The formula measures working capital and not cash. So, the corporation may find itself in a position where it’s subject to a tax liability without having the cash required to make a distribution to stockholders. However, a statement of the corporation’s cash flow can usually be used as a defense against a tax liability.
• Valuing assets. The third problem is a question of whether to value assets used in determining working capital needs by cost or current market value. Courts have said that current market value should be used for marketable securities. For other assets, there is no definitive answer except that it’s probable that the IRS will consider the current market value to be correct.
• Service Companies. The formula needs to be adjusted when applied to most service companies. The inventory cycle needs to be replaced with a calculation that measures hours or costs associated with producing a service or project.