Accounting Flashcards
1
Q
What are the 3 financial statements?
A
Income statements (i.e., some call it Statement of Earnings, or P&L), Balance Sheet and Cash Flow Statements.
2
Q
Walk me through the 3 financial statements?
A
The income statement tells the story of the company’s ability to make money, documenting revenue, various expenses, including taxes and all the way down to net income, which gets carried to change the Retained Earning Balance in the Balance Sheet and flow through as the starting point of the Cash Flow Statement.
Balance Sheet reflects asset, liabilities and equity items. Some important ones for Asset are Cash, Marketable Securities, Account Receivables, Inventory, PP&E, Prepaid Expenses and Intangible Assets. The other sides are liabilities, such as Account Payables, Accrued expenses, Deferred Revenue, AND Shareholders’ Equity. The sum of them should equate to total asset.
Lastly, it is that Cash Flow Statement, the one that reconcile the cash flows from three business activities, over a period of time. The statement relies on income statement and the working capital change that is based on Balance Sheet. Meanwhile, Cash Flow Statemen also outline important information, such as Capital Expenditures, Debt Repayment.
3
Q
What is the Income Statement?
A
The income statement lists a company’s revenues, expenses, and taxes, with its after tax-profit over a period of time
4
Q
What are the requirements for something to appear on the Income Statement?
A
1) It must correspond to the current period shown on the income statement
2) It must affect the company’s taxes.
5
Q
What is the difference between COGS and Operating Expenses?
A
COGS are linked directly to the sale of products and services.
Operating Expenses are items not linked directly to product sales.
6
Q
What is revenue?
A
The value of the products/services provided and sold in the given period.
7
Q
What are some items that NEVER appear on the Income Statement
A
Operating Activities: — Changes in Net working Capital
Financing Activities: — Share Repurchased, CapEx, Issuance of debt or debt repayment, Dividends
Investing Activities: — Investments
8
Q
What is the Balance Sheet?
A
The Balance Sheet shows the company’s resources and obligations, or Assets and Liabilities and Equity, for a specific point in time.
9
Q
What is an asset?
A
An asset is a resource with economic value that a company/individual owns with the expectation that it will provide future benefits.
10
Q
What is a liability?
A
A liability is an debt or obligation that is legally binding and requires the company to fulfill in the ongoing future. Often, it is paid off in form of cash.
11
Q
What is equity?
A
Equity is the value of the ownership of the company. In the balance sheet, what we see is the book value, which is the capital originally raised to fund or support the company’s operations. But what truly matters is the market value.
12
Q
What are short-term investments?
A
CDs, other Money-Market accounts which are relatively less liquid than cash
13
Q
What are accounts receivable?
A
The company has recorded this as revenue on its income statement but has not received it in cash yet. This will turn into cash when the customer pays.
14
Q
What are prepaid expenses?
A
The company has paid these expenses in cash but has not recorded them as expenses on the Income Statement yet.
15
Q
What is inventory?
A
Inventory is finished goods, parts and raw materials that the company either sells them to other parties or uses them in production.
16
Q
What are PP&E?
A
That is Plant, Property and Equipment. For most companies, these are essential resources for the core businesses of the company to thrive.
17
Q
What are other intangible assets?
A
Other intangible assets are, for examples - Patents, Trademarks, IP. These usually does not have a indefinite life, meaning amortization over the asset’s definite lifespan. If the company acquires new intangible assets through corporate mergers, these intangibles are typically re-evaluate and get recorded on the balance sheet at the current fair market value and then amortized over its useful life.
18
Q
What are long-term investments?
A
Long term investment is a type of asset that individual investors or companies intend to hold for more than a year, examples could be Stocks, Bonds, Real Estate and mutual funds.
19
Q
What is Goodwill?
A
The concept of goodwill comes into play when a company is looking to acquire another company. Mathematically, it represents the price premium paid above the fair market value of the acquired company’s net assets.
20
Q
What is a Revolver?
A
It acts as a way for company to borrow money as needed, such as provide support to working capital matters to maintain the company’s stable operations. But, it is a short-term liabilities that requires quick repayments.
21
Q
What are Accounts Payable?
A
Account receivables typically represents short-term liabilities to vendors, which the company has recorded them as expenses in the income statement but not yet paid off. Typically used for one-time expenses, with specific invoices.
22
Q
What are accrued expenses?
A
The concept is similar to Account Payables - it represents expenses that has been booked in the income statement without the company actually paying it off. But unlike Account Payables, Accrued Expenses refers to the costs that are recurring, such as wages, rent and utilities.
23
Q
What is Deferred Revenue?
A
The company receives cash payment from customers but the products or services are not yet delivered. For example, a magazine company gets paid for annual subscriptions, but it delivers their magazine, weekly or monthly. Therefore, the company would recognize these as revenue over time.
24
Q
What is a Deferred Tax Liability?
A
There is discrepancy between taxable income and pre-tax income, due to different rules of accounting. In some cases, the company may end up paying less taxes than what it really owes over a specific period. They don’t want to pay it off now, but still have to pay it off in the future, so they book it as Deferred Tax Liability.
25
What is long-term debt?
It is debt that is due and the principal must be repaid in over a year
26
What is Common Stock and Additional Paid in Capital?
Common Stock and Additional Paid in Capital represents the total dollar value of the shares at the time when they are issued to the public by the company.
27
What is Treasury Stock?
Treasury Stock is a balance sheet item, it is cumulative. So it looks at the cumulative value of the shares repurchased from investor by the firm over time.
28
What is retained earnings?
The retained earnings is basically the company’s saved up, it is the after-tax profits less dividends issued.
29
What is Accumulated Other Comprehensive Income?
This often refers to miscellaneous income, such as Currency exchange in favor of the company or unrealized gains or losses on certain assets that have not yet been sold.
30
What is the Cash Flow Statement?
Cash Flow Statement tracks the changes of cash over a period of time. It further takes into account not only the non-cash revenue or expenses (such as D&A) but also additional cash inflows or outflows that has not appeared elsewhere, such as CapEx.
31
Where does Deferred Revenue show up on the cash flow statement?
Deferred revenue is regarded as revenue that comes from customers paying for products/services, therefore it can be found under Cash Flow from Operations.
32
Where do Short-Term investments show up in the Cash Flow Statement?
Short-term investments would show up in cash flow from investing, since it is an investment which has nothing to do with operations and financing activities
33
Where does a Revolver show up in the Cash Flow Statement?
Revolver is often provided by lenders, banks for examples. Companies or corporations often use it as a short-term financing vehicles for working capital. Therefore, it shows up as a financing activity.
34
How do you treat gain/losses on asset sales?
Since gain or loss on asset sales has been booked on income statement, the gain on asset sales should be subtracted, and loss should be added back. Overall, we don't need to do anything but to record the cash flow from the asset sales (often the selling price)
35
What happens to the three statements if Accounts Receivable increases by $10?
First of all, Account Receivable is Revenue recorded but not yet received in cash.
I/S:
-- Revenue up $10, Pre-tax income up $10, assuming 40% tax rate, Net Income up $6
CFS:
-- Net Income goes up by $6, however, the increase in Account Receivable is an increase in Assets, which decreases cash by $10, so the net change in cash sees a decline of $4.
B/S:
-- Cash balance goes down by $4, Account Receivable goes up by $10, so total asset amount goes up by $6; nothing changes in liabilities, net income goes up by $6 as indicated in the income statement, two sides balanced.
36
What happens to the three statements if Prepaid expenses increase $10?
Prepaid expenses are expenses that have not yet realized, like we pay annual subscription for newspaper, but we get distributed daily.
IS:
-- no changes
CFS:
-- The increase in Prepaid expenses is an increase in asset, which decreases cash by $10; no cash changes in investing and financing activities. Therefore, the net change in cash is negative $10
B/S:
-- Prepaid expenses goes up by $10 as an asset, but cash balance decreases by $10, overall, no changes in asset. Two sides balanced.
37
What happens to the three statements when Accounts Receivables decreases $10?
Account Receivables decreases $10, meaning the revenue we previously recognized is being paid for so we are receiving $10 in cash. So Cash increases $10 and Accounts Receivables decreases $10., two sides balanced. no changes in income statement.
38
What happens if Prepaid expenses decreases $10?
Since prepaid expenses are expenses paid for but not realized, if it decreases it means we are recognizing the expense.
I/S:
-- as the prepaid expenses decreases/recognized, COGS/SG&A increases $10, pre-tax income decreases $10, assuming 40% tax rate, Net income decreases by $6
CFS:
-- Net Income decreases by $6, the $10 decrease in Prepaid expense is cash inflow. No cash flows from financing and investing activities, the net change in cash is cash inflow, which is a positive $4
B/S:
-- Cash balance sees a increase of $4, Prepaid expenses decrease by $10, so total asset amount decreases by $6. Net income decreases by $6, which reflects decrease in Equity. No changes in liabilities, so two sides balanced.
39
What it means when Inventory increases by $10?
Depending on the business, Inventory could be raw materials for a manufacturing facility, but also a bottle of coca cola at a convenience store.
I/S:
-- No change since no revenue or expense is being recognized
CFS:
-- Increases in inventory is a cash outflow (-) of $10, no changes from investing and financing activities, the net change of cash for the period would be -$10.
B/S:
-- Cash goes down by $10, inventory goes up by $10, implying the company use cash on hand to purchase more inventory, but total asset balance has not changed and both sides balanced
40
What if inventory decreases by $10?
Decreases in inventory means the end goods has been manufactured and sold to the customer, therefore, it becomes the Cost of Good Sold.
I/S: (Assuming 40% tax rate)
-- COGS increases by $10, pre-tax income goes down by $10, net income decreases by $6.
CFS:
-- Net income up $6 is cash outflow, inventory decreases by $10 is cash inflow, no changes from the Financing and Investing activities. so there is a net cash inflow of $4
B/S:
-- Cash goes up by $4, inventory goes down by $10, net asset goes down by $6. no change in Liability side, the decrease in Equity by $6 is driven by the $6 decrease in Net Income. Two sides balanced.
41
What happens if Accrued Expenses increases by $10?
Accrued Expense are expenses recognized on the income statement but not yet paid as cash yet, typically these expenses are recurring, such as employee compensations, rent.
I/S: (Assuming 40% tax rate)
-- accrued expenses up by $10, pre-tax income down by $10, therefore, net income goes down by $6
CFS:
-- Net income goes down by $6, $10 increase in accrued expenses is a cash inflow, no changes in investing and financing activities. The net change of cash for the period is an $4 cash inflow.
B/S:
-- Cash goes up by $4, Accrued Expenses goes up by $10, Equity goes down $6 by Net Income. Two sides balanced.
42
What happens if accrued expenses decreases by $10?
The decrease in accrued expenses means the company paid off these expenses in cash
I/S: (Assuming 40% tax rate)
-- no changes
CFS:
-- Accrued expenses going down is a cash outflow of $10, no changes in investing and financing activities, Net change of cash over the period is cash outflow $10
B/S:
-- Cash goes down $10, Accrued Expenses (Liabilities) goes down by $10; two sides balanced
43
What happens if Accounts Payable increases by $10
Account payables are often non-recurring expenses line items, and they are typically related to transactions with vendors/suppliers
I/S: (Assuming 40% tax rate)
--Account Payable up by $10, Operating expenses goes up by $10, Pre-tax income goes down $10, Net income goes down $6
CFS:
-- Net income goes down by $6, Account Payable going up by $10 is cash inflow, no changes in investing and financing activities, the net change of cash for the period is $4
B/S:
-- Cash up $4, Accounts Payable up $10, Net income down $6; two sides balanced
44
What happens if Accounts Payable is down $10?
Account payables goes down, meaning the company paid off the liabilities
I/S:
-- No changes
CFS:
-- Account payables down $10 is a cash outflow, no changes from investing and financing activities, the net change of cash for the period is a cash outflow of $10
B/S:
-- Cash goes down by $10, Account Payable down $10, Two sides balanced
45
What happens if deferred revenue increases $10?
Deferred revenue is revenue that the company have received cash but the services/products have not yet provided.
I/S: (assuming tax rate at 40%)
-- no changes (I/S is based on accrual accounting so no revenue is recognized)
CFS:
-- Deferred revenue (liability) up $10 is a cash inflow, no changes in investing and financing activities, the net change of cash for the period is $10 cash inflow=
B/S:
-- Cash up $10, Deferred Revenue up $10, two sides balanced
46
What happens if deferred revenue is down $10?
Deferred Revenue goes down, meaning the company has provided the products or services to the customers
I/S: (assuming tax rate 40%)
-- Revenue goes up 10, pre-tax income up 10, net income up $6
CFS:
-- Net income up $6, Deferred revenue down by $10 is a cash outflow, no changes from investing and financing activities, net change in cash is a cash outflow of $4
B/S:
-- Cash goes down $4, Deferred revenue goes down by $10, Net income goes up by $6, two sides balanced
47
How do you decide when to capitalize rather than expense a purchase?
Basically, looking at the useful life of the purchase, if the Asset can be used for more than a year, typically the purchase is capitalized and depreciated over the useful life.
For multi-year lease, the company should not capitalize it unless it owns the building or the company pay for the entire period all at the beginning
48
What is the difference between accounts payable and accrued expenses?
The two are functionally the same, both highlighting the expenses that have been recognized but not yet being paid. However, theoretically, account payables are for non-recurring expenses with invoices (legal fees etc.), while accrued expenses are often recurring such as utilities and employee wages
49
What are examples of deferred revenue?
Subscription-based services, such as network carriers, magazine publishers and web-based subscription services
50
How are accounts receivable and deferred revenue different?
Account receivables are revenue already recognized but not yet received in cash - it is an asset items; whereas Deferred revenue are revenue not yet being recognized but cash has been collected from customers, so recognized as liabilities.
51
How are prepaid expenses and accounts payable different?
Prepaid expenses are expenses the company paid in cash for the products/services that have not yet received, it is a asset item; while account payables are liabilities that need to be repaid for the services or product it has already received.
52
What are income taxes payable?
income tax payable are liabilities recognized in the income statement as Tax Expenses but not yet being paid off in cash. The creation of Income Tax Payable is primarily due to timing between tax expenses being recognized in the income statement (often quarterly) and tax expenses actually required being paid off (often annually)
53
What is noncontrolling interest?
Noncontrolling interests aka. minority interests are portion of the equity where a shareholder owns more than 50% (less than 100%) of outstanding shares and have no control over decisions-making. In a consolidated financial statements, the company must acknowledge and include the financials of another company it owns but one must subtract the portions that the company does not own;
54
What are Investments in Equity Interests?
If the company owns 20%-50% of another company, the company are not required to consolidate the financial statements but record it as Equity Investments as Asset item in the balance sheet.
55
Can you have negative Shareholder’s Equity?
Yes, there are two situations:
1) Dividend Recap (financially) - the company takes on new debt and uses the cash to pay dividend to shareholders; As a result, Equity portion shrinks and the pie for debt get larger
2) Operationally - the company has not been profitable, and retained earning became accumulated deficit
56
What is working capital?
Working capital = Current Assets - Current Liabilities
Working capital highlights the company's ability to meet short-term obligations or liabilities
57
What is operating working capital?
Often referred as Net Working Capital as well, formulated as (Current assets - Cash) - (Current Liabilities - Debt)
It stresses the company's operating abilities to meet short-term obligations after removing financing and investing activities.
58
What does negative working capital mean?
It could indicate that the company could be in financial trouble (at risk of bankruptcy), however, this is not always a negative thing:
1) it is not so accurate for Subscription-based businesses; they have a large portion of Deferred Revenue, which would create a negative working capital
2) Some firms such as e-commerce (Amazon, Walmart), may have low Account Receivable but high in Accrued Expenses or Account Payables, since for the most part of these businesses, they often require customers to pay up front (before shipping the product or providing services)
59
If a company’s EBITDA was positive for 10 years but now it is bankrupt, what could have happened?
EBITDA omits the impact from Interest expenses, Depreciation & Amortization and other obligatory Debt Repayment. Therefore, there are a few scenarios that unveil the fact that sometimes a positive EBITDA does not tell the true story of the company's financial health:
1) Company may heavily spend on PPE and Capital Expenditures
2) The company may have high interest expenses that may not be able to cover
3) The company may have large amount of debt matured in a large bullet payment that a positive EBITDA may not be sufficient to cover
4) Besides these, the company may have non-recurring expenses that affect cash flow such as litigation charges or asset writeoffs
60
When is Goodwill impaired?
There are two scenarios:
1) During an merger or acquisition transaction, the assets of the company need to be reassessed and gets carried on to the new entity. There would be a Goodwill Impairment when the recorded/pre-acquisition goodwill value is higher than its fair market value (after reassessment)
2) Also if a company discontinues certain operations, it should test the goodwill associated with that discontinued operation for impairment and record a loss if the fair value of the goodwill is less than its carrying amount
61
What happens to the 3 statements when the company issues $100 of shares?
When the company issues $100 of shares, it has impact on the company capital structure reflected on the balance sheet.
I/S:
-- no changes
CFS:
-- $100 Cash inflow as Financing activities, net change in cash is $100
B/S:
-- Cash up by $100, Shareholder's Equity goes up by $100, two sides balanced
62
What happens if you record $100 of income tax on the income statement and pay it in cash, but then change to only $90 paid in cash and $10 if deferred for a future period.
First, on the Income Statement, NOTHING CHANGES as the $100 Tax Expenses (the company is required to pay) has been taken into considerations, Net income remains the same.
CFS:
-- since $90 already being paid in cash, the remaining $10 is deferred, a $10 Deferred Tax Liabilities, which is a Cash inflow of $10, net change in cash is +$10
B/S:
-- Cash up by $10, Deferred Tax Liabilities up by $10, two sides balanced
63
What happens when a company is bailed out? (debt / equity investment)
I/S:
-- No changes
CFS:
-- Cash inflow from financing activities
B/S:
-- Cash goes up by X amount and Either Debt or Equity or the combination of the two goes up by X amount
64
What happens if we write down debt by $100?
Debt written-down is actually an addition to the income statement
I/S: (assuming 40% tax rate)
-- Gain on the extinguishment + 100, Net Income up by $60
CFS:
--Net income up $60, Gain on extinguishment is a cash outflow by $100 (financing activities), no change in investing activities, the net change of cash over the period is -$40
B/S:
- Cash down $40, Debt down $40, two sides balanced
65
What is a Deferred Tax Asset?
Deferred Tax Asset created when the company paid more taxes than it should, so it remains in the balance sheet and the company pay less in cash taxes in the future.
66
What is Deferred Tax Liabilities
A deferred tax liability means you underpaid taxes that you owed and requires more cash tax expenses in the future
67
How do DTLs and DTAs come about?
Deferred Tax Liabilities (DTLs) and Deferred Tax Assets (DTAs) arise from temporary differences between financial accounting income and taxable income.
These differences result from timing mismatches in recognizing revenues and expenses for accounting vs. tax purposes.
Another scenario is when the company uses different depreciation methods for tax accounting vs book accounting, either in an ordinary or during an M&A transaction.
68
How can both DTAs and DTLs exist at the same time on a Balance Sheet?
Companies can have both DTAs and DTLs at the same time because some temporary differences increase future taxable income while others reduce it.
A company may owe more taxes later (DTL) while also having future tax benefits (DTA).
There are two folds of it. First, a company carries certain percentage of Net Operating Loss from pervious unprofitable years which booked as a Deferred Tax Assets, while the DTL arises from tax depreciation being higher than book depreciation today and requires to more tax expenses to be paid in the future.
69
What is the difference between income taxes payable and deferred tax liabilities?
Income taxes payable are accrual accounts for taxes that are owed in the current year,
whereas deferred tax liabilities are longer-term and arise because of events that do not occur in the normal course of business.
70
What are examples of non-recurring charges we need to add back to a company’s EBIT/DA when analyzing financial statements?
To adjust for EBITDA from Net income, the items adding back must be affecting Operating Income.
The most common examples are
Restructuring charges
Goodwill impairment
Asset Write-downs
Bad Debt Expenses
One-Time legal expenses
Disaster Expenses
Changes in accounting policies
71
What are operating leases?
An operating lease is a contract that allows a company to use an asset without owning it, similar to renting. The company pays periodic lease payments to the lessor (owner) for the right to use the asset for a specific period.
Operating lease expenses show up as Operating Expenses on the Income Statement and impact Operating Income, Pre Tax Income, and Net Income.
72
What are capital leases?
A capital lease aka Finance lease are used for longer-term items and gives the lessee ownership rights.
Unlike operating leases, which are rental agreements, capital leases are structured more like asset purchases with financing.
73
What are the parameters of capital leases?
If any one of the following are true:
1) If there’s a transfer of ownership at the end of the term
2) If there’s an option to purchase the asset at a bargain price at the end of the term
3) If the term of the lease is greater than 75% of the useful life of the asset
4) If the Present Value of the lease payments is greater than 90% of the assets fair market value.
74
How would $100 of Net Operating Losses affect the 3 financial statements?
When there is a $100 Net Operating Losses, assuming a 20% tax rate, the pre-tax loss is actually $125.
I/S:
-- $125 pre-tax loss, net loss of $100, creating $25 tax benefits
CFS:
-- With a net loss of $100 as well as $25 DTA created, so net change of cash is -$125
B/S:
-- cash down $125, DTA up $25, and Equity decreases by the net income loss of $100, two sides balanced
75
How do Net Operating Losses affect the statements>
NOLs create a DTA in loss years, improving cash flow when used in future years by reducing taxable income and tax payments.
76
What is the difference between tax benefits from Stock Based Compensation and EXCESS Tax Benefits from Stock Based Compensation?
Tax benefits simply record what the company saves in taxes as a result of SBC.
Excess Tax Benefits are the portion of these Tax Benefits and represent the amount of taxes saved due to share price increases (as SBC is worth more due to share price increases)
For Example:
Tax Benefits:
- Exercise Price: $10
- Expected Stock Price (at exercise): $20
- Estimated Tax Benefit: $10 per share (difference between $20 expected price and $10 exercise price).
Excess Tax Benefits:
- When employees actually exercise the options, the stock price turns out to be higher than originally anticipated.
- For example, the market price at exercise might be $30, instead of the anticipated $20.
- Actual Tax Benefit: The company now gets a tax deduction of $20 (difference between $30 market price and $10 exercise price).
77
How do you reclassify Excess Tax Benefits?
Excess Tax Benefits should initially be reported in the operating section of the cash flow statement as an adjustment to net income. However, after that, they need to be reclassified to the financing section because they are linked to the issuance of stock in stock-based compensation plans. The reclassification ensures that the company’s cash flow statement properly reflects the nature of these tax benefits and the related financing activity.
In other words, On the Cash Flow Statement you subtract Excess Tax Benefits from Cash Flow from Operations but add it back in the CFF financing activities sector. That eventually, flows into the APIC (Additional Add-in Capital) on the balance sheet.
78
What is calendarizing?
Calendarizing is a process of adjusting financial statements or data to align with a standard calendar period, such as a fiscal year or quarter
"Imagine you have a company with a fiscal year ending in March, and you want to compare its financial data to a company that follows the calendar year (January to December). You might "calendarize" the data for the company with the fiscal year ending in March by adjusting the data so that it represents a 12-month period that begins on January 1st and ends on December 31st.
If the company reports $10 million of revenue for the fiscal year from April to March, you might estimate what the full calendar year’s revenue would be by adjusting for the months that fall outside of that fiscal year."
79
What happens to DTAs and DTLs if we record accelerated depreciation for tax purposes but straight line for book purposes?
If depreciation is higher on the tax schedule in the first few years, our DTL will increase because we are paying less in cash taxes initially and need to make up for it later.
As tax Depreciation switches and becomes lower in the later years, the DTL will decrease as you pay more taxes.
80
If you own 50% but less than 100% of another company, what happens on the financial statements?
This is a noncontrolling interest scenario.
First you must consolidate all the financial statements and add 100% of the other company’s statements to your own.
Next, you create a liability called noncontrolling interest to reflect the portion of the company you don’t own (if it is worth $100 and you own 70%, the liability is worth $30).
After, you remove the shareholder’s equity portion of the minority company when you combine it with yours.
Next, you subtract Net Income Attributable to Noncontrolling Interests on the income Statement but add it back on the cash flow statement in CFO.
On the balance sheet, the Noncontrolling interest line item increases by that number (Net Income Attributable to Noncontrolling Interests) each year and Retained Earnings decreases by that amount each year.
81
If you own 20% but less than 50% of another company, what happens on the financial statements?
This is the case of Equity Interest. You do not consolidate the financial statements.
Instead you reflect Equity interest as an Asset on the Balance Sheet. (if you own 25% of a $200 company, you add $50 in asset).
You also add other company’s net income * & ownership to your Net Income on the Income Statement and subtract it from Cash Flow Statement because it is non-cash.
Each year, the Equity Interest line item increases by that number and then decreases by any dividends issued from the company to our company.
82
What are the different types of securities that a company can use on its balance sheet?
Trading: These securities are very short-term and you count all as gains/losses on the income statement under AOCI - Accumulated other comprehensive income, even if unrealized
Available for Sale (AFS): these are longer term securities and don’t report gains/losses. They appear under AOCI and are marked to market.
Held-to-Maturity (HTM): These securities are the longest and don’t report any unrealized gains/losses until sold.
83
You own 70% of a company that generates $10 of Net Income. Everything above the line has been consolidated.
Income Statement: Net Income attributable is added near the bottom and you subtract $3 to represent the 30% of the company you do not own. At the bottom of the IS, Net Income Attributable to Parent is down $3.
CFS: NI is down $3 but we add back the charge because we own over 50% of the company and receive this cash. Cash change is 0
Balance Sheet: there are no changes to the Balance Sheet Side. The Noncontrolling interest line (liabilities) item is up $3 while the Net Income part of retained earnings is down $3.
84
Now assume this firm issues $5 of dividends.
IS - no change as Dividends do not appear on IS.
CFS - the dividend outflow of $5 so CFF is down $5.
Balance Sheet: cash is down $5 as a result and so too is $5 down on the Retained Earnings figure.
85
Say we own 30% of a company with Net Income of $20.
We do not consolidate the statements.
IS - We create a net income from equity interests line item and records our real net income which is up $6 (20*30%)
CFS - Net income is up $6 but we subtract this out because we haven’t actually received it yet, so cash remains unchanged.
Balance Sheet:
We create an Equity Interests asset and increase it by $6. Retained earnings is also up by $6.
86
Now let’s assume the company issues $10 of dividends. Using the information as before, what happens.
IS - Same as before, NI is up $6.
CFS. Net Income is up $6. We subtract this $6 and also add $3 (30% of $10 dividends) that we will receive from the equity interests.
BS - Cash is up $3.Our Equity interest line only goes up by $3 ($6-$3) since we realized $3 of dividends. Shareholder’s equity is up $6.
87
What happens when you pay $20 in interest, 50% cash 50% PIK.
IS - you record Interest expense as $20. Net Income is down $16 (20% tax)
CFS - you add back the PIK interest ($10) as it is non-cash. Cash change is -$6
BS - Cash is down $6. Liabilities is up $10, Equity is down $16 balancing both sides.
88
Assume a company records $100 in Tax Benefits from SBC and $40 of Excess TB. What happens?
IS - no change.
CFS - we add back the entire $100 to CFO and subtract out the $40 excess tax benefit. Now, we add back the $40 under CFF to reclassify as a flow from financial rather than operations. Cash is up $100.
BS - Cash is up $100. Equity is up $100 from Common Stock and APIC.
89
A company records depreciation of $10 per year for 3 years. On its tax financial statements, it records depreciation as $15 in year 1, 10 year 2, and 5 in year 3. What happens in year 1?
"
Book Depreciation:
Year 1 - $10
Year 2 - $10
Year 3 - $10
Tax depreciation:
Year 1 - $15
Year 2 - $10
Year 3 - $5
"
Year1:
Book I/S (assuming 20% tax rate)
-- depreciation + $10, pre-tax income -$10, tax expenses (benefit) -$2, Net income -$8
Tax I/S:
-- depreciation +$15, taxable income -$15, tax expenses (benefits) -$3, Net income -$12, the company paid less than it supposed to be so DTLs created by (-$2-(-$3)) = $1
CFS: (On the cash flow statement, we use the book net income)
-- Net income -$8, +$1 DTLs is a cash inflow, adding back Depreciation (non-cash expenses) of +$10, net change in cash is $3
B/S:
-- cash +$3, depreciation -$10, DTLs +$1, net income -$8, two sides balanced
90
What happens in year 2?
"
Book Depreciation:
Year 1 - $10
Year 2 - $10
Year 3 - $10
Tax depreciation:
Year 1 - $15
Year 2 - $10
Year 3 - $5
"
Year 2:
Since book and tax depreciation are the same, we treat this similarly to a $10 depreciation charge over the year.
91
What happens in year 3?
"
Book Depreciation:
Year 1 - $10
Year 2 - $10
Year 3 - $10
Tax depreciation:
Year 1 - $15
Year 2 - $10
Year 3 - $5
"
Year 3:
Book I/S (assuming 20% tax rate)
-- Depreciation -$10, pre-tax income -$10, tax expenses (benefits) -$2, net income -$8
Tax I/S:
-- Depreciation -$5, taxable income -$5, tax expenses (benefits) -$1, net income -$4, since the company paid more than it supposed to be and there is existing DTLs of $1 from year 1, so the company will be recognizing it, equivalent to DTLs -$1
CFS: (On the cash flow statement, we use the book net income)
-- net income -$8, adding back depreciation +$10, -$1 DTLs is a cash outflow, net change in cash, $1
B/S:
-- Cash +$1, depreciation -$10, DTLs -$1, net income -$8, two sides balanced
92
A company records a goodwill impairment for $100 (not tax deductible). How does this affect the 3 statements?
When goodwill impairment is recorded, it reduces book income, but in most jurisdictions, it does not impact taxable income (under tax accounting)
Book I/S: (assuming 20% tax rate)
-- Goodwill impairment -$100, pre-tax income -$100, tax expenses (benefits) -$20, net income -$80
Tax I/S:
-- Goodwill impairment $0, taxable income $0, tax expenses (benefits) $0, NI $0, since the company pay more than it should be, DTA of $20 created
CFS:
-- Net income -$80, DTA created is a cash outflow of -$20, adding back Goodwill impairment (non-cash expenses) +$100, net change in cash is $0
B/S:
-- DTA +$20, Goodwill -$100, Net income -$80, two sides balanced
93
A company has a NOL of $100 included in the DTA on its balance sheet because it has been unprofitable up to this point. Now its PreTax Income is $200. NOL can be used as a direct tax deduction.
When the NOL from previously created DTA of $100 is used to offset the current year pre-tax income.
I/S: (assuming 20% tax rate)
-- pre-tax income -$100, tax expenses (benefits) -$20, net income -$80
CFS:
-- net income -$80, the offset of DTA is an cash inflow of +$100, net change of cash is +$20
B/S:
-- cash +$20, DTA -$100, net income -$80, two sides balanced
94
The company wants to calendarize its EBITDA. TTM as of March 2051.
Jan 1 - Dec 2050 - Rev $1000, EBITDA $200
Jan 1 - Mar 31 2050 - $200 rev EBITDA $50
Jan 1- mar 31 2051 - revenue $300 EBITDA $75
TTM EBITDA as of March:
+$200 - $50 +$75 = $225
95
Combine Company A and Company B’s financial statements. Acquisition was a 50% stock 50% cash and $1000 price.
Company B has $1000 Assets and $800 Liabilities
Company A uses $500 cash and $500 of stock to acquire the company. The assets are absorbed and so are the liabilities but the equity is wiped out.
New Liabilities - $800 and $500 in stock issued = +1,300
New Assets: we add $1000 but subtract $500 for cash. So to make up the additional $800 we add in Goodwill.
96
$100 in short term investments on balance sheet that are AFS. The market value increases to $110.
Since we are dealing with AFS securities, Income statement does not change, no unrealized gain
I/S:
- no gains on NI
CFS:
- no changes since no gain recognized in I/S and no cash changes hand
B/S:
- Short-term Investment (under asset) +$10, AOIC under Equity +$10, two sides balanced
97
If the securities were trading instead, what would happen?
If the securities is Trading, unrealized gain recorded under I/S
I/S: (assuming tax rate at 20%)
-- pre-tax income +$10, tax expenses (benefits) -$2, net income +$8
CFS:
-- NI +$8, subtracting unrealized gain since it is non-cash, so -$10, net change in cash is -$2
B/S:
-- cash -$2, Short-term investments +$10, net income +$8, two sides balanced
