Accounting - 3 FS Scenarios

Question 1

Walk me through how Depreciation going up by $10 would affect the statements.

Answer 1

1. Noncash expense on the income statement. Tax rate? 40%. Net income down by 10*(1-T)=6
2. CF = net income down 6, D&A up 10 = cash up $4mm which is your tax shield
3. Cash up 4, PPE down 10 = assets down 6. NI and RE down 6 as well

Question 2

What happens when Accrued Expenses increases by $10?

Answer 2

Expenses that have been accrued but not paid. Treat as a non-cash expense, assuming in SG&A for example
1. SG&A up 10, NI down 6
2. Never paid cash; accrued exp is working capital account, liability up 10, cash up 4mm
3. Assets - cash up 4
L = Acc Liab up 10
E = RE down 6

Question 3

What happens when Accrued Expenses decreases by $10 (i.e. it’s now paid out in the form of cash)? Do not take into account cumulative changes from previous increases in Accrued Expenses.

Answer 3

Payment of working capital; already been incurred so it does not show on the income statement.

1. IS = no impact
2. CF = acc liab down 10, cash payment of 10
3. BS: cash down 10, acc liab down 10

Question 4

Accounts Receivable increases by $10. Walk me through the 3 statements.

Answer 4

Working capital account. Recognize AR when revenue has been earned but you have not been paid.
1. Sales up 10; for illustrative purposes, okay to assume no COGS? Cool. Taxes of 4mm, NI up 6
2. CF: NI up 6, AR up 10; Cash down 4mm which is equal to your tax check.
BS: cash down 4, AR up 10; net +6
RE: NI up 6

Question 5

5. Prepaid Expenses decreases by $10. Walk me through the statements. Do not take into account cumulative changes from previous increases in Prepaid Expenses.

Answer 5

Expense that has been paid but has not been incurred (i.e. prepaid rent, insurance, etc.)
- When it decreases, you are recognizing the expense
1. -10 in expense, -6 in NI
2. -6 NI, +10 for unwind in Prepaid = 4 cash
BS: Cash up 4; prepaid down 10 = -6 = RE

Question 6

7. A company sells some of its PP&E for $120. On the Balance Sheet, the PP&E is worth $100. Walk me through how the 3 statements change.

Answer 6

Assume done on the first of the year.

IS: $20mm gain. NI up $12.

CF: gain is non cash / and is captured in investment proceeds: Net income of 12; -20 in CFO; +120 of proceeds from sale; 112 of cash. Check = tax of 8mm.

BS: Cash up 112; ppe down 100 = 12
RE: up 12

Question 7

8. Walk me through what happens on the 3 statements when there’s an Asset Write-Down of $100.

Answer 7

IS: write down of 100; NI down (1-T)*100=60
CF: NI = -60, impairment of 100; cash up 40
BS: cash up 40; building down 100 = down 60, which equals NI

Question 8

9. Explain what happens on the 3 statements when a company issues $100 worth of shares to investors.

Answer 8

Dr. Cash, Cr. equity issuance.
CF = show +100 in CFF
Equity up 100, cash up 100

Question 9

10. Let’s say we have the same scenario, but now instead of issuing $100 worth of stock to investors, the company issues $100 worth of stock to employees in the form of Stock-Based Compensation. What happens?

Answer 9

Non cash expense; Dr. SBC, Cr. Equity
NI = -100 * .6 = -60
CF = CFO = -60+100=40
BS = Cash 40, Equity = 100, RE= -60

Question 10

11. A company decides to issue $100 in Dividends – how do the 3 statements change?

Answer 10

Assume cash on balance sheet

Dr. Retained earnings, Cr. Cash

Question 11

12. A company has recorded $100 in income tax expense on its Income Statement. All $100 of it is paid, in cash, in the current period. Now we change it and only $90 of it is paid in cash, with $10 being deferred to future periods. How do the statements change?

Answer 11

Deferred tax liability.

No change to tax expense per book, but you reflect on the cash flows, recognizing 10 increase in DTL.

Cash down 90.
DTL up 10. RE down 100.

Question 12

13. Walk me through a $100 “bailout” of a company and how it affects the 3 statements.

Answer 12

Please define “bailout”. Cash infusion in equity, preferred, debt; buying assets, etc.

Debt?
CF: CFF up 100, cash up 100
BS: Cash 100, Gov’t loan up 100

Question 13

14. Walk me through a $100 Write-Down of Debt – as in OWED Debt, a Liability – on a company’s Balance Sheet and how it affects the 3 statements.

Answer 13

Effectively a gain; may be taxed on the OID if considered a substantial change. Let’s say you are taxed.

$100mm write down = gain, $60 to net income
CF: -60 + 100 = -40
BS: cash -40; bond = -100; RE +60

Question 14

15. Wait a minute – if writing down Liabilities boosts Net Income, why don’t companies just do it all the time? It helps them out!

Answer 14

Rx with lenders, which comes with another headache.

• Concessions / fees for amendment
• Advisor fees
• Also must accurately report your liabilities

Question 15

1. Let’s say Apple is buying $100 worth of new iPad factories with debt. How are all 3 statements affected at the start of “Year 1,” before anything else happens?

Answer 15

Clarify structure, are you raising cash to buy factory or are you issuing the debt as consideration?
- Cash first.
IS unchanged
CF: Building in CFI -100; Debt issuance +100
BS: Building +100, Debt +100

Question 16

2. Now let’s go out one year, to the start of Year 2. Assume the Debt is high-yield, so no principal is paid off, and assume an interest rate of 10%. Also assume the factories Depreciate at a rate of 10% per year. What happens now?
   Assume that we have already factored in the changes from Part 1 and are only tracking what happens AFTER those have taken place.

Answer 16

After year 1… 10% interest, 10 year life. $10mm interest and $10mm D&A.

IS: -$20mm; NI -$12 if tax = 40%
CF: NI -12, D&A +10 = Cash down -2
BS: Cash -2, PPE - 10; NI -12

Question 17

3. At the end of Year 2, the factories all break down and their value is written down to $0. The loan must also be paid back now. Walk me through how the 3 statements ONLY from the start of Year 2 to the end of Year 2.

Answer 17

Let’s hope you have the cash.
First, must recognize current D&A to find the book value of PPE. Same exercise as before.
NI down 6, cash up 4, PPE down 10 = carrying value of 80

IS: Write down of -80 plus -10 interest, taxes paid of 40% = NI down 54
CF: NI -54, Write down +80 = 24mm cash
CFF: pay back 100mm
Net cash = -74
BS: cash -74, PPE -80 = -154 = Debt -100 0 54 in RE

Question 18

6. A company raises $100 worth of Debt, at 5% interest and 10% yearly principal repayment, to purchase $100 worth of Short-Term Securities with 10% interest attached. Walk me through how the 3 statements change IMMEDIATELY AFTER this initial purchase.

Answer 18

CFI = -100 of ST Securities
CFF = +100 LT Debt Issuance
= 0 Cash

BS; Asset in marketable securities, liability in debt

Question 19

7. Now walk me through what happens at the end of Year 1, after the company has earned interest, paid interest, and paid back some of the debt principal.

Answer 19

LT Debt:
- Interest =5, Amort = 10
ST Debt = interest INCOME = 10

IS: +5 in interest income (net), NI up 3
CF: +3 NI, less Debt paydown of 10 = Cash -7
BS: Cash -7, Debt -10, NI +3

Question 20

8. Now let’s say that at the end of year 1, the company sells the $100 of Short-Term Securities but gets a price of $110 for them instead. It also uses the proceeds to repay the $90 worth of remaining Debt.
   Walk me through the statements after ONLY these changes.

Answer 20

Gain of $10mm assuming that's the carrying value.
IS: Gain of 10, NI up 6
CFO NI up 6, gain -10 = -4 CFO
CFI Sold securities +110
CFF paydown -90
Net Cash = 16

Cash 16, Securities -100 = -84 assets
LT Debt -90, NI +6 = -84

Question 21

1. You own 70% of a company that generates Net Income of $10. Everything above Net Income on your Income Statement has already been consolidated.
   Walk me through how you would recognize Net Income Attributable to Noncontrolling Interests, and how it affects the 3 statements.

Answer 21

Assume you have control and consolidate.

NI +7, NCI +3 = cash at 10
Cash +10
NCI +3
RE +7

Question 22

1. You own 70% of a company that generates Net Income of $10. Everything above Net Income on your Income Statement has already been consolidated.
   Walk me through how you would recognize Net Income Attributable to Noncontrolling Interests, and how it affects the 3 statements.
2. Let’s continue with the same example, and assume that this other company issues Dividends of $5. Walk me through how that’s recorded on the statements.

Answer 22

30% of the dividends will be distributed, but since you show 100% of the cash, the intercompany transfer won’t be reflected in the consolidated CF.

No IS impact
CFF: -1.5
NCI: -1.5

Question 23

3. Now let’s take the opposite scenario and say that you own 30% of another company. The other company earns Net Income of $20. Walk me through the 3 statements after you record the portion of Net Income that’s you’re entitled to.

Answer 23

Equity method of accounting
NI attributable to affiliates = 30%*20=6
Subtract out of CFO because non cash. Net cash zero

Affiliate interest up 6, RE up 6

Question 24

4. Now let’s assume that this 30% owned company issues Dividends of $10. Taking into account the changes from the last question, walk me through the 3 statements again and explain what’s different now.

Answer 24

Recognize dividends as income in CFO and reduce Affiliate balance accordingly.

CFO: Dividend received = cash of 30%*10=3
BS: cash +3, Affiliate balance -3

Question 25

5. What if you now only own 10% of this company? Would anything change?

Answer 25

Fair value measurements. Do not have significant influence. Only recognize dividends received and not be income.

Question 26

6. Walk me through what happens when you pay $20 in interest on Debt, with $10 in the form of cash interest and $10 in the form of Paid-in-Kind (PIK) interest.

Answer 26

10mm is noncash
NI down 20*.6=-12
Cash -12+10=-2
BS: cash -2, debt +10, RE -12

Question 27

7. Due to a high issuance of Stock-Based Compensation and a fluctuating stock price, a company has recorded a significant amount of Tax Benefits from Stock-Based Compensation and Excess Tax Benefits from Stock-Based Compensation.
   Assume that it records $100 in Tax Benefits from SBC, with $40 of Excess Tax Benefits from SBC, and walk me through the 3 statements. Ignore the original Stock-Based Compensation issuance.**

Answer 27

What is this?
Tax benefits = normal tax savings from an increase in an expense.
Excess tax benefits = additional tax benefit due to an increase in the share price. (i.e. SBC is now worth more due to the share price increase than when it was announced)

IS: No change
CF: CFO: add back 100-40=60
CFF +40 to reflect financing activity
Cash up $100
CS and APIC up 100

Question 28

8. A company records Book Depreciation of $10 per year for 3 years. On its Tax financial statements, it records Depreciation of $15 in year 1, $10 in year 2, and $5 in year 3.
   Walk me through what happens on the BOOK financial statements in Year 1.

Answer 28

Year 1
Book depreciation < Tax = DTL b/c lower taxes today
Difference = (15-10)*4=2

IS: -10 Dep, -6 in NI
CF: -6+10+2 of DTL = 6 in cash
BS: Cash up 6, PPE down 10 = Assets -4
DTL up 2, NI -6=Net Assets -4

Question 29

8. A company records Book Depreciation of $10 per year for 3 years. On its Tax financial statements, it records Depreciation of $15 in year 1, $10 in year 2, and $5 in year 3.
   Walk me through what happens on the BOOK financial statements in Year 2**

Answer 29

Year 2
Book depreciation = Tax = No DTL / DTA

IS: -10 Dep, -6 in NI
CF: -6+10 = 4 in cash
BS: Cash up 4, PPE down 10 = Assets -6
NI -6

Question 30

8. A company records Book Depreciation of $10 per year for 3 years. On its Tax financial statements, it records Depreciation of $15 in year 1, $10 in year 2, and $5 in year 3.
   Walk me through what happens on the BOOK financial statements in Year 3***

Answer 30

Year 3
Book depreciation > Tax = Unwind DTL

IS: -10 Dep, -6 in NI
CF: -6+10 - 2 in DTL unwind = 2 in cash
BS: Cash up 2, PPE down 10 = Assets -8
NI -6, DTL -2 = -8

Question 31

11. A company you’re analyzing records a Goodwill Impairment of $100. However, this Goodwill Impairment is NOT deductible for cash tax purposes. Walk me through how the 3 statements change.

Answer 31

Not a temporary difference, so you won’t recognize a DTA or DTL

IS: -100, no impact to taxes = NI-100
CF: -100+100=0 ch in cash
Goodwill -100, RE -100
[TBD]

Question 32

13. A company has a Net Operating Loss (NOLs) balance of $100 due to losses in prior years.
    The company finally generates a Pre-Tax Income of positive $200 this year. Walk me through the 3 statements, assuming a 40% tax rate.

Answer 32

Tax expense per book = 40%*200=800
Taxable income, though, is (200-100)*40%=40
IS: NI -80
CF: -80 + 40 decrease in DTA = 40 cash
BS: Cash -40, DTA -40, NI -80

Question 33

14: You’re analyzing a company’s financial statements and you need to calendarize the revenue, EBITDA, and other items.
The company has earned revenue of $1000 and EBITDA of $200 from January 1 to December 31, 2050. From January 1 to March 31, 2050, it earned revenue of $200 and EBITDA of $50. From January 1 to March 31, 2051, it earned revenue of $300 and EBITDA of $75.
What are the company’s revenue and EBITDA for the Trailing Twelve Months as of March 31, 2051?

Answer 33

S: 1,100
E: 225

Question 34

15. A company acquires another company for $1000 using 50% stock and 50% cash. Here’s what the other company looks like:
    • Assets of $1000 and Liabilities of $800.
    Using that information, combine the companies’ financial statements and walk me through what the Balance Sheet looks like IMMEDIATELY after the acquisition.

Answer 34

Goodwill = 1000-200=800

Dr. Goodwill 800
Dr. Assets 1000
   Cr. Liab 800
   Cr. Cash 500
   Cr. Equity 500

Question 35

16. You’re analyzing a company with $100 in Short-Term Investments on its Balance Sheet. These Investments are classified as Available-for-Sale (AFS) Securities.
    The market value for these securities increases to $110. Walk me through what happens on the 3 statements.

Answer 35

AFS = no unrealized gain on IS (Only AOCI)

10 unrealized gain in investment income
6 in NI increase

AOCI and ST Investments up 10

Question 36

17. Now let’s say that these were classified as Trading Securities instead – walk me through the 3 statements after their value increases by $10.

Answer 36

10mm hits pre tax income as unrealized gain,.

Question 37

Buy a building for $100mm funded with 50/50 D/E. Year 0 and Year 1 FS.

Answer 37

Year 0 - clarify issuing shares or using cash on hand. Probably issuing shares
IS no impact
CF: CFI -100; CFF = 50 shares, 50 debt
BS: Building 100, Debt 50, Equity 50

Year 1 - Assume 10 year life, 10% interest
$5mm interest, 10 D&A
40% tax rate
9mm Net Loss

CF: -9+10=1mm cash

BS: Cash 1, Building -10 = -9 = RE