Advanced Accounting Flashcards
What is the Income Statement
The income statement lists a company’s revenues, expenses, and taxes, with its after tax-profit over a period of time
What are the requirements for something to appear on the Income Statement?
1) It must correspond to the current period shown on the income statement
2) It must affect the company’s taxes.
What is the difference between COGS and Operating Expenses?
COGS are linked directly to the sale of products and services.
Operating Expenses are items not linked directly to product sales.
What is revenue?
The value of the products/services provided and sold in the given period.
What are some items that NEVER appear on the Income Statement
CapEx, Purchases of PPE, Investments, Dividends, Issuing or Repaying Debt Principal, Issuing or Repurchasing Shares, Changes to Working Capital
What is the Balance Sheet?
The Balance Sheet shows the company’s resources and obligations, or Assets and Liabilities and Equity, for a specific point in time.
What is an asset?
An asset is an item that will result in additional cash in the future
What is a liability?
A liability is an item that will result in less cash in the future
What is equity?
Equity is a line that refers to the ways to fund company’s internal operations rather than through external parties
What are short-term investments?
Certificates of deposits and money-market accounts (less liquid than cash)
What are accounts receivable?
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.
What are prepaid expenses?
The company has paid these expenses in cash but has not recorded them as expenses on the Income Statement yet.
What is inventory?
Inventory are the goods needed to manufacture and sell products.
What are PP&E?
Items that last over a year and contribute to the company’s core business (factories, buildings, land, equipment).
What are other intangible assets?
Patents, trademarks, IP, usually received through acquisitions but AMORTIZE due to their definite lifetime value
What are long-term investments?
Less liquid and longer lasting that cash or short-term investments
What is Goodwill?
Goodwill is the excess of the cost of an entity over the net of the amounts assigned to assets acquired and liabilities assumed.
What is a Revolver?
It acts as a way for companies to borrow money as needed, with the obligation for quick repayment.
What are Accounts Payable?
The company has recorded these expenses on the Income Statement but has yet to pay them out in cash yet. Typically used for one-time items with specific invoices.
What are accrued expenses?
The company has recorded these as expenses on the Income Statement but hasn’t paid yet - used for recurring monthly items such as invoices, wages, rent, utilities.
What is Deferred Revenue?
The company has collected cash in advance from its customers but has yet to deliver the product or service and will recognize these over time.
What is a Deferred Tax Liability?
The company has paid lower taxes that what it really owes for a specific period (accounting/tax discrepancy), and needs to pay additional taxes to the government in the future
What is long-term debt?
This is debt that is due and must be repaid in over a year
What is Common Stock and Additional Paid in Capital?
This represents the market value of shares at the time those shares issued by the company. The total dollar value of shares issued at IPO/listing.
What is Treasury Stock?
This represents the cumulative value of shares the company has repurchased from investors.
What is retained earnings?
This represents the company’s saved up, after-tax profits less dividends issued.
What is Accumulated Other Comprehensive Income?
This is for other miscellaneous income, such as FX exchange, as well as unrealized gains and losses on certain assets (not yet sold).
What is the Cash Flow Statement?
It tracks changes of cash over a period of time
1) Non-cash revenue or expenses
2) Additional cash inflows or outflows that have not appeared elsewhere
Where does Deferred Revenue show up on the cash flow statement?
Cash flow from operations (because it is related to customers paying the company for products/services)
Where do Short-Term investments show up?
Shows up in Cash Flow from Investing as it’s an investment and has nothing to do with operations
Where does a Revolver show up?
It appears in Cash Flow from Financing because it is related to the financing of operations.
How do you treat gain/losses on asset sales?
You subtract (add) the gain (loss) and account for the transaction as part of the full selling price of the asset in the Cash Flow from Investing portion. Reclassification.
What happens if Accounts Receivable increases by $10?
Accounts Receivable is Revenue recorded but not yet received as Cash.
I/S: Revenue increases by $10, pre-tax income increases by $10, Net Income increases $8 (20%tax)
CFS: Net Income down $8. Subtracting the change in Accounts Receivable, -$10, brings us to Change in cash of -$2.
B/S: Cash is down $2, Accounts Receivables up $10, Assets are up $8.
Net Income flows into Retained Earnings of $8 which balances the two sides.
What happens if Prepaid expenses increase $10?
Prepaid expenses are expenses not yet realized but paid for, so cash has left our account for services not expensed.
IS- no change
CFS - we have a cash outflow of $10 with an overall change in cash of -$10
B/S - Cash is down $10 but Prepaid Expenses, an asset, is up $10.
What happens when Accounts Receivables decreases $10?
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.
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: Expenses, COGS, increases $10. Pretax income decreases $10 with Net Income decreasing $8.
CFS: Net Income decreased $8, adding the change in the prepaid asset account of $10 overall cash changes by +$2.
B/S: Cash is up $2, prepaid income is down $8, shareholders equity is down $8 from retained earnings and net income decrease.
What it means when Inventory increases by $10?
Inventory is just the raw materials needed to manufacture to provide goods or services to a customer.
IS - no change since no revenue or expense is being recognized.
CFS - purchasing inventory reduces our cash balance so we are at Cash -$10
BS - cash is down $10 but inventory increases $10.
What if inventory decreases by $10?
If Inventory decreases, this means some of the raw materials purchased have been used to provide goods to the client.
I/S: COGS increases by $10, pretax income decreases $10 Net Income decreased $8
CFS: Net Income is down $8, adding back the change in the working capital account, Cash flow increases $2.
B/S: Cash is up $2, Inventory is down $10 so $-8 asset side, Shareholders Equity down $8 from Net Income
What happens if Accrued Expenses increases by $10?
Accrued Expenses are expenses recognized on the Income Statement but not paid for in cash yet.
IS: Expenses increase by $10, pretax income decreases by $10, Net Income decreases $8
CFS: Net income down $8 add back the $10 change in working capital so cash is up $2
BS: Cash is up $2. Accrued Expenses, the liability is up $10 and shareholders equity is down $8 balancing both sides at $2.
What happens if accrued expenses decreases by $10?
Accrued expenses are expenses recognized on the Income statement but yet to be paid for in cash.
IS: no change
CFS: Cash flow from operations down $10
Change in cash -$10
B.S: Cash is down $10. Accrued Expenses a liability is down $10.
What happens if Accounts Payable increases by $10
Accounts payable are expense line items that are typically non-recurring but you are given a grace period to pay them in.
Income Statement: Pre-tax expense increases by $10, Net Income decreases by $8.
Cash Flow Statement: Net Income is down $8, we add $10 change in the working capital to arrive at $2 change in cash
BS: Cash is up $2, Accounts payable is up $10 but Net Income is down $8.
What happens if Accounts Payable is down $10?
Accounts payable are expenses listed with a grace period so they are recognized but paid for at a later period.
We are now paying for a recognized expense:
IS - no change
CFS: cash flow from operations is down $10. Change in cash is -$10
Balance Sheet: Cash -$10. Accounts Payable is -$10.
What happens if deferred revenue increases $10?
Deferred revenue is revenue that we have received cash for but not yet recognized.
I/S: no change.
CFS: we have received $10 of cash so net change in cash is +$10.
BS: Cash is up $10 Deferred Revenue is up $10.
What happens if deferred revenue is down $10?
If deferred revenue is down $10, it means we are recognizing revenue that we have previously received cash for.
Revenue increases by $10, pretax income +$10, Net Income +$8.
CFS: net income +$8. We adjust for the decreasing deferred revenue, so subtract $10. Net change in cash is -$2.
Balance Sheet: Cash is down $2. On liabilities side, deferred revenue is down $10 and equity side Net Income is up $8, overall -$2 on each side.
How do you decide when to capitalize rather than expense a purchase?
If the purchase corresponds to an Asset with a useful life of over 1 year, it is capitalized and put on the Balance Sheet, depreciated over a certain number of years.
Even if you are paying for a multi-year lease for a building, you would not capitalize it unless you own the building and pay for the entire building in advance,
What is the difference between accounts payable and accrued expenses?
The two are the same functionally, highlighting expenses that have been recognized yet to be paid; however theoretically, accounts payable are for non-recurring expenses with invoices (legal fees) whereas accrued expenses are employee wages or rent utilities etc.
What are examples of deferred revenue?
Web-based subscription services, cell phone carriers, magazine publishers / subscription-based providers.
How are accounts receivable and deferred revenue different?
Accounts receivable are revenues recognized on the income statement but yet to receive cash for. This is an asset as we will receive future cash as a result.
Deferred revenue is cash received from a consumer but where we have not yet provided a service or product so we have not recognized the revenue. This is a liability as it will cause us to recognize the revenue and pay tax expenses in the future (without the benefit of any cash inflow)
How are prepaid expenses and accounts payable different?
Prepaid expenses are expenses not yet recognized but already paid for in advance. As a reuslt, it is an asset.
Accounts Payable are expenses that have been recognized on the Income Statement and are yet to be paid. They are a liability.
What are income taxes payable?
These are expenses recognized on the income statement (tax expenses) but yet to be paid for in cash. This may be a result of timing of drawing up the accounts (Income Statement and Balance Sheet organized monthly and but taxes paid every quarter)
What is noncontrolling interest?
Noncontrolling interest is a liability. It is shown when you own 50% or more of a company (but less than 100% of it) because, as a result of consolidated financial statements, you must acknowledge and subtract the portion of the value of the firm that you do not own.
What are Investments in Equity Interests?
If you own 20-50% of another company, you are not required to consolidate your financial statements, however, you want to acknowledge the portion of the company that you do own. This is an asset on the balance sheet.
Can you have negative Shareholder’s Equity?
Yes in 2 situations:
1) With a dividend recapitalization - where the equity holders in the company take out a large portion of their equity in the form of cash
2) If the company has been losing money consistently and their retained earnings become accumulated deficits.
What is working capital?
Working Capital = current assets-current liabilities
Highlights the company’s ability to cover is short-term obligations / liabilities.
What is operating working capital?
(Current Assets-Cash)-(Current Liabilities - Debt)
Highlights the operating ability of the company and removes and financing and investment activities.
What does negative working capital mean?
It means that the company could be in financial trouble (or at risk of bankruptcy) however this is not always a negative thing:
Deferred revenues could create negative working capital in firms with subscription based models or web companies
Some firms may have low accounts receivable balances but high accrued expenses or accounts payable since consumers pay up front (Amazon, Walmart)
If a company’s EBITDA was positive for 10 years but now it is bankrupt, what could have happened?
Since EBITDA excludes Interest Depreciation and Amortization expenses, as well as obligatory debt repayments there are a few scenarios.
1) Company could be spending heavily in PPE and Capital Expenditure not captured by EBITDA
2) The company may have high interest expenses that it may not be able to cover
3) The company’s debt may have matured in a large bullet payment that it may not be able to sufficiently cover
4) The firm may have had some non-recurring expenses that affect cash flow such as litigation charges or writeoffs
When is Goodwill impaired?
Usually during an acquisition and the assets are reassessed to see the surpayment value on the deal.
Also if the company discontinues any operations in a specific industry or vertical it must impair the associated goodwill with that vertical.
What happens to the 3 statements when the company issues $100 of shares?
If a company issues $100 of shares, this doesn’t affect the income statement (since it doesn’t affect our taxes)
On the cash flow from financing, cash is up $100 for the shares issued and paid for in cash.
On the balance sheet: cash is up $100. In the shareholder’s equity and liabilities section, Common Stock and APIC has increased by $100.
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.
Firstly, on the income statement, nothing changes since both current and deferred taxes are accounted for under taxes and Net Income remains the same.
Next, on the cash flow statement, Net Income remains the same and we add back the change in the deferred tax liability, the $10. SO overall change in cash flow is +$10.
Lastly on the balance sheet, cash is up $10 and our liability of deferred tax expenses is up $10.
What happens when a company is bailed out? (debt / equity investment)
IS - no change
CFS - cash from financing increases by bailout amount
BS - cash +$amount
liabilities (debt) or common stock and APIC +$amount
What happens if we write down debt by $100?
Writing down debt is actually an addition on IS.
IS - debt write-down is added to the income statement - pretax income is up $100, Net Income +$80.
CFS - NI is up $80, write down is subtracted since it is not cash - Cash change is -$20.
BS - Cash is -$20. Debt is -$100, SEq is +$80.
What is a Deferred Tax Asset?
A Deferred Tax Asset means you have overpaid in taxes so you pay less in cash taxes in the future
What is a Deferred Tax Liability?
A deferred Tax Liability means you have underpaid taxes and owe more in tax in the future
How do DTLs and DTAs come about?
They arise as a result in the difference between book and cash tax accounting.
1) When companies record depreciation differently for book and tax purposes (depreciation recorded more quickly to save on taxes)
2) When assets are written up for book and not for tax purposes (in M&A deals)
3) When pension contributions get recognized differently for book and for tax purposes
How can both DTAs and DTLs exist at the same time on a Balance Sheet?
A company can owe and save on future tax for different reasons. A company may carry over Net Operating Losses from previous, unprofitable years which can be counted as Deferred Tax Assets.
Alternatively, the company may record accelerated depreciation for tax purposes but straight-line for book purposes which could result in a DTL in the early years.
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.
What are examples of non-recurring charges we need to add back to a company’s EBIT/DA when analyzing financial statements?
Restructuring charges Goodwill impairment Asset Write-downs Bad Debt Expenses One-Time legal expenses Disaster Expenses Changes in accounting policies
To qualify for add-back or non-recurring charges, it needs to affect Operating Income.
What are operating leases?
Operating leases are used for short-term leasings of equipment and property, and do not involve ownership of anything. Operating lease expenses show up as Operating Expenses on the Income Statement and impact Operating Income, Pre Tax Income, and Net Income.
What are capital leases?
Capital leases are used for longer-term items and gives the lessee ownership rights. These items depreciate and incur interest expense, and are also counted as debt.
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.
How would $100 of Net Operating Losses affect the 3 financial statements?
If we have $100 of Net Operating losses, that means that this is our tax adjusted (20%) net income. This means that our pretax income was $100/(1-20%) = ($125). So our taxes are $25. This means our deferred tax asseet increases $25.
On the Cash Flow statement. We start with Net Income -$100, we subtract the deferred tax asset of $25 to arrive at Cash of -$125.
Balance Sheet: We have cash of -$125 and a deferred tax asset of $25. On Shareholders Equity side we have Net Income -$100.
How do Net Operating Losses affect the statements>
We reduce taxable income by the portion of the NOLs that we can use each year, applying the same tax rate, an then subtracting the new Tax number from the old Tax number. This delta is deducted from the NOL balance (and should be a part of the DTA line item).
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)
How do you reclassify Excess Tax Benefits?
On the CFS you subtract ETB from CFO but add it back in CFF. You do this to accrue to APIC on the balance sheet.
What is calendarizing?
You use this with public comps to align financials rather than use actual fiscal years to offer more true comparability.
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.
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.
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.
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 (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.
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 item is up $3 while the Net Income part of retained earnings is down $3.
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.
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.
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 falls $3 since we realized $3 of dividends. Shareholder’s equity is up $6.
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 as it is non-cash. Cash change is -$6
BS - Cash is down $6. Liabilities and SHE - Debt is up $10, SEQ is down $16 balancing both sides.
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. SEq is up $100 from Common Stock and APIC.
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?
On the book income statement, you list the book depreciation number, so pre tax income falls $10 and net income falls $8 (20% tax).
Note now that in the tax income statement, depreciation was $15, so Net income falls $12 rather than $8. This means that taxes were $4 less on the books than in the tax version.
On the cash flow statement, we use the book net income, so net income is down $6. We add back the $10 depreciation charge, as well as adding back the $2 deferred tax liability created from the deviated depreciations. This means cash has become +6
Balance sheet: Cash is up $6, but PPE is down $10. On Assets side we are down $4. Liabilities, we have a DTL of +$4 and our retained earnings in Shareholders Equity is down $8 balancing out as -$4 on both sides.
What happens in year 2?
Since book and tax depreciation are the same, we treat this similarly to a $10 depreciation charge over the year.
What happens in year 3?
On the book income statement, we use the book depreciation, with is $10. Pre Tax Income falls $10 and net Income falls $8.
Now, tax depreciation is only $5, so on the tax books, Net Income is only down $4 compared to the $8. This is when we are recognizing our deferred tax liability.
So on CFS - Net income is down $8. We add back the $10 of depreciation but subtract the $4 of deferred taxes so Cash is down $2.
Balance Sheet, Cash is down $2 and PPE is down $10.
Liabilities are down $4 and Net Income is down $8 balancing both sides at -$12.
A company records a goodwill impairment for $100 (not tax deductible). How does this affect the 3 statements?
Since this is still an impairment, we recognize it as a pre-tax line item on the IS.
IS - In the books, Pre Tax Income is down $100. Net Income is down $80 with a 20% tax rate.
In the tax records, Pretax income didn’t change so Net Income stays the same, so we have a $20 delta in taxes paid versus taxes recorded (we paid $20 additionally in taxes).
CFS - Net Income is down $80. We add back the impairment of $100 and subtract the $20 deferred tax asset created. Cash is unchanged
Balance Sheet. Goodwill is down $100. But a deferred tax asset is created of $20. Assets are down $80.
Liabilities - Net Income is down $80.
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.
The company can apply its entire NOL to offset its PreTax Income, so PreTax income falls by $100 and Net Income falls by $80 at a 20% tax expense.
CFS - Net Income is down $80. We have used out deferred tax asset so we add back $100 so cash is up $20.
BS - Cash is up $20, DTA is down $100 so assets are down $80. Liabilities are unchanged and Net Income is down $80.
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 = New Partial Period + Twelve Months - Last period
For Revenue =
$300 + 1000 - 200 = $1100
For EBITDA =
75 + 200 - 50 = $225
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.
$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.
CFS - there is no change on the cash flow statement since this is not a cash change.
BS - Short term investments increase by $10 to $110. ShEq increases $10 in AOCI so the balance sheet balances.
If the securities were trading instead, what would happen?
Now we recognize the unrealized gain.
IS - operating and pretax income increase by $10. Net income increases by $8.
CFS - NI is up $8 but we subtract the gain of $10 so cash is down $2 overall.
BS -Cash is down $2, Short term investments is up $10. Assets up $8. Net Income is up $8.
