Advanced Accounting Qs

Question 1

Explain what a DTA or DTL is.

How do they usually get created?

Answer 1

A DTL means you need to pay additional cash taxes in the future, you’ve underpaid on taxes and need to make up for it. DTA is the opposite.

They are created usually when companies record depreciation differently for tax vs financial purposes.

Question 2

How can DTAs and DTLs exist at the same time?

Answer 2

Difference in timing that arise due to recognition of income and expenses for financial reporting purposes vs tax purposes

Question 3

How do income taxes payable and receivable differ from DTLs and DTAs.

Answer 3

These are accrual accounts which are owed for the current year/ quarter, whereas DTAs and DTLs tend to be longer-term and arise because of events that do not occur in the normal course of the business.

Question 4

Walk me through how you project revenue for a company

Answer 4

Simplest - assume a % growth rate, 15% Y1, 12% Y2, etc.
OR
Bottoms-up method or Tops-Down method.

Question 5

Bottoms up revenue projection method

Answer 5

Start with individual product lines or services, estimate the sales volume and price for each, aggregate them to get total revenue.

Question 6

Top-Down Approach:

Answer 6

Start with the overall market size and apply the company’s market share to estimate revenue.

Question 7

In general projecting revenue:

Answer 7

1. Analyse historical data: past trends, seasonality, key drivers like units sold and ASP
2. Market and industry analysis: industry growth rates, competition
3. Make assumptions: pricing changes, future growth rates
4. Build the model: top down or bottom up
5. Compare projections with industry benchmarks, refine estimates.

Question 8

Walk me through how you project expenses for a company.

Answer 8

Simplest - make each income statement expense a % of revenue and hold it fairly constant or maybe decrease slightly due to EoS
Complex - could start with each department of a company, number of employees, salary, bonuses, make assumptions.

Question 9

In general projecting expenses:

Answer 9

1. Analyse historical data
2. Identify key drivers
3. Make assumptions
4. Build projection model: variable costs, fixed costs, semi variable costs.
5. Adjust for external factors
6. Validate and refine.

Question 10

How do you project BS items like accounts receivable and accrued expenses over several years

Answer 10

• Accounts Receivable: % of Revenue.
• Prepaid Expense: % of Operating Expenses.
• Inventory: % of COGS.
• Deferred Revenue: % of Revenue.
• Accounts Payable: % of Operating Expenses.
• Accrued Expenses: % of Operating Expenses.

Question 11

How should you project depreciation and capital expenditures

Answer 11

Simplest: make each one a % of revenue
Alternative: make depreciation a % of revenue, but for capEx, average several years of previous CapEx, or make it percentage change or absolute dollar change.

Complex: create a PP&E schedule, where you estimate a CapEx increase each year based on managements plans, then depreciate it using each assets useful life and straight line method, also depreciate CapEx with same approach.

Question 12

Examples of non-recurring charges we need to add back to a company’s EBITDA when analysing its financial statements

Answer 12

• restructuring charges
• goodwill impairment
• asset write-downs
• bad debt expenses
• one time legal or disaster expenses

Question 13

How to qualify as an add back or non-recurring charge for EBITDA

Answer 13

needs to affect operating income on the income statement

• do add back DA and stock-based compensation, but that these are not non-recurring charges because all companies have them every year - they are just non-cash charges.

Question 14

Difference between capital leases and operating leases?
How do they affect the statements?

Answer 14

Operating leases are used for ST leasing of equipment and property, no ownership. Show up as operating expenses on the income statement and impact operating, pre tax and net income.

Capital leases used for longer-term items and give lessee ownership rights. They depreciate, incur interest expense and counted as debt.

Question 15

A lease is a capital lease if any 1 of the following 4 conditions is true

Answer 15

1. If there is a transfer of ownership at the end of the term
2. There’s an option to purchase 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. Present value of lease payments is greater than 90% of the asset’s fair market value.

Question 16

How do Net Operating Losses (NOLs) affect a company’s 3 statements?

Answer 16

IS: NOLs can reduce taxable income in future periods, leading to lower tax expenses when utilised.
CFS: tax benefit increases net income, but adjusted as a non-cash item, so doesn’t affect cash flow. Actual cash savings occur when NOLs reduce future tax payments.
BS: creates a DTA

Question 17

Define net operating loss

Answer 17

A Net Operating Loss (NOL) happens when a company’s expenses are greater than its income for a year, resulting in a financial loss.
This loss can be used to reduce the company’s taxable income in future years, helping to lower future tax bills.

Question 18

NOL example

Answer 18

Year 1: 200k NOL
Year 2: 50k profit.

Taxable income before = 50k
NOL carry forward = 200k IN YEAR 1
Adjusted taxable income = 50k profit - 50k NOL used = 0 taxable income. 150k left to use.

Company pays no income tax in year 2.

Question 19

What are different classifications for securities that a company can use on its balance sheet

Answer 19

Trading
Available for sale
Held-to-Maturity

Question 20

What’s the difference between Tax Benefits from Stock-Based Compensation and Excess Tax Benefits from Stock-Based Compensation? How do they impact the statements?

Answer 20

• tax benefits simply record what company ahs saved in taxes
• excess tax benefits are a portion of these normal tax benefits, and represent the amount of taxes they’ve saved due to share price increases.
• on CFS excess tax benefits are subtracted out of CFO and added to CFF to reclassify.
• on CFS you add back tax benefits to CFO, for it to accrue to APIC

Question 21

Let’s say you’re creating quarterly projections for a company rather than annual projections. What’s the best way to project revenue growth each quarter?

Answer 21

Split historical data by quarters and analyse year over year growth for each quarter to account for seasonality.

Question 22

What is the purpose of calendarising financial figures?

Answer 22

Calendarising means rather than using a company’s normal fiscal year figures, lets use another year-long period during the year and views metrics for THAT period.

In order to compare companies with different fiscal years.

Question 23

What happens to the DTA/DTL line if we record accelerated depreciation for tax purposes, but straight line depreciation for book purposes?

Answer 23

If depreciation is higher on the tax schedule in the first few years, the DTL will rise because you’re 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 in cash taxes and ‘make up for’ early tax savings.

Question 24

If you have noncontrolling interest, how do you record the acquisition

Answer 24

• you consolidate all the financial statements
• add all assets and liabilities on balance sheet
• in equity, add parent’s equity and non controlling interest
• on income statement, include 100% of subsidiary’s revenue and expenses
• show the net income attributable to both NCI and parent separately.
• wipe out other company’s SE when you combine
• subtract net income attributable to noncontrolling interests on the income statement, but then add back on CFO

Question 25

You own between 20 and 50% of another company, how do you record this acquisition

Answer 25

This called Equity Interest
- do not consolidate statements
- recorded on balance sheet as non-current asset ‘investment in associate’ at purchase cost.
- IiA rises, cash falls both by purchase cost
- net income x share = increase in both IiA and Equity in Earnings of Associate - on income statement
- dividends x share = decrease in investment in associate, as well as increase in cash.

Question 26

Trading securities

Answer 26

• Intent: Securities bought and held primarily for selling them in the near term to generate short-term profits.
• Measurement: Reported at fair value on the balance sheet
• Income Recognition: Unrealized gains and losses from changes in fair value are recognized in the income statement

Question 27

Available for sale securities

Answer 27

• Intent: Securities not classified as trading or held-to-maturity. These might be sold in response to liquidity needs or changes in interest rates, risks, or other factors.
• Measurement: Reported at fair value on the balance sheet.
• Income Recognition: Unrealized gains and losses are recognized in other comprehensive income (OCI), not affecting the income statement until they are realized through a sale.

Question 28

Held to maturity

Answer 28

• Intent: Debt securities that the company has the positive intent and ability to hold until maturity.
• Measurement: Reported at amortized cost on the balance sheet.
• Income Recognition: Interest income is recognized in the income statement. Unrealized gains and losses are not recognized because the securities are expected to be held until they mature.