Ch. 2: Terminology, Concepts, and Methodology

Question 1

Labeling the follow events as CFO, CFI, or CFF:

1. Firm issues $100 in stock for cash
2. The firm borrows $10
3. The firm buys PPE by paying in both cash/debt
4. The firm buys inventory.
5. The firm sells $15 of inventory for $28.
6. The firm records interest expense on debt.

Answer 1

1. CFF
2. CFF
3. CFI
4. CFO
5. CFO
6. CFO

Question 2

Are there recordable events to the cash flow statement if the source is credit?

Answer 2

No.

Question 3

What is the difference between capitalizing something versus expensing something?

Answer 3

Capitalizing something creates an asset, while expensing something decreases owners equity.

Question 4

What are gains versus losses?

Answer 4

Gains are similar to revenues, but they are the result of activities not central to the firms normal operating activities.

Losses are similar to expenses, but they are the result of activities not central to the firms normal operating activities.

Question 5

A firm sells a piece of equipment for $1000 cash. The equipment is listed on the balance sheet at $800.

List the two different outcomes if the transaction was a part of a firms on-going operations or the result of a peripheral activity.

Answer 5

On-going Operations:

Cash $1000

Equipment ($800)

Revenue $1000

COGS ($800)

Peripheral Operations

Cash $1000

Equipment ($800)

Gain $200 (Owner’s Equity portion)

Question 6

Why differentiate between gains/revenues and losses/expenses?

Answer 6

Revenues and expenses are likely to continue, whereas gains/losses may not persist and MAY be material enough to be considered as one-off items.

This is why I reported “quality of earnings” due to the impact of gains/losses and other one-offs.

Question 7

What is the difference between statutory and effective tax rates?

How are effective tax rates derived?

What is the current corporate tax rate?

Answer 7

Statutory rates are set by a nation and state’s government. Effective rates are a blend of the two across multiple countries. The formula to derive the effective rate is:

Tax Expense/Pre-Tax Income

Current corporate tax rate is 21%

Question 8

What is unique about municipal bond interest?

Answer 8

The interest is added to pre-tax income, but it is NOT taxed. So, do NOT include municipal bond interest in tax calculations.