Error Log Accounting IBV Flashcards
Assuming a 30% tax rate, walk me through 3 statements with a:
$100 interest expense (50% cash interest / 50% PIK interest) and $50 interest income
Starting on the IS…
Net interest expense down 50, pre-tax income down by 50, NI down by 35
Moving onto the SCF…
NI down by 35, add back 50 from PIK interest in CFO, so cash at bottom is up by 15
Finally, on the BS…
A: Assets up 15, Cash up 15
L: Liabilities up 50, Long-term debt up 50
SE: Equity down 35, Retained earnings down 35
…and the Balance Sheet balances
MULTI-STEP: Assuming a 20% tax rate, walk me through 3 statements with a:
Year 0: Buy PP&E for $100 using Debt. Walk through the 3 statements.
Year 2: PP&E depreciates over 10-year period using straight-line depreciation. After two years, you sell the PP&E for $120. Assume depreciation has been accounted for on the financial statements. Walk through the 3 statements after the sale of PP&E.
Starting on the IS…
Gain on sale recorded positively as 40, pre-tax income up 40, NI up 32
Moving onto the SCF…
NI up 32, subtract 40 from gain on sale under CFO, add 120 under CFI, so cash at bottom is up 112
Finally, on the BS…
A: Assets up 32, cash up 112, PP&E down 80
L: no change in liabilities
SE: Equity up 32, retained earnings up 32
…and the Balance Sheet balances
MULTI-STEP: Assuming a 20% tax rate, walk me through 3 statements with a:
You raise $100 debt with 5% interest and 10% yearly principal repayment. You use that money to purchase $100 of short-term assets that have 10% yearly interest income attached.
Part 1) Right when you raise the debt and purchase short term assets, walk me through the 3 statements.
Part 2) After one year, walk me through the 3 statements.
Part 1)
Starting on the IS…
No change
Moving onto the SCF…
In CFI, outflow of $100 for short term assets.
In CFF, increase of $100 because of debt raised.
So, net change in cash is $0.
Finally, on the BS…
A: Short-term assets up $100.
L: Debt up $100.
SE: No change.
…and the Balance Sheet balances
Part 2)
Starting on the IS…
Interest income is $10 and interest expense is $5
Pretax income increases by $5, Net Income increases by $4
Moving onto the SCF…
Net Income up by $4, in CFF repay $10 of debt, so net change in cash is down $6
Finally, on the BS…
A: cash down $6
L: debt down $10
SE: Retained Earnings from Net Income up $4
…and the Balance Sheet balances
If Apple buys $100 worth of new iPod Factories with debt, how are all 3 statements affected at the start of “Year 1” before anything else happens?
Now go out 1 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?
At the start of Year 3, the Factories all break down and the value of the equipment is written down to $0. The loan must also be paid back now. Walk through what happens in the 3 statements.
After 2 years, the value of the factories is now $80 if we go with the 10% depreciation per year assumption. It is this $80 that we will write down in the 3 statements.
On the Income Statement:
- The $80 write-down shows up in the Pre-Tax Income line. With a 40% tax rate, Net Income declines by $48
On the Cash Flow Statement:
- Net Income is down by $48 but the write-down is a non-cash expense, so we add it back
* and therefore Cash Flow from
Operations increases by $32
-There are no changes under Cash Flow from Investing
-Under Cash Flow from Financing there is a $100 charge for the loan payback
-Overall the Net Change in Cash Falls by $68
On the Balance Sheet:
-Cash is now down by $68 and PP&E is down by $80 so Assets have decreased by $148 altogether.
-Debt is down by $100 since it was paid pff, and since was down by $48, Shareholders equity is down by $48.
-Together Liabilities and Shareholders’ Equity are down by $148 and both sides balance.
Can you ever end up with negative Shareholders’ equity? What does it mean?
1) Leveraged Buyouts with dividend recapitalizations
- It means that the owner of the
company has taken out a large portion
of its equity (usually in the form of
cash) which can sometimes turn the
number negative
2) It can also happen if the company has been losing money consistently and therefore has a declining Retained Earnings balance, which is a portion of Shareholder’s Equity
-It doesn’t “mean” anything in particular, but it can be a cause for concern and possibly demonstrate that the company is struggling (in the 2nd scenario)
Walk me through a $100 “bailout” of a company and how it affects the 3 statements.
First confirm what type of “bailout” this is
- Debt?
- Equity?
- Combination?
The most common scenario is an equity investment from the government so here’s what happens:
On the Income Statement:
- No changes
On the Cash Flow Statement:
- Cash Flow from Financing goes up by $100 to reflect the government’s investment,
* So the Net Change in Cash is up by
$100
On the Balance Sheet:
- Cash is up by $100 so Assets are up by $100
- On the other side, Shareholders’ Equity would go up by $100 to make it balance
When would a company collect cash from a customer and not record it as revenue?
Three examples:
1) Web-based subscription software
2) cell phone carriers that sell annual contracts
3) Magazine publishers that sell subscriptions
- Companies that agree to services in the future often collect cash upfront to ensure stable revenue
- This makes investors happy as well
since they can better predict a
company’s performance - Per the rules of GAAP (Generally Accepted Accounting Principles), you only record revenue when you actually perform the services
- So the company would not record everything as revenue right away
Normally Goodwill remains constant on the Balance Sheet - why would it be impaired and what does Goodwill Impairment mean?
-Usually Goodwill impairment happens when a company has been acquired and the acquirer re-assesses its intangible assets (such as customer relationships, trademarks/trade names, and intellectual property) and finds that they are worth significantly less than what they originally thought.
- It often happens in acquisitions where the buyer “overpaid” for the seller and can result in a large net loss on the Income Statement.
- It can also happen when a company discontinues part of its operations and must impair the associated goodwill.
What are deferred tax assets/liabilities and how do they arise?
DTLs and DTAs arise because of temporary differences between what a company can deduct for cash tax purposes vs. what they can deduct for book tax purposes.
Deferred Tax Liabilities:
- DTLs arise when you have a tax expense on the Income Statement but haven’t actually paid that tax in cold, hard cash yet.
Deferred Tax Assets:
- DTAs arise when you pay taxes in cash but haven’t expensed them on the Income Statement yet.
The most common way they occur is with asset write-ups and write-downs in M&A deals - an asset write-up will produce a deferred tax liability while a write-down will produce a deferred tax asset.
Walk me through how you create a revenue model for a company.
There are 2 ways you could do this:
1) Bottoms-Up Build
- Start with individual
products/customers
- estimate the average sale value or
customer value
- and then the growth rate in sales and
sales values to tie everything together
2) Tops-Down Build
- Start with the “big-picture” metrics like
overall market size
- then estimate the company’s market
share and how that will change in the
coming years
- and then multiply to get their revenue
Of these two methods, Bottoms-Up is more common and is taken more seriously because estimating “big-picture” numbers is almost impossible.
Walk me through how you create an expense model for a company.
To do a true Bottoms-Up build, you:
- Start with each different department of a company, the # of employees in each, the average salary, bonuses and benefits.
-Then make assumptions on those going forward.
- Usually you assume that the number of employees is tied to revenue, and then you assume growth rates for salary, bonuses, benefits, and other metrics.
- COGS should be tied directly to Revenue and each “unit” produced should incur an expense.
- Other items such as rent, Capex , and miscellaneous expenses are either linked to the company’s internal plans for building expansion plans (if they have them), or to Revenue for a more simple model.
Walk me through the major items in Shareholders’ Equity.
Common Items include:
Common Stock
- Simply the par value of however much stock the company has issue
Retained Earnings
- How much of the company’s Net Income it has “saved up” over time
Additional Paid-In Capital (APIC)
- This keeps track of how much stock-based compensation has been issues and how much new stock employees exercising options have created. It also includes how much over par value a company raises in an IPO or other equity offering.
Treasury Stock
- The dollar amount of shares that the company has bought back.
Accumulated Other Comprehensive Income
- This is a “catch-all” that includes other items that don’t fit anywhere else, like the effect of foreign currency exchange rates changing.
Walk me through what flows into Retained Earnings.
R.E. = Old Retained Earnings Balance
+ Net Income
- Dividend Issued
if you’re calculating Retained Earning for the current year, take last year’s Retained Earnings number, add this year’s Net Income, and subtract however much the company paid out in dividends.
Walk me through what flows into Additional Paid-In Capital (APIC)
APIC = Old APIC
+ Stock-Based Compensation
+ Stock Created by Option Exercises
If you’re calculating APIC, take the APIC balance from last year, add this year’s stock-based compensation number, and then add in however much new stock was created by employees exercising options this year.
What are some examples of non-recurring charges that we need to add back to a company’s EBIT/EBITDA when looking at its financial statements?
- Restructuring Charges
- Goodwill Impairment
- Asset Write-Downs
- Bad Debt Expenses
- Legal Expenses
- Disaster Expenses
- Change in Accounting Procedures
Note that to be an “add-back” or “non-recurring” charge for EBIT/EBITDA purposes, ** it needs to affect Operating Income on the Income Statement.**
So if you have charges “below the line” then you do not need to add it back for the EBIT/EBITDA calculation.
Also note that you do add back Depreciation, Amortization, and sometimes Stock-Based Compensation for EBIT/EBITDA, but that that these are not “non-recurring charges” because all companies have them every year
* These are just non-cash charges
