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MW RECRUIT > Picasso - Accounting > Flashcards

Picasso - Accounting Flashcards

1
Q

List the line items in the cash flow statement.

A

1) CFO
Indirect Method:
- Net income, D&A, ch. in NWC, PIK, (+) NCI earnings. unwind of DTL; (-) Equity Earnings; (+) dividends from affiliates; (-) gains and (+) losses; impairments

2) CFI
- Capex, proceeds from divestitures, other investments

3) CFF
- Dividends, share repurchases, financing decisions, financing costs

Net change in cash

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2
Q

If you could have only two of the three main financial statements, which would it be?

A

Income statement and balance sheet (last two**) and we can derive the CF stmt

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3
Q

If you could have only one of the three main financial statements, which would it be?

A

Depends on the situation.

  • Many times I’d say cash flow because cash is king and no accounting / non cash items
  • Balance sheet if I’m a distressed investor looking at liquidation value and margin of safety. Can also back out Capex, working capital investment, net income, dividends)
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4
Q

What is the link between the balance sheet and income statement?

A 
Net income - retained earnings
PPE - D&A
Cash - FX effects
Debt - interest expense (PIK)
AR/Def. revenue - Sales (not perfect)
Inventory - COGS (not perfect)
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5
Q

How to account for earnings in affiliates?

A

Ability to exercise significant influance but not control
Earnings in affiliate = NI * ownership %
$10 in equity earnings
$5 in dividends received

I/S
(+) Earnings in Affiliates = $10
Net Income = $6 (40% tax rate)

CF Stmt
NI = $6
(-) Earnings in Affiliates (non-cash) ($10)
(+) Dividends Received $5
Cash = +$1

BS
Cash $1
Investment in Affiliate $10-5=$5

RE +$6

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6
Q

How to account for NI attributable to NCI?

A

Control but don’t own 100%; represents 3rd party ownership. Revenues, expenses, balance sheet items all presented at 100% ownership.

Sub NI = $10, Ownership of 80%

IS = NI attributable to NCI = ($2)

CF
NI = ($2)
NCI = +$2 (non-cash, cash presented at 100% ownership)
Change in Cash = $0

BS
RE = ($2)
NCI = $2

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7
Q

If a company has seasonal working capital, is that a deal killer?

A

It depends on the magnitude of the swings relative to its ability to pay suppliers, meet contractual obligations (mainly debt), and sell its inventory.

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8
Q

If a company issues a PIK security, what impact will it have on the three statements?

A

$100mm PIK Bond with $10% interest

  1. I/S ($10mm interest, NI down $6mm)
  2. CF Stmt (NI down 6, add back non-cash interest of 10, cash up $4mm which is your tax shield)
  3. BS (Cash up 4, Debt up 10, RE down 6)
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9
Q

If I increase AR by $10mm, what effect does that have on cash? Explain what AR is in layman terms.

A

AR represents the amount of cash that customers owe you for purchases of your goods.

With no context, an increase an AR means you have not collected cash, so no change to cash in period.

If that AR represents a sale that you originally thought you had collected cash on, cash would go down by 10 and AR would go up by 10.

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10
Q

Give examples of ways companies can inflate earnings.

A

Accrual method

  • Revenue recognition - when do recognize timing
  • Expensus - recognize as incurred (what if you can capitalize the expense? What if you’re WorldCom that recognizes Capex instead? )
  • D&A - accelerated depreciation methods to reduce your tax expense; change useful life
  • Inventory accounting - LIFO in an inflationary period will increase COGS (last in first out) which will decrease your taxable income and tax liability . Switch to FIFO
  • Fair value hedges show up in earnings, while cash flow hedges do not
  • Manipulating your pre-tax gains (basis? asset sales?)
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11
Q

Is goodwill depreciated?

A

Tested for impairment every year; otherwise, it will sit there on the balance sheet at its historical cost
Goodwill = Consideration less FV of NIA

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12
Q

What is a stock purchase and what is an asset purchase?

A

Stock purchase - buy the stock of selling shareholders; step into the shoes of the seller

Asset purchase - seller retains the stock; buy specified assets

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13
Q 
Which structure (stock purchase vs asset purchase) does the seller prefer and why? What
about the buyer?
A

Seller = if many liabilities, prefer stock deal. Can completely extract yourself from the business.

  • Also, asset deals are subject to double taxation (once at the corporate level and once at the shareholder level).
  • Stock sale = shareholder selling shares so taxed at the capital gains rate

Buyer = prefer asset deals so you can specify assets and liabilities to purchase; more flexibility with valuation and less due diligence
- Step up asset value for tax purposes and get non-cash tax shield

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14
Q

What is Sarbanes-Oxley and what are the implications?

A

2002 legislation created in response to Enron, WorldCom and Arthur Andersen - leading accounting scandals at the time.

Created the Public Company Accounting Oversight Board and many hoops that public companies must jump through to be publicly listed.

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15
Q

What are the differences between extraordinary and special charges?

A

Extraordinary = Unusual AND Infrequent; below-the-line (i.e. hurricane)

Special charges = Unusual OR Infrequent; included in operating income (Rx charges, severance, plant closing)

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16
Q

What is the definition of fair value?

A

Price received or paid to transfer an asset in a market.

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17
Q

What is the LIFO method?

A

Last in first out –> more accurate income statement. In a period of rising costs, COGS is higher and inventory lower

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18
Q

What is the FIFO method?

A

First in First Out –> more accurate B/S

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19
Q

What is the LIFO reserve?

A

Contra-asset account reconciling the FIFO Inventory Balance to LIFO
- Ever-increasing balance during period of rising price

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20
Q

What is the allowance method?

A

Setting asside an amount of AR expected to be uncollected
Dr. Bad Debt expense
Cr. Allowance for doubtful accounts

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21
Q

What is the direct method?

A

Charging off AR as soon as the accounts become uncollectible

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22
Q

What is a trading security?

A

Debt securities only (used to include equities)

  • Held to be traded
  • Marked to market
  • Unrealized gains / losses in IS
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23
Q

What is a held-to-maturity security?

A

Debt securities only

  • Not intended to be traded
  • Held at “amortized cost” (like a mortgage)
  • Recognize realized gains / losses only
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24
Q

What is an available-for-sale security?

A

Debt securities only

  • Not intended to be traded in the next month
  • Marked to market but
  • Unrealized gains / losses in OCI
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25
Q

What is net debt?

A

Interest bearing liabilities less cash and cash equivalents

Debt after it uses cash to pay off

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26
Q

What is the link between the balance sheet and statement of cash flows?

A

BoP cash from last year’s BS cash number
EoP cash links to this year’s BS cash number
Working capital - CFO
Capex and D&A - PPE
NI - Retained earnings
Non cash interest - debt
Dividends, buybacks, issuances - shareholders’ equity

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27
Q

What is the difference between the income statement and statement of cash flows? How are
the two financial statements linked?

A

Linked: both represent operating performance and cash inflows / outflows over a period of time

I/S follows accrual accounting, which includes non-cash items such as depreciation. The CF statement reconicles the IS to show the changes of cash.

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28
Q

What is goodwill?

A

Intangible. Excess of purchase price over fair value of net identifiable assets.

  • Allocate excess to in process R&D and other FV write ups before goodwill
  • Tested annually for impairment. Only recognized during M&A
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29
Q

Walk me through the major line items of the income statement.

A 
Sales
- COGS
= Gross Profit
SG&A
R&D
Other Opex
= EBITDA - NON-GAAP
D&A
= EBIT
Interest
= EBT
Taxes
= Net income
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30
Q

What is a capital lease?

A

Deemed ownership over the leased asset. Depreciated. Interest expense.

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31
Q

What is meant by recovery value?

A

Recovery value of assets during a liquidation

32
Q

Could you ever end up with negative shareholders’ equity? What would this imply?

A

Yes

  • Negative NI due to operating performance or large on-time write down like the value of oil and gas reserves
  • Accompanied by dividends and share buybacks (dividend recap)

Does not mean anything without context. Company may be underperforming though.

33
Q

Why do companies report both GAAP and non-GAAP earnings?

A

They don’t have to report non-GAAP earnings, but investors and analysts find EBITDA and other non-GAAP metrics useful

EBITDA - may include non-operating items that obscure this metric of operating cash flow. Also excludes D&A and other non-cash charges

34
Q

What is a NINJA loan?

A

No income, no job, no assets –> subprime loan

Loans packaged into CDOs

35
Q

Under what circumstances would goodwill increase?

A

M&A

36
Q

Why would goodwill be impaired and what does goodwill impairment mean?

A

Appraised; intangible value that cannot be allocated of business has been impaired (eBay / Skype)
- Reassess value of brand and IP

37
Q

How do you decide when to capitalize vs expense a purchase?

A

Is the benefit expected to be realized under or over 1 year?

38
Q

What is the difference between cash based and accrual based accounting?

A

Cash: recognize revenues and expenses when cash comes in and leaves the door. Net income is very lumpy

Accrual: revenue = when earned; expenses = when incurred. Matching principal

39
Q

Give examples of when a company could collect cash from a customer and not record revenue.

A

Deferred revenue - company has not met its performance obligation (magazine, software, prepaid for services, deposit)

40
Q

What is a credit default swap?

A

Effectively insurance paid on a bond defaulting, sold OTC. Used for hedging or speculating.
- Pay premiums and receive payout equivalent to bond’s value in default

41
Q

If depreciation is a non-cash expense, then why does it affect the cash balance?

A

Tax shield

42
Q

What is a collateralized debt obligation?

A

Securitized or packaged debt instruments in a SPV that bring in cash flows. It is tranched and sold to investors (AAA, BBB, all the way down to equity)

43
Q

What is a mortgage-backed security?

A

Securitization vehicle where mortgages back the SPV

44
Q

What is securitization?

A

Pool of assets

Waterfall. Tranches.

45
Q

What is a net operating loss?

A

Allowable tax deductions > taxable income

- May be able to offset future taxes

46
Q

What is a loss carry forward?

What is a loss carryback?

A

Before CARES but after TCJA, carry forward 80% of NOL indefinitely, no carry backs

Before TCJA, carry back 2 years and forward 30 years

47
Q

What is the accounting for notes receivable?

A

Dr. Notes Receivable
Cr. Asset

Dr. Cash
Cr. Note receivable
Cr. Interest revenue

48
Q

What is inventory?

A

Goods that you expect to sell in the ordinary course of business. Record at cost and expensed as COGS. Increased by purchases.

49
Q

What is meant by mark-to-market and why is it so important?

A

Mark assets and liabilities to their fair market values (opposed to at historical value)

  • Can be expensed in earnings?
  • If used as credit support, what if the fair values are wrong?
  • If sold after value declines, may create a loop of further selling
50
Q

Why is the income statement not affected by changes in inventory?

A

Only recognize cost of invenory in COGS when you sell the product

51
Q

Is an increase in accounts receivable a source or use of cash?

A

Use. You haven’t collected cash

52
Q

Is an increase in accounts payable a source or use of cash?

A

Source. Stretching payables. Obtain goods without paying cash

53
Q

If depreciation is non-cash, explain how a $10 pre-tax increase in depreciation causes cash to increase by $4.

A

Tax shield.

54
Q

A pen costs $10 dollars to buy. It has a life of ten years. How would you put it on the balance sheet?

A

Record at historical cost and depreciate over its useful life by debiting depreciation and crediting the asset; NI down by $1*(1-T)

55
Q

A pen costs $10 dollars to buy. It has a life of ten years. At the end of the second year, you discover the pen is a rare collector’s item. How much is it on the balance sheet?

A

Does not change. Recorded at historical cost.

Would change if you sold the business with pen included.

56
Q

A pen costs $10 dollars to buy. It has a life of ten years. At the end of the second year, the pen runs out of ink and you have to throw it away. How much is it on the balance sheet?

A

Impair the thing.
Accumulated D&A = 2*1=2
BV of pen = 8
Dr. impairment expense 8, Cr. pen 8

57
Q

You sold an asset where you received $500 million in cash. How does this affect your three financial statements?

A

What is its book value? Calculate gain or loss
If BV of 400, gain of $100 in IS. $60mm after tax

NI = 60, subtract gain of $100 = $(40)
CFI = proceeds from sale of 500
Net cash of $460

BS = Asset down 400, cash up 460
RE = +60 :)
58
Q

How would a $10 million increase in depreciation in year four affect the DCF valuation of a company?

A

Increase the value due to the tax shield.

PV increases by = $10*(0.4)/(1+wacc)^4

59
Q

Suppose you purchase $100 million of equipment on December 31, 2001 with a debt issuance. Walk me through the impact of this event on the three financial statements during 2001 and 2002.

A

What’s the useful life and interest rate on the debt? 5 years and 10%

2001:
1) IS: no change
2) CF: capex of 100, issuance of debt of 100, cash change zero
3) BS: PPE up 100, Debt up 100

2002:
1) IS: (20+10)*.6=down ($18)
2) CF: CFO = +$2
3) BS: Cash +$2; PPE ($20); RE ($18)

60
Q

Suppose you purchase $100 million of equipment (5 year useful life) on December 31, 2001 with a debt issuance. On January 1, 2003, the equipment breaks down and is worthless. Walk me through the impact of this event on the three financial statements.

A 
2003: 
BV of equipment = $100 - 20*1=$80
1) IS: Impairment of $80, NI down $48
2) CF: NI ($48); Impairment $80 = $32mm Cash
3) BS: Cash +$32, PPE ($80); RE ($48)
61
Q

Suppose you issue $80 worth of debt for $100 in cash. Walk me through the effect of this transaction on the three financial statements.

A

Dr. Cash 100
Cr. Debt 80
Cr. Premium 20

1) IS: no change
2) CF: Issuance of debt = $100
3) BS: Cash $100; Debt: $80; Premium $20

62
Q

Suppose you repurchase debt of $100 for $80 in cash. What is the effect of this transaction on the three financial statements?

A

Dr. Debt 100
Cr. Cash 80
Cr. Gain on debt extinguishment 20

1) IS: Gain on debt extinguishment 20, NI up $12
2) CF: $12 NI - $20 = CFO ($8); Repurchase of bonds ($80) = Cash ($88)
3) BS: Cash ($88); Debt: ($100); RE $12

63
Q

Suppose you sell a pair of jeans for $20 that cost you $10. Walk me through the effect of this transaction on the three financial statements.

A

Dr. Cash 20
Cr Sales 20
Dr. COGS 10
Cr. Inventory 10

IS: Gross profit $10; NI $6
CF: NI $6; Inventory down 10; CFO $16
BS: Cash $16, Inv ($10); NI $6

64
Q

How does a $10 million purchase of inventory from your supplier on credit flow through the three financial statements?

A

Dr. Inv 10
Cr. AP 10

IS: no change
CF: No change in cash, working capital accounts cancel each other out
BS: Inv and AP both up 10

65
Q

Suppose you buy $100 million of inventory. You sell half of the inventory at 50% gross margin. Using a 50% tax rate, walk me through the changes in the three financial statements.

A 
Sales $200mm
COGS $100mm
Gross Profit = $100
NI = $50
CF: 50+100=$150
BS: Cash $150, Inv ($100) NI $50
66
Q

Suppose you purchase a new fixed asset at $100 with 50% cash and 50% debt on December 31. Take me through how it affects all the financial statements.

A

CF: Capex of $100, debt issuance of 50, cash down 50
BS: PPE up 100, cash down 50, debt up 50

67
Q

You own a hotdog business. (1) Assume that you buy a hot dog on credit for $1 and sell that hot dog to a person on credit for $3. (2) You receive cash from the party that bought the hot dog and you pay off your creditor. Explain the impact on the three financial statements of both events.

A
  1. IS Gross margin (3-1) of 2, NI of $1.2
    CF: NI $1.2, Inventory no change, AP up $1, and AR up $3 = ($0.8)
    BS: Cash ($0.8); AR = $3 = $2.2; AP $1, NI of $1.2
2. Dr. Cash 3, Cr. AR
Dr. AP, Cr. Cash 1
1) No Change
2) AP down 1, AR down 3 = CFO +2
3) BS: Cash +2, AR -3, AP -1
68
Q

What is the balance sheet?

A

Snapshot of the company’s financial position at a moment in time
Assets = resources; things the company has to generate value
Liabilities and Equity = how it finances those resources
- Liabilities = capital you must pay back in the future
- Equity = residual value representing financing from equity investors or reinvested earnings less money distributed to equity holders

69
Q

What is the statement of retained earnings?

A

Statement showing the changes in retained earnings due to net income and dividends
What is mgmt doing with its earnings?

70
Q

What is the statement of cash flows?

A

Statement showing the sources and uses of cash over a period of time, broken out by CFO, CFI, and CFF

71
Q

What are deferred taxes?

A

Temporary accounting differences between book and tax accounting.

  • DTA: paid more to the IRS than what your GAAP books say
  • DTL: paid less to IRS than what your GAAP books say

Reconciles the two

72
Q

What is Days Inventory Outstanding and how is it calculated?

A

Number of days it takes a company to sell its inventory
Inv / COGS * number of days in period
high inventory levels are unhealthy It also opens the company up to trouble should prices begin to fall.

73
Q

What is Days Receivables Outstanding and how is it calculated?

A

Amount of days it takes a company to collect on its AR
AR / Sales * number of days in period

by maintaining accounts receivable, firms are indirectly extending interest-free loans to
their clients.

74
Q

What is the cash conversion cycle and how do you calculate it?

A

Number of days it takes to buy inventory, sell it, collect on your credit, and pay suppliers
DSO + DIO - DPO
Can be a major source of cash flow

75
Q

What is asset turnover and how is it calculated?

A

Efficiency ratio of how well you are using assets

Sales / Assets

76
Q

What are two methods of depreciation?

A

Straight line
Double declining balance
Tie it to amount of production
Sum of year digits = accelerated method

77
Q

How would a change in LIFO/FIFO flow through the financial statements?

A

Is the change in COGS tax deductible?
Increase in COGS = decrease in taxable income and greater tax savings
NI down, but not as much as the increase in cash from inventory, reflecting the tax shield

MW RECRUIT (14 decks)

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