Single Step Accounting Flashcards
Walk me through how Depreciation going up by $10 would affect the statements
Income Statement: Operating Income and Pre-Tax Income would decline by $10 and, assuming a 40% tax rate, Net Income would go down by $6.
Cash Flow Statement: The Net Income at the top goes down by $6, but the $10 Depreciation is a non-cash expense that gets added back, so overall Cash Flow from Operations goes up by $4. There are no changes elsewhere, so the overall Net Change in Cash goes up by $4.
Balance Sheet: Plants, Property & Equipment goes down by $10 on the Assets side because of the Depreciation, and Cash is up by $4 from the changes on the Cash Flow Statement.
Overall, Assets is down by $6. Since Net Income fell by $6 as well, Shareholders’ Equity on the Liabilities & Equity side is down by $6 and both sides of the Balance Sheet balance.
Intuition: We save on taxes with any non-cash charge, including Depreciation.
What happens when Accrued Expenses increases by $10?
For this question, remember that Accrued Expenses are recognized on the Income Statement but haven’t been paid out in cash yet. So this could correspond to payment being set aside for an employee, but not actually the employee in cash yet.
Income Statement: Operating Income and Pre-Tax Income fall by $10, and Net Income falls by $6 (assuming a 40% tax rate).
Cash Flow Statement: Net Income is down by $6, and the increase in Accrued Expenses will increase Cash Flow by $10, so overall Cash Flow from Operations is up by $4 and the Net Change in Cash at the bottom is up by $4.
Balance Sheet: Cash is up by $4 as a result, so Assets is up by $4. On the Liabilities & Equity side, Accrued Expenses is a Liability so Liabilities is up by $10 and Shareholders’ Equity (Retained Earnings) is down by $6 due to the Net Income decrease, so both sides balance.
Intuition: We record an additional expense and save on taxes with it… but that expense hasn’t been paid in cash yet, so our cash balance is actually up.
What happens when Accrued Expenses decreases by $10 (i.e. it’s now paid out in the form of cash)? Do not take into account cumulative changes from previous increases in Accrued Expenses.
Assuming that you are not taking into account any previous increases (confirm this):
Income Statement: There are no changes.
Cash Flow Statement: The change in Accrued Expenses in the CFO section is negative $10 because you pay it out in cash, and so the cash at the bottom decreases by $10.
Balance Sheet: Cash is down by $10 on the Assets side and Accrued Expenses is down by $10 on the other side, so it balances.
Intuition: This is a simple cash payout of previously recorded expenses.
Accounts Receivable increases by $10. Walk me through the 3 statements.
If AR “increases” by $10, it means that we’ve recorded revenue of $10 but haven’t received it in cash yet. For example, a customer has ordered a $10 product from us and we’ve delivered it, but we are still waiting on cash payment.
Income Statement: Revenue is up by $10 and so is Pre-Tax Income, which means that Net Income is up by $6 assuming a 40% tax rate.
Cash Flow Statement: Net Income is up by $6 but the AR increase is a reduction in cash (since we don’t have the cash yet), so we need to subtract $10, which results in cash at the bottom being down by $4.
Balance Sheet: On the Assets side, Cash is down by $4 and AR is up by $10, so the Assets side is up by $6. On the other side, Shareholders’ Equity is up by $6 because Net Income has increased by $6. Both sides balance.
Intuition: When AR increases, it means that we’ve paid taxes on additional revenue but haven’t received any of that revenue in cash yet… so our cash balance decreases by the additional amount of taxes we’ve paid.
Prepaid Expenses decreases by $10. Walk me through the statements. Do not take into account cumulative changes from previous increases in Prepaid Expenses.
When Prepaid Expenses “decreases,” it means that expenses are now recognized on the Income Statement. For example, we’ve previously paid for an insurance policy in cash and have now recognized that same expense on the IS.
Income Statement: Pre-Tax Income is down by $10, and Net Income is down by $6.
Cash Flow Statement: Net Income is down by $6 but since Prepaid Expenses is an Asset, a decrease of $10 results in an increase of 10 in cash. At the bottom of the CFS, cash is up by $4 as a result.
Balance Sheet: On the Assets side Cash is up by $4 and Prepaid Expenses is down by $10, so the Assets side is down by $6 overall. On the other side, Shareholders’ Equity is down by $6 because of the reduced Net Income, so both sides balance.
Intuition: Here, we’re losing Net Income and paying additional taxes… but oh, wait, we’ve already paid out these expenses in cash previously! So our Cash balance goes up rather than down, despite the additional Income Statement expenses.
What happens when Inventory goes up by $10, assuming you pay for it with cash?
This really just means, “Walk me through what happens on the statements when you purchase $10 worth of Inventory with cash.”
Income Statement: No changes.
Cash Flow Statement: Inventory is an Asset so that reduces Cash Flow from Operations – it goes down by $10, as does the Net Change in Cash at the bottom.
Balance Sheet: On the Assets side, Inventory is up by $10 but Cash is down by $10, so the changes cancel out and Assets still equals Liabilities & Equity.
Intuition: We’ve spent cash to buy Inventory, but haven’t manufactured or sold anything yet.
A company sells some of its PP&E for $120. On the Balance Sheet, the PP&E is worth $100. Walk me through how the 3 statements change
Income Statement: You record a Gain of $20 ($120 – $100), which boosts Pre-Tax Income by $20. At a 40% tax rate, Net Income is up by $12.
Cash Flow Statement: Net Income is up by $12, but you need to subtract out that Gain of $20, so Cash Flow from Operations is down by $8.
Then, in Cash Flow from Investing, you record the entire amount of proceeds from the sale – $120 – so that section is up by $120. At the bottom of the CFS, cash is therefore up by $112.
Balance Sheet: Cash is up by $112, but PP&E is down by $100 since we’ve sold it, so the Assets side is up by $12. The other side is up by $12 as well, since Shareholders’ Equity is up by $12 due to the Net Income increase.
Intuition: Gains and Losses are not non-cash, but they are re-classified on the CFS. The cash increase here simply reflects the after-tax profit from the Gain – if we had sold the PP&E at its Balance Sheet value, there would be no change on the IS.
Walk me through what happens on the 3 statements when there’s an Asset Write-Down of $100.
Income Statement: The $100 Write-Down reduces Pre-Tax Income by $100. With a 40% tax rate, Net Income declines by $60.
Cash Flow Statement: Net Income is down by $60 but the Write-Down is a non-cash expense, so we add it back – and therefore Cash Flow from Operations increases by $40. Cash at the bottom is up by $40.
Balance Sheet: Cash is now up by $40 and an Asset is down by $100 (it’s not clear which Asset since the question never stated it). Overall, the Assets side is down by $60.
On the other side, since Net Income was down by $60, Shareholders’ Equity is also down by $60 – and both sides balance.
Intuition: The same as any other non-cash charge: we save on taxes, so our Cash goes up, and something on the Balance Sheet changes in response.
Advanced Note: No, Write-Downs are not always tax-deductible like this – see the Advanced section for more.
Explain what happens on the 3 statements when a company issues $100 worth of shares to investors.
Income Statement: No changes (since this doesn’t affect taxes and since the shares will be around for years to come).
Cash Flow Statement: Cash Flow from Financing is up by $100 due to this share issuance, so cash at the bottom is up by $100.
Balance Sheet: Cash is up by $100 on the Assets side and Shareholders’ Equity (Common Stock & APIC) is up by $100 on the other side to balance it.
Intuition: This one does not affect taxes and does not correspond to the current period, so it doesn’t show up on the IS – just like similar items, all that changes is Cash and then something else on the Balance Sheet.
Let’s say we have the same scenario, but now instead of issuing $100 worth of stock to investors, the company issues $100 worth of stock to employees in the form of Stock-Based Compensation. What happens?
Income Statement: You need to record this as an additional expense because it’s now a tax-deductible and a current expense – Pre-Tax Income falls by $100 and Net Income falls by $60 assuming a 40% tax rate.
Cash Flow Statement: Net Income is down by $60 but you add back the SBC of $100 since it’s a non-cash charge, so cash at the bottom is up by $40.
Balance Sheet: Cash is up by $40 on the Assets side. On the other side, Common Stock & APIC is up by $100 due to the Stock-Based Compensation, but Retained Earnings is down by $60 due to the reduced Net Income, so Shareholders’ Equity is up by $40 and both sides balance.
Intuition: This is a non-cash charge, so like all non-cash charges it impacts the IS and affects one Balance Sheet item in addition to Cash and Retained Earnings – in this case, it flows into Common Stock & APIC because that one reflects the market value of stock at the time the stock was issued. The cash increase here simply reflects the tax savings.
A company decides to issue $100 in Dividends – how do the 3 statements change?
Income Statement: No changes. Dividends count as a financing activity and are not tax-deductible, so they never appear on the IS.
Cash Flow Statement: Cash Flow from Financing is down by $100 due to the Dividends, so cash at the bottom is down by $100.
Balance Sheet: Cash is down by $100 on the Assets side, and Shareholders’ Equity (Retained Earnings) is down by $100 on the other side so both sides balance.
Intuition: This is another non-operational CFS / BS item, so it is a simple use of cash and nothing else changes.
A company has recorded $100 in income tax expense on its Income Statement. All $100 of it is paid, in cash, in the current period. Now we change it and only $90 of it is paid in cash, with $10 being deferred to future periods. How do the statements change?
Income Statement: Nothing changes. Both Current and Deferred Taxes are recorded simply as “Taxes” and Net Income remains the same. Net Income changes only if the total amount of taxes changes.
Cash Flow Statement: Net Income remains the same but we add back the $10 worth of Deferred Taxes in Cash Flow from Operations – no other changes, so cash at the bottom is up by $10.
Balance Sheet: Cash is up by $10 and so the entire Assets side is up by $10. On the other side, the Deferred Tax Liability is up by $10 and so both sides balance.
Intuition: Deferred Taxes save us on cash in the current period, at the expense of additional cash taxes in the future.
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? A combination? The most common scenario here is an equity (or Preferred Stock) investment from the government, so here’s what happens:
Income Statement: No changes.
Cash Flow Statement: Cash Flow from Financing goes up by $100 to reflect this new investment, so the Net Change in Cash is up by $100.
Balance Sheet: Cash is up by $100 so the Assets side is up by $100; on the other side, Shareholders’ Equity goes up by $100 to make it balance (Common Stock & APIC for a normal equity investment or Preferred Stock for preferred).
Intuition: It’s the same as a normal stock issuance: no Income Statement changes because nothing affects the company’s taxes.
Walk me through a $100 Write-Down of Debt – as in OWED Debt, a Liability – on a company’s Balance Sheet and how it affects the 3 statements
This one is counter-intuitive. When a Liability is written down you record it as an addition on the Income Statement (with an asset write-down, it’s a subtraction).
Income Statement: Pre-Tax Income goes up by $100, and assuming a 40% tax rate, Net Income is up by $60.
Cash Flow Statement: Net Income is up by $60, but we need to subtract that Debt Write-Down because it was non-cash – so Cash Flow from Operations is down by $40, and Cash is down by $40 at the bottom.
Balance Sheet: Cash is down by $40 so the Assets side is down by $40. On the other side, Debt is down by $100 but Shareholders’ Equity is up by $60 because the Net Income was up by $60 – so Liabilities & Shareholders’ Equity is down by $40 and both sides balance.
If this seems strange to you, you’re not alone – click to read this Forbes article for more on why writing down debt actually benefits companies accounting-wise.
Intuition: One way to think about this is that writing down Assets is “bad” for us because it reduces our ability to generate future cash flow, but writing down Liabilities is “good” because it reduces our future expenses… sort of. I don’t recommend presenting it like that in an interview.
Wait a minute – if writing down Liabilities boosts Net Income, why don’t companies just do it all the time? It helps them out
This is like asking, “If declaring bankruptcy helps you relieve your obligations, why not do it whenever you rack up debt?!”
And the answer is similar: Because it may help in the short-term, but in the long-term it hurts the company’s credibility and ability to borrow in the future. If a company continually writes down its Liabilities, investors will stop trusting it – and the inability to borrow again will hurt it far more than a reduced Net Income would.
