Accounting Problems

Question 1

(Easy) How would Depreciation increasing by $10 affect the three financial statements?

Answer 1

Single-Step Scenario

IS
D&A: +10
Pre-Tax Income: -10
Net Income (assuming a 20% tax rate): -8

CF
CFO Net Income: -8
CFO D&A: +10
Net Change CFO: +2
No Change CFI/CFF
Net Change in Cash: +2

BS
Assets
Cash: +2
PP&E: -10
Shareholder’s Equity
RE from Net Income: -8

Question 2

Mechanistically, how do you link the 3 financial statements? (Memorize Key Rule #4)

Answer 2

1) IS => CF Net Income
- bottom line item of IS flows to the top line item of CF

2) IS => CF Non-Cash Expenses, Gains/Losses
- Add back non-cash expenses to the CF
- flip the signs of IS Gains/Losses

3) BS => CF changes in Operational Working Capital into CFO
- Asset inc, Cash dec
- Liability inc, Cash inc

4) BS => CF changes PP&E, Purchases/Sales of Investments flows to CFI

5) BS => CF changes Dividends, Debt issued/repurchased, Shares issues/repurchased flows to CFF

6) Net Change in Cash CF calculation

7) CF => BS update next period
ex: Cash, Debt, Equity, Investments, PP&E

Question 3

(Easy) Accrued Expenses decrease $10 affect on three financial statements?

Answer 3

Single-step Scenario

Accrued Expenses is a Liability decreasing because of a cash payment.

IS
no change - because this is not a new revenue or expense, but a change in cash for an already existing expense

CF
CFO: -10 from paying down the Liability
No Change CFI/CFF
Net change in Cash: -10

BS
A = Cash: -10
L = Accrued Expenses: -10

Question 4

(Easy) Accounts Receivable up by $10, walk me through the financial statements.

Answer 4

Single-Step Scenario

Accounts Receivable are assets on BS we record as revenue on IS although haven’t received the cash yet.

Intuition: when AR increases, we pay taxes on additional revenue without having received cash, so cash balance decreases due to additional taxes.

IS
Revenue: +10
Pre-Tax Income: +10
Net Income (assuming 20% tax): +8

CF
CFO Net Income: +8
CFO Asset Increase: -10
CFO Net change: -2
No Change CFI/CFF
Cash Net change: -2

BS
A = Cash: -2
A = Accounts Receivable: +10
SE = Retained Earnings: +8

Question 5

(Easy) Prepaid Expenses decreases by $10, walk me through the financial statements (without cumulative previous increases in Prepaid Expenses)

Answer 5

Single-Step Scenario

Prepaid Expenses decreasing on the BS Assets means you’re recognizing the expense on the IS. Expense is now matched to the revenue it helped earn.

Intuition: losing Net Income and paying additional taxes, but we’ve already paid these expenses in cash already! Cash balance goes up, despite the additional expense.

IS
Operating Expenses: +10
Pre-Tax Income: -10
Net Income (assuming a 20% tax rate): -8

CF
CFO Net Income: -8
CFO Asset decrease: +10
CFO net change: +2
No Change in CFI/CFF
Net Change in Cash: +2

BS
A = Cash: +2
A = Prepaid Expenses: -10
SE = Retained Earnings: -8

Question 6

(Easy) Inventory goes up by $10, paid in cash – walk me through the financial statements.

Answer 6

Single-step scenario

Inventory, an asset on BS, is paid via cash.

Intuition: we’ve spent cash to buy inventory, but we haven’t manufactured or sold anything yet.

IS
no change - no revenue or expense here from operations of the business

CF
CFO Asset increase: -10
No Change CFI/CFF
Net Change in Cash: -10

BS
A = Cash: -10
A = Inventory: +10

Question 7

(Easy) A company sells some PP&E for $120. On the Balance Sheet, the PP&E is worth $100. Walk through the financial statements.

Answer 7

Single-step Scenario

IS
Gain: +20
Pre-tax Income: +20
Net Income (20% tax): +16

CF
CFO Net Income: +16
CFO Subtract Gain: -20
CFO Net Change: -4

CFI Sale of PP&E: +120

Net Change in Cash: +116

BS
A = Cash: +116
A = PP&E: -100
Net A = +16

SE = Retained Earnings: +16

Question 8

(Medium-Hard) Impact on Statements:

1) Buy $100 PP&E, 50% Cash & 50% Debt
2) next year 500 Rev, 20% EBITDA margin, 10% Interest, 20% Tax, 20% D&A

Answer 8

Part 1 (Get some feedback on this)

IS
no change

CF
CFO cash: -50
CFF debt raise: +50
CFI investment in PP&E: -100
net change in cash: -100

BS
A = cash: -100
A = PP&E: +100
L = debt: +50

Part 2
IS
revenue 500
pre-tax income: +500
EBITDA margin 20%
EBITDA: +400
interest expense 10% = -5
pre-tax income: +395
D&A: -20
pre-tax income: +375
tax 20%
net income: +300

CF
CFO net income: +300
CFO non-cash expense: +20 D&A
CFF/CFI no change
net change in cash: +320

BS
A = cash: +320
A = PP&E: -20
SE = RE: +300

Question 9

(Medium) Purchase of PPE $1000 with debt. Useful life of 10 years, interest rate of 20%. Walk through three statements year 0,1,2. Assume a salvage value of $0.

Answer 9

Feedback from Nick
1000/10 = depreciation of 100

IS

Question 10

(Easy) Walk me through the financial statements when there’s an Asset Write-Down of $100

Answer 10

Single-Step Scenario

IS
Pre-tax Income: -100
Net Income (20% tax): -80

CF
CFO Net Income: -80
CFO Non-Cash Expense: +100
CFO Net Change: +20
no change in CFI/CFF
Net Change in Cash: +20

BS
A = Cash: +20
A = Write Off: -100
Net Change A: -80

SE = Retained Earnings: -80

Question 11

(Easy) What happens on financial statements when company issues $100 worth of shares to investors?

Answer 11

IS = no change

CF
CFO no change
CFI no change
CFF: +100 equity issuance
net change in cash: +100

BS
A = cash: +100
SE = common stock & APIC: +100

Question 12

(Easy) What happens to the financial statements when company issues $100 of stock to employees as Stock-Based Compensation?

Answer 12

Stock-based Compensation is a non-cash expense

IS
pre-tax income: -100
net income: -80

CF
CFO net income: -80
CFO non-cash expense: +100
change CFO: +20

BS
A = cash: +20
SE = common stock & APIC: +100
SE = retained earnings: -80

Question 13

(Easy) What happens to the 3 financial statements when a company issues $100 in dividends?

Answer 13

IS
no change

CF
CFO no change
CFI no change
CFF dividend issuance: -100
net change cash: -100

BS
A = cash: -100
SE = retained earnings: -100

Question 14

(Medium) 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 other periods. How do the 3 financial statements change?

Answer 14

IS
no change, because total taxes remains the same. Net Income changes only if total amount of taxes changes.

CF
CFO change OWC (increase Deferred Taxes, Liability): +10
CFI/CFF no change
net change in cash: +10

BS
A = cash: +10
L = deferred taxes: +10

Question 15

(Easy) Walk me through how a $100 bailout of a company affects the 3 financial statements?

Answer 15

what kind of bailout?

The most common scenario is an equity or Preferred Stock investment from the government.

IS
no change

CF
CFF equity investment: +100
no change CFO/CFI
net change in cash: +100

BS
A = cash: +100
SE = common stock & APIC, or Preferred: +100

Question 16

(Easy) Walk me through how a $100 Write-Down of Debt (owed Debt, Liability) on the Balance Sheet and how it affects the 3 statements?

Answer 16

Write-Down of Liability = increase in pre-tax income (opposite of Write-Down of Asset)

IS
pre-tax income: +100
net income: +80

CF
CFO net income: +80
CFO subtract non-cash revenue: -100
net CFO: -20
net change cash: -20

BS
A = cash: -20
L = Debt: -100
SE = RE: +80

Question 17

(Medium-Hard) Multi-Step Scenario 1/3: Let’s say Apple is buying $100 worth of new factories with debt. How are the 3 statements affected at the start of Year 1?

Multi-Step Scenario 2/3: Now let’s go out to the start of Year 2. Assume Debt is high-yield, so no principal is paid off, and assume an interest rate of 10%. Also assume that factories depreciate at a rate of 10% per year. What happens to the 3 financial statements?

Multi-Step Scenario 3/3: Now let’s go out to the end of Year 2. All factories break down and their value is written down to 0. The loan must be paid back now. Walk me through how the 3 financial statements from the start of Year 2 to the end of Year 2.

Answer 17

PART 1: Start Year 1
IS - no change, no associated revenue with PP&E purchase yet

CF
CFO change OWC: -100
CFF debt raise: +100
net change in cash: 0

BS
A = PP&E: +100
L = Debt: +100

PART 2: Start Year 2
IS
interest expense: +10
depreciation expense: +10
pre-tax income: -20
net income: -16

CF
CFO net income: -16
CFO non-cash expense: +10
CFO net: -6
no change CFF/CFI
net change cash: -6

BS
A = cash: -6
A = PP&E: -10
SE = RE: -16

PART 3: end of year 2
Asset Write-Down

IS
depreciation expense 10
interest expense 10
asset write-down 80
pre-tax income: -100
net income: -80

CF
CFO net income: -80
CFO non cash expenses: +90
net CFO: +10
CFF debt principal payoff: -100
CFI no change
net change cash: -90

BS
A = cash: -90
A = PP&E: -90
L = Debt: -100
SE = RE: -80

Question 18

(Easy) accounting three statements - sale for $10 with an inventory of $5

Answer 18

IS
revenue +10
COGS -5
pre-tax income: +5
net income: +4

CF
CFO net income: +4
CFO change OWC: +5
CFO net change: +9

BS
A = cash: +9
A = inventory: -5
SE = RE: +4

Question 19

(Easy) How does $150 decrease in deferred revenue impact the 3 FS? Tax rate of 20%

Answer 19

Deferred Revenue = Liability on Balance sheet, received cash not recognized revenue yet. Decrease in deferred revenue means revenue is now recognized on IS.

IS
revenue +150
pre-tax income: +150
net income: +120

CF
CFO net income: +120
CFO change OWC: -150
CFO net change: -30
no CFF/CFI
net change in cash: -30

BS
A = cash: -30
L = deferred revenue: -150
SE = RE: +120

A = L + SE

Question 20

(Medium)

Buy $100 Machinery and finance 100% with debt 10% interest with 5 year useful life - walk me through the 3 statements for end of year 1

Answer 20

Year 0
IS
no change

CF
CFO no change
CFF debt raise: +100
CFI PP&E purchase: -100
net change in cash: 0

BS
A = cash: 0
A = PP&E: +100
L = Debt: +100

A = L + SE

Year 1
100/5 = $20/year straight line depreciation

IS
interest expense -10
depreciation expense -20
pre-tax income: -30
net income: -24

CF
CFO net income: -24
CFO non-cash expense: +20
net change CFO: -4
no CFF/CFI
net change in cash: -4

BS
A = cash: -4
A = PP&E: -20
SE = RE: -24

Question 21

(Easy) Accrued Compensation goes up by $10, effect on financial statements

Answer 21

IS
new expense recognized
pre-tax income: -10
net income: -8

CF
CFO net income: -8
CFO working capital change: +10
net CFO: +2
no CFF/CFI
net cash change: +2

BS
A = cash: +2
L = Accrued Expenses: +10
SE = RE: -8

A = L + SE

Question 22

(Easy) Inventory goes up by $10, paid in debt

Answer 22

IS
no change

CF
CFO change OWC -10
CFF debt issuance +10
net change cash: 0

BS
A = cash: 0
A = inventory: +10
L = debt: +10

Question 23

(Easy) Inventory goes up by $10, paid in equity

Answer 23

IS
no change

CF
CFO change OWC: -10
CFF equity issuance: +10
net change cash: 0

BS
A = cash: 0
A = inventory: +10
RE = common stock & APIC: +10

Question 24

(Easy) Company sells PP&E they bought for $200 for $100. Affect of three statements?

Answer 24

Loss on Asset

IS
loss +100
pre-tax income: -100
net income: -80

CF
CFO net income: -80
CFO add loss: +100
net CFO: +20

CFI sale of asset: +100
net change cash: +120

BS
A = cash: +120
A = PP&E: -200
SE = RE: -80

Question 25

(Easy) Apple orders $10 of additional inventory with cash on hand. Changes to statements?

Answer 25

IS no change CF CFO change OWC: -10 no CFF/CFI net change cash: -10 BS A = cash: -10 A = inventory: +10

Question 26

(Easy) Apple sells iPads for a revenue of $20 and cost of $10. Impact on statements?

Answer 26

IS revenue 20 COGS 10 pre-tax income: +10 net income: +8 CF CFO net income: +8 CFO change OWC: +10 CFO net change: +18 no CFI/CFF net change in cash: +18 BS A = cash: +18 A = inventory: -10 SE = RE: +8

Question 27

(Medium-Hard) A company raises $100 worth of Debt, at 5% interest and 10% yearly principal repayment, to purchase $100 worth of Short-term securities with 10% interest attached. Part 1) Walk me through how the 3 statements change IMMEDIATELY AFTER the initial purchase. Part 2) What happens at the end of year 1? Part 3) at the end of year 1, the company sells $100 of Short-term Securities but gets a price of $110 on them. It also uses the proceeds to repay the $90 of debt principal. Walk me through the statements after ONLY these changes.

Answer 27

PART 1) PURCHASE IMMEDIATE AFTERMATH IS no change CF CFO no change CFF debt raise: +100 CFI buy short-term investments: -100 net change in cash: 0 BS A = cash: 0 A = short-term investments: +100 L = debt: +100 PART 2) END OF YEAR 1 IS interest expense 5 interest revenue 10 pre-tax income: +5 net income: +4 CF CFO net income: +4 CFF debt repayment: -10 CFI no change net change in cash: -6 BS A = cash: -6 L = debt: -10 SE = RE: +4 A = L + SE PART 3) SELLING SHORT-TERM ASSETS WITH GAIN, PAYING DOWN DEBT (still end of year 1) IS gain on asset 10 pre-tax income: +10 net income: +8 CF CFO net income: +8 CFO reverse gain: -10 CFI sale of asset: +110 CFF debt repayment: -90 net change in cash: +18 BS A = cash: +18 A = short-term securities: -100 L = debt: -90 SE = RE: +8 A = L + SE

Question 28

(Medium-Hard) 100 inventory is sold at a 50% profit margin. The sale occurred on credit. What happened to the 3 statements

Answer 28

Rev = COGS / 1 - Margin Rev = 100 / 0.5 = 200 IS Revenue +200 COGS -100 Pre-tax income +100 Net income @20% tax +80 CF CFO net income +80 CFO change in owc inventory down +100 AR up -150 no CFF/CFI net change in cash +30 BS A = cash: +30 A = AR: +150 A = inventory: -100 SE = RE: +80

Question 29

(Easy) Operating Expenses Increase by $100, walk through statements

Answer 29

IS OpEx +100 Pre-tax income -100 Net Income -80 CF CFO Net Income -80 no CFF/CFI net change Cash -80 BS A = Cash: -80 SE = RE: -80

Question 30

(Easy) Depreciation increases by $200

Answer 30

IS Depreciation Expense -200 Pre-tax income -200 Net income -160 CF CFO Net Income -160 CFO non-cash expense +200 no CFF/CFI net change in cash +40 BS A = Cash: +40 A = PP&E: -200 SE = RE: -160

Question 31

(Easy) A company runs into financial distress and needs Cash immediately. It sells a factory that's listed at $100 on its BS for $80. What happens on statements?

Answer 31

Loss on Sale of Asset Sale - Book = 80 - 100 = -20 IS Loss on Asset: -20 Pre-tax income: -20 Net income: -16 CF CFO Net Income: -16 CFO non-cash expense: +20 CFI asset sale: +80 net change in cash: +84 BS A = Cash: +84 A = PP&E: -100 SE = RE: -16

Question 32

(Easy) Walk me through the financial statements when a customer orders a product for $100 but doesn't pay in cash. Then, walk me through the cash collection, combining it with the first step.

Answer 32

Increase AR by 100, then paying AR with cash. Part 1 - AR increase IS Revenue +100 Pre-tax income +100 Net Income +80 CF CFO Net Income +80 CFO change OWC AR increase -100 CFF/CFI no change net change in cash -20 BS A = Cash: -20 A = AR: +100 SE = RE: +80 Part 2 - Cash collection, AR decrease combined with first step IS Net Income +80 CF CFO net income +80 CFO change OWC AR combined 0 net change in cash +80 BS A = Cash +80 A = AP 0 SE = RE: +80

Question 33

(Easy) A company prepays $20 in utilities one month in advance. Walk me through what happens when the company prepays the expense, and then what happens when the expense is recognized combined with the first step.

Answer 33

Prepaid Expenses (A) increases Then expense is recognized on the IS Part 1 IS no change CF CFO change in OWC PE increase -20 net change in cash -20 BS A = Cash -20 A = PE +20 Part 2 IS expense -20 pre-tax income -20 net income -16 CFO CFO net income -16 CFO change in OWC pt1 PE increase -20 pt2 PE decrease +20 net change in cash -16 BS A = Cash: -16 A = PE: 0 SE = RE: -16

Question 34

(Difficult) Share price $100 P/E 50x Shares outstanding 5000 Interest on debt 10%, EBITDA 25,000 Debt 10,000 Tax rate 50% Gross margin 70% What is depreciation?

Answer 34

Create an IS, remember P/E = Equity Value / Net Income P/E = EqV / Net Income 50 = (5000*100) / (Net Income) Net Income = (5000*100) / 50 = (5*10^3*10^2) / (5*10^1) = (5*10^5) / (5*10^1) = 10^4 = 10,000 Income Statement EBITDA = EBIT + DA DA = EBITDA - EBIT Revenue - COGS - Operating Expenses (including D&A) = EBIT - net interest expense = pre-tax income pre-tax income(1-tax rate) = net income Working Back net Income 10,000 pre-tax income(0.5) = 10,000 pre-tax income = 20,000 EBIT = pre-tax income + net interest expense = 20,000 + 1000 = 21,000 DA = 25,000 - 21,000 = 4,000

Question 35

(Medium) Walmart buys $400 in Inventory for products it will sell next month. Walk me through what happens on the statements when 1) they first buy the inventory 2) when they sell the products for $600, combining it with the first step

Answer 35

Inventory = think of COGS First purchase IS no change CF CFO change in OWC Inventory inc -400 no CFF/CFI net change in cash: -400 BS A = Cash: -400 A = Inventory: +400 Selling inventory (combining with first step) IS Revenue +600 COGS -400 pre-tax income +200 net income +160 CF CFO net income +160 CFO change OWC Inventory inc -400, dec +400 = 0 no CFF/CFI net change in cash: +160 BS A = Cash +160 A = Inventory 0 SE = RE +160

Question 36

(Medium) Amazon decides to pay several key vendors $200 on credit, and says it will pay them in cash in one month. What happens on the financial statements when the expense is incurred, and when it is paid in cash?

Answer 36

Accounts Payable +200 AP being paid in cash Expense Incurred IS operating expense +200 pre-tax income -200 net income -160 CF CFO net income -160 CFO change in OWC AP (L) inc, +200 no CFF/CFI net change in cash +40 BS A = Cash +40 L = AP +200 SE = RE -160 AP Paid in Cash IS no change, net income = -160 CF CFO change in OWC AP (L) decrease, -200 net change in cash = +40-200 = -160 BS A = Cash: -160 L = AP: +200 - 200 = 0 SE = RE: -160

Question 37

(Medium) Salesforce sells a customer a $100 per month subscription but makes the customer pay all the cash upfront for a year. What happens to the statements? What happens after one month has passed, and the company has delivered one month of service for $100? Assume there are $20 in Operating Expenses associated with delivery of service for this one month. Combine this step with the previous one.

Answer 37

Increase in Deferred Revenue (L) = no revenue recognized yet, but cash received. FOR ENTIRE YEAR = 1200 for entire year IS no change CF CFO change in OWC Def. Rev. (L) inc +1200 CFF/CFI no changes net change in cash +1200 BS A = Cash +1200 L = Deferred Revenue +1200 AFTER ONE MONTH IS Revenue +100 Operating Expense -20 Pre-tax income +80 Net Income +64 CF CFO Net Income +64 CFO change in OWC Def. Rev (L) inc +1200 Def. Rev (L) dec -100 CFF/CFI no changes net change in cash: +1100 + 64 = +1164 BS A = Cash +1164 L = Deferred Revenue +1100 SE = RE: +64

Question 38

(Easy) A company issues $100 in common stock to new investors to fund its operations. How do the statements change? This same company now realizes it has too much Cash, and now wants to issue Dividends or repurchase common shares. How do they impact the three statements differently?

Answer 38

$100 equity raise IS no change CF CFO no change CFF equity raise +100 net change in cash +100 BS A = Cash +100 SE = CSE +100 The changes are of similar impact, but Dividends do NOT reduce shares outstanding, while Stock Repurchases DO. IS no change CF CFF repurchase shares OR issue dividends -100 CFI/CFO no change net change in cash -100 BS A = cash -100 SE = for dividends RE -100, for stock repurchase Treasury Stock -100

Question 39

(Medium) A company has a factory shown at $200 on its BS but a hurricane hits the factory and destroys part of it, so the company records a $100 P&E Write-Down. Walk me through the statements.

Answer 39

Writing down part of Asset. Asset Write Downs are NOT cash-tax deductible, so the Deferred Tax Asset, not Cash, changes. IS PP&E Write Down -100 Pre-tax income -100 Net income -80 CF CFO Net Income -80 reverse non-cash expense +100 Change in OWC DTA inc, -20 net change in cash 0 BS A = Cash 0 A = Deferred Tax Asset +20 A = PP&E -100 SE = RE: -80

Question 40

(Medium-Hard) Your company decides to acquire another company for $500, using 50% Debt and 50% Common Stock. The other company has $300 in Assets, no Liabilities, and $300 in Common Shareholders’ Equity. Assume that the purchase premium is distributed 50/50 between Goodwill and Other Intangible Assets. What happens to your company’s financial statements immediately after this acquisition takes place? On December 31 of Year 1, this same company now decides that this acquired company is worth far less than expected, so it writes down the entire $100 balance of Goodwill. Assume a 25% tax rate. Walk through JUST THIS STEP BY ITSELF, ignoring the cumulative changes in the previous two steps.

Answer 40

Purchase Premium = Purchase Price - Seller SE = 500 - 300 = 200 IS no change CF CFF debt raise +250 equity raise +250 CFI acquisition -500 Net Change in Cash 0 SE A = Assets +300 A = Goodwill +100 A = Other Intangible Assets +100 L = Debt +250 SE = Common Stock & APIC +250 December 31st Goodwill Write-Down IS Goodwill/Asset Write-Down -100 Pre-tax income -100 Net Income -75 CF CFO Net Income -75 CFO non-cash expense +100 CFO change in OWC Deferred Tax Asset inc, -25 Net Change in Cash 0 BS A = Cash 0 A = Deferred Tax Asset +25 A = Goodwill -100 SE = RE -75

Question 41

If we acquire PP&E for $800, straight line depreciation over 10 years (no salvage value), and we sell it for $700 at the end of year 4, what are changes to financial statements?

Answer 41

TBD depreciation expense = 800/10 = $80/year gain = sale price - book value 700 - (800 - 4*80) = 700 - 800 + 320 = +220 End of Year 4 IS depreciation expense -80 gain on sale of asset +220 pre-tax income +140 net income (20% tax) +112 CF CFO net income +112 reverse non-cash +80 - 220 = -140 CFI sale of asset +700 net change in cash +812-140 = +712-40 = +672 CFF no change BS A = cash +672 A = PP&E -480