Accounting: Interview Questions

All,

Looking for help with some basic accounting interview questions. Thanks in advance:

1) How does increasing a Deferred Tax Asset by $100 affect the three statements?

2) How does decreasing a Deferred Tax Asset by $100 affect the three statements?

3) If you use accelerated depreciation on your tax books but straight line on your GAAP books, how does this flow through the 3 statements? (Deferred Tax Liability Question)

 
Best Response

Here's my thought process. Deferred taxes always jumbles my brain up so these are very likely partially incorrect:

1) Assuming all else equal, if DTA increases by $100, it means that compared to before, your pre-tax taxable income is now $250 (40% tax rate) higher than your pre-tax book income. Therefore, you pay $100 (25040%) more in taxes than your books reflect, which creates a $100 DTA. So, NI is +150 (25060%), CFS is +50 (NI +150; DTA -100), BS balances (Cash +50, DTA +100; RE +150).

2) Vice versa to (1).

3) For the first few years, you will have a lower taxable income than book income, as accelerated depreciation will cause your D&A to be higher on your tax statements. Therefore, you are paying less in taxes than what your books reflect - a DTL is thus created. In the ending years where depreciation from MACRs is lower than yearly straight-line depreciation, your D&A will be lower on your tax statements, which causes you to pay more taxes than what your books reflect, and therefore the previous DTL balance you created is reduced until eventually it zeroes out.

 

1) Income Statement will be impacted by a profit / loss on disposal which will simply be the price you sold it for minus the cost minus accumulated depreciation on the asset.

Balance Sheet will have a reduction in whatever line item the asset was from, an increase in cash and a reduction in Accumulated Depreciation (this last bit only applies if the company splits out acc.dep and doesn't just report the carrying value)

Cash Flow Statement will have positive cash flow from the sale.

2) I believe that share buybacks don't have any impact on the income statement, could be wrong though.

Balance sheet - treasury stock will go up (effectively down since it is a negative) and cash will go down.

CFS - negative cash flow in either Financing or Investing,

Just a couple of things to add to Asatar's post:

1) Income Statement - If you disposed of the asset during year two, and not at the very beginning (Jan 1), you're going to have a prorated depreciation expense amount to include for the time that you held the asset.

Cash Flow Statement - You'll add back any depreciation expense taken for the asset (assuming the scenario mentioned above). Any gain/loss will also be subtracted/added into the cash flow from operations (CFO). The actual dollar amount received will show up as a positive cash for in the cash flow from investing (CFI) section. BTW, I'm using the indirect method for the CFO since it's easier to compute.

2) Your post mentions a bond whereas Asatar's answer refers to shares (or common stock). I'm not sure if you originally meant bond or stock, so I'll do the bond side of things.

Income Statement - You'll most likely have a gain or loss from the early retirement of the bond. This is mainly dependent on if the bond was issued at a discount or at a premium, the bond issuing costs, and how much you paid for the retirement of the bond. You'll also record the equivalent interest expense on the bond in the same manner you would the depreciation scenario in #1.

Balance Sheet - Your cash obviously will go down for the purchase price to retire the bond. Subsequently the bond (at book value), the discount/premium (if there was any) and the bond issue costs will all be removed from the balance sheet.

Cash Flow Statement - As with the asset in #1, any gain/loss will be subtracted/added in the CFO, and any interest expense is added back in (again indirect method). On this part I'm not 100% sure, but I believe the purchase amount you paid for the retirement of the bond will be a negative cash flow from financing (GAAP anyway). Overall though there should be a cash outflow for the repurchase.

crackjack:
Just a couple of things to add to Asatar's post:

1) Income Statement - If you disposed of the asset during year two, and not at the very beginning (Jan 1), you're going to have a prorated depreciation expense amount to include for the time that you held the asset.

Cash Flow Statement - You'll add back any depreciation expense taken for the asset (assuming the scenario mentioned above). Any gain/loss will also be subtracted/added into the cash flow from operations (CFO). The actual dollar amount received will show up as a positive cash for in the cash flow from investing (CFI) section. BTW, I'm using the indirect method for the CFO since it's easier to compute.

2) Your post mentions a bond whereas Asatar's answer refers to shares (or common stock). I'm not sure if you originally meant bond or stock, so I'll do the bond side of things.

Income Statement - You'll most likely have a gain or loss from the early retirement of the bond. This is mainly dependent on if the bond was issued at a discount or at a premium, the bond issuing costs, and how much you paid for the retirement of the bond. You'll also record the equivalent interest expense on the bond in the same manner you would the depreciation scenario in #1.

Balance Sheet - Your cash obviously will go down for the purchase price to retire the bond. Subsequently the bond (at book value), the discount/premium (if there was any) and the bond issue costs will all be removed from the balance sheet.

Cash Flow Statement - As with the asset in #1, any gain/loss will be subtracted/added in the CFO, and any interest expense is added back in (again indirect method). On this part I'm not 100% sure, but I believe the purchase amount you paid for the retirement of the bond will be a negative cash flow from financing (GAAP anyway). Overall though there should be a cash outflow for the repurchase.

This was a good answer.

 
Asatar:
crackjack:
Just a couple of things to add to Asatar's post:

Good catch on the bond versus share.

The fact that he mentioned 'after one year of depreciation' led me to assume that it was bought on Jan 1st X1 and sold on Jan 1st X2, hence I didn't include any reversals of depreciation.

The depreciation is probably not a deal breaker for an interview. I would say though that during the interview it would be good to mention, just to show you know that may be the case. Since the start date is never mentioned, it could easily have been bought in June or whenever.

Better to know too much than too little.

 

Graduated from engineering, all interviews I had with all the differents banks were all very technical and involved knowing detailed things (plus the typical IB questions..)

 

If you bought the interview prep, stick with it. Master it, because it's compiled from the information you could be expected to know. I doubt it would get more technical than the WSO or BIWS guides.

I am permanently behind on PMs, it's not personal.
 

How does a transaction flow through all statemants Have other people got other questions? It will be great if will can accumulate these accounting questions

 

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