Apple buys $100 of new factories with debt. How are statements affected at start of year 1?
My answer:
IS: Nothing happens
CFS: Cash flow financing: +100 Cash flow investing -100
BS: PPE +100, Liabilities: Debt +100
My question is why the factories go under cash flow from investing? I thought I should treat it as INVENTORY and therefore it should be -100 under cash flow from operations?
Inventory refers to products that have been made (and thus costed money to create) but have not yet been sold. Buying factories counts as an investment, just like buying a home.
Partially correct. Inventory also includes raw materials and WIP.
sorry, double post.
Cap Ex
Factories. Put them in your inventory.
You said it yourself in PPE +100.
Inventory is something that is sold in the normal course of business. If the company normally bought and sold factories, then it would be considered INV. Apple obviously doesn't do this so it would be considered PPE, or fixed depreciable assets that would be an investment.
Balance sheet. Debit PP&E $100, credit long-term debt $100.
As for factories in inventory for even a private equity firm, isn't inventory something that you can reasonably be able to dispose of in a year? I think your auditors are going to have some questions about that if you try and classify factories as a short-term asset on any level unless the market for them suddenly gets as liquid as cars or at least industrial bailers.
Inventory is generally a short-term asset. Something you expect to get rid of in the next year.
BIWS
No, this is really just Accy 101. Take a financial accounting class at school. You'll also learn about Porter's 5 forces, divisions of a company, how they operate, different strategies for competing, etc.
You won't learn about that stuff in a financial accounting class...
Illini I asked my professor about it because you made a good argument and I wasn't too sure anymore. A better example would be real estate. My professor said it would be considered inventory because it is purchased in the normal course of business and is bought to be sold. As to the current asset, she said maybe not if their operating cycle is longer than a year.
I pulled up a REIT's BS and it appears all of their holdings are in PPE.. so I don't really know. I'm curious... http://finance.yahoo.com/q/bs?s=GGP+Balance+Sheet&annual
[quote=beancounter]Illini I asked my professor about it because you made a good argument and I wasn't too sure anymore. A better example would be real estate. My professor said it would be considered inventory because it is purchased in the normal course of business and is bought to be sold. As to the current asset, she said maybe not if their operating cycle is longer than a year.
I pulled up a REIT's BS and it appears all of their holdings are in PPE.. so I don't really know. I'm curious... http://finance.yahoo.com/q/bs?s=GGP+Balance+Sheet&annual[/quote] A REIT's not a good example here. The buildings are rented in the normal course of business, not sold. In effect, they are literally factories for generating "months of rent" (sold in increments of one year).
A better example would be a homebuilder. Their product is buildings/land rather than rent. For them, the land may be inventory and the manufacturing equipment is PP&E.
I still don't like classifying something as a short-term asset just because it's inventory, though. It's a bastardization of the principals of accounting. We have separate line on balance sheets for "Current long-term debt" that falls under current liabilities. There should at least be a separate line for "Long-term/illiquid inventory" if there isn't one in the case of property you can't reasonably expect to sell- even at a significant but reasonable discount- in the next year.
Why would a factory be treated as inventory? Does the hypothetical company sell factories?
Assets with a life over 1 year are capitalized, put on the balance sheet, and depreciated (hence they are not part of working capital and don't affect cash from operations). Purchases with a life under 1 year are expensed and put on the income statement (COGS, opex, etc).
this is a scenario straight from BIWS fundamentals/accounting course. Brian walks through this - same company, same amount...Looking at his other posts, I'm assuming OP got it straight from BIWS. but yes, this is a basic question that any acct 101 course would cover.
You're right, all the recent questions he posted are from BIWS. I think he either really doesn't get it (even after the book goes through explanations)...
... or he's a weird troll.
Either way he wants some clarification. My example about the REIT isn't valid since they don't actually but parcels of land, rather investments made up of real estate.
A better example to show what I was talking about is a yacht manufacturer that generally doesn't sell within 1 year. They would still be classified as inventory and NOT depreciated.
Yeah sorry for some reason I thought REIT would be an example but you're right. In general, the 1 year rule works except for land and certain other exceptions that probably won't come up if you're prepping for an interview.
Hi, I'd like a little clarification on this please. Why is there no change on the income statement? Shouldn't this $100 factory be capitalized and thus reflected on the income statement under depreciation?
Is it because it's Year 1?
Let's say the factory lasts 5 years. And let's say, you pay back debt in 2 years with 10% interest. This is what I have so far...
Year 1 : BS: PPE +100, Debt +100
CF: CapEx -100
IS: Depreciation 0
Year 2 : BS: PPE -20, Debt -50 CF: Depreciation -20, CapEx 0, Debt Payment -55 IS: Depreciation +20, Interest Expense +5
Year 3 : BS: PPE -20, Debt -50 CF: Depreciation -20, Debt Payment -55 IS: Depreciation +20, Interest Expense+5
Year 4: BS: PPE -20, Debt 0 CF: Depreciation -20, Debt Payment 0 IS: Depreciation +20, Interest Expense 0
Is this right? How is BS balanced? I know I made it a little more complicated but help is much appreciated. Thanks.
The question asks "how are statements affected at start of year 1." Since the I/S and SCF are based on activity of the period, there would be nothing on either of those statements at the START of year 1.
If you mean end of year 1 - there would only be 0 change in the IS (resulting from depreciation exp) in year 1 if you purchased it on 12/31.
You're forgetting the cash out for repaying of debt.
Assuming everything else in year 2 is right - JE should look like this:
Db. Interest expense 5 to IS Db. deprecation expense 20 to IS Db. Notes Payable (debt) 50 B/S Cr. Cash 55 B/S Cr. Accum Depr. 20 B/S (contra asset, same as reducing PPE)
Thanks beancounter.
nothing changed. apple doesn't have debt - i wish any one of the candidates said that to me...
Haha good point
Why does this transaction impact Cash Flows from Investing. I know it's CAPEX, but isn't it funded with debt? Shouldn't that impact CFF?
There are two separate cash flows here:
Cash inflow from the bank to Apple. Cash Flow from Financing increases by €100
Cash outflow from Apple to purchase the factory. Cash Flow from Investing decreases by €100
Financing generally relates to items effecting capital structure such as raising debt, taking out or repaying a loan or raising equity financing.
Investing generally relates to capital expenditure i.e. buying items that are going to be used by the business in future operations e.g. factories, machinery, private jets etc.
Ultimately what you have to understand is that these classifications are logical yet artificial....one goes into CFF and the other goes into CFI because some accountancy body says so. Like I said it is logical and you should understand why they are treated differently but ultimately realise these decisions come from accounting bodies and are set out in accounting standards.
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