Accrued compensation goes up by $10
Confused about this...
1) Assume we recognize a new expense (salary accrues) instead of reclassifying non-accrued to accrued. Income Statement: SG&A up by $10. Pre-tax income down by $10. Taxes recovery +2. Net income down by $8. Cash Statement: Net income down $8. Add-back non-cash expense of accrued compensation of $10, net cash position up $2. Balance Sheet: Cash up $2. Accrued compensation up $10. Shareholder equity down $8. Balances.
Question: Technically accrued compensation is part of working capital and is a (current) liability. We are adding back $10 in cash flow due to it being a non-cash expense but do we also need to add back an additional $10 due to change in working capital?
2) Assume now that we reclassify non-accrued to accrued compensation. Income Statement: SG&A down by $10. Pre-tax income up by $10, taxes of $2, so net income up $8. Cash Statement: Net income up $8, accrued compensation increasing means working capital decreases so source of cash +$10. Net cash position is +$18? Balance Sheet: Cash +$18. Accrued comp up $10, Shareholder's equity up $8. Balances.
Question: So here you are actually receiving cash back so it's not non-cash and you don't need to subtract out $10 in the cash flow statement right?
In general can someone help explain how to reconcile non-cash addbacks versus adjusting for source vs. use of cash due to changes in operating working capital (or changes in operating long-term assets/liabilities)? For the first example, do we classify the increase in accrued comp as an operating working capital change or a non-cash expense add-back or both?
Bump, so confused pls halp
With an increase in accrued compensation, for the cash flow statement, you add back $10 of accrued compensation because it is an increase in a current liability (which itself is a source of cash).
If you are decreasing accrued compensation, you are subtracting $10 from the cash flow statement because you are decreasing a current liability (which is considered a use of cash, or reducing a source of cash).
A current liability is a source of cash. And a source of cash is a current liability. They are synonymous and only need to be reconciled once.
That part I'm aware of, and it also extends to not just operating working capital but all types of operating assets/liabilities: if a LT asset increases it's a use of cash for example.
What is confusing to me is when do I know to add back for non-cash expenses/gains? Is this non-cash add-back separate from the change in assets/liabilities or is it already being accounted for?
To clarify: the accrued compensation is a non-cash expense: we are not paying out cash right now, but it is an expense that we nonetheless record. Same idea with $10 PIK interest: we record an interest expense but we don't pay it out in cash. With PIK interest we therefore add-back the non-cash expense on the cash flow statement. But while PIK interest technically increases liabilities, we're not adding a further +$10 on the cash flow statement due to liabilities increasing BECAUSE the PIK interest accrual to principal debt balance is NOT operating.
The issue becomes more confusing when we consider accrued compensation: this is considered an operating liability but it is also a non-cash expense... what to do then?
Here's how to think about it. The moment you recognize an expense, you must think about how to pay for it. 1) Either via a direct cash payment 2) Defer it (via increasing a liability)
So the non-cash expense add-back IS the increase to liability. To perform a non-cash add-back and ALSO apply source of cash due to liability increase would be to double-count the impact. Put in another way: if we are recording some expense charge, we're going to have to pay for it somehow or defer it. We can't just magically let it disappear. The $10 cash-addback represents our choice to defer it: it is considered non-cash expense precisely/only because we have deferred it into a future cash expense (via the increase to accrued comp).
It's best not to think about non-cash. Instead, think about changes to operating assets and liabilities as they mirror the change in cash. For example, think about D&A. We always add-back D&A to cash flow from operations because it's considered a non-cash expense but what we really mean is that we have booked a decrease to PP&E value (assets have decreased) and we didn't pay for it in cash. Since assets have decreased this is a source of cash and that's why we add back D&A. We wouldn't go and add back another further $10 to cash flow from operations due to the PP&E asset decreasing on the balance sheet; this has already been done/is precisely what the $10 D&A add-back (non-cash) thing does.
The next thing to consider is that we have now recognized an expense but deferred it to pay later. Does that mean we have a DTA created? Yes, see https://www.aslcpa.com/tech-blog/dta-and-dtl-say-what/. We have deducted $10 of expenses on book income but in cash we still have $10 sitting there and we pay taxes on that. In the books, we have recorded $10 of expense reduction before it is allowed to be a deductible for tax purposes. In the future our cash taxes will be lower, so we have created a DTA.
Tenetur quisquam similique deserunt corrupti veniam qui. Corporis reprehenderit et quis deleniti nulla omnis sunt. Vero placeat sit ipsam autem ut harum.
Tempora non quos incidunt quo quis. Ex fugiat esse aut pariatur explicabo quo. Eos minus alias nobis est aut nisi sit. Vel totam velit eaque non minus enim.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...