how does interest expense run through the balance sheets?

Interest costs may be capitalized under certain conditions.

Interest expense is subtracted from gross profit on the income statement. So an increase in interest expense of X dollars, reduces net income by X(1-T). Which reduces cash from operations by X(1-T). This reduces cash on the balance sheet by X(1-T) and reduces retained earnings by X(1-T) which makes the balance sheet balance... correct?

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yeah I think that is the big one. But sometimes companies capitalize interest when they use loans to improve some asset.

I am trying to solve it in an old-fashioned way.

The accounting entry when I pay Interest Expense (IE) let's say 10 dollars is:

Interest Expense (+E, -SE) 10 Cash(-A) 10

How come and cash goes down by 6 and not by 10? What is wrong in my thinking? Any help appreciated!

let's start with income statement and not complicate things with capitalized financing costs.

I pay $10 interest. assume 40% tax rate. Net income goes down by $6. This flows through into your CF statement, so cash flow and cash on balance sheet decreases by $6 - think of this as the tax authorities literally mailing you a $4 cheque after you paid $10. At the same time, net income comes out of retained earnings so retained earnings are $6 lower as well.

Your earnings before tax (EBT) is down 10 Your net income only goes down 6 because of 40% tax rate.

Real life example: You sell a stock at a loss. If you sell it at a loss and have nothing else to say about it, you can write down that loss.

So if you and me decided to build a business together and fucked it all up losing $10.... The Gov't would allow us to use this as a tax impact, so "they send us a check". What he really means is your "tax liability goes down by $4"

Now for your last question how much do you pay tax authorities.

If you MADE money then sure you're just paying $X times 40% on your EBT earnings. Now if you LOST money you're not paying squat and you pick up "NOLs" which is a whole different topic.

Ya dig?

WallStreetPlayboys & mrb87 thank you very much! I miss something in the whole story but I am close!!

The balance sheet looks like this.

Your Net income swims to retained earnings.

A = L + E

Cash is an asset it goes down by -6. Liabilities no change Retained earnings is part of shareholder equity so it goes down by -6. because Net income swims to RE.

Balance sheet balances. (Does homosexual happy dance when model balances back when he was a lowly 1st year analyst coked out of his mind)

Solved?

Sure thing!