How would you answer this 3 F/S question?

http://www.ibankingfaq.com/category/interviewing-technical-questions/ac…

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Hey, I had previously seen that, but I am not sure how the reduction in value and the equipment being sold affects the f/s

Awesome, thanks guys! that helps a lot. Also, is the cash raised from corporate bonds taxed? I couldn't find a clearcut answer.

Depends on the tax rules of the jurisdiction you're in.

I expect it would be no tax on the cash raised from the bond issue, as that's capital in nature for tax purposes.

As interest accrues on the bonds, you'd get a tax deduction for the interest.

If there is any original issuer discount (OID) on the bond (eg it's issued at $97 on a $100 par value, representing a 3% OID), then it depends on local tax rules. At a guess, I'd say the OID is treated as part of the interest expense and the OID is amortised over the life of the bond for tax deduction purposes.

Raise $ via bonds & purchase PP&E IS: Interest expense from BP Increased depreciation expense from new PP&E

Balance sheet Increase in bonds payable Increase in fixed assets Increase in accumulated depreciation

Statement of cash flows: Operating cash flow: +Depreciation expense -Interest on BP

Investing cash flows: - Purchase of PP&E

Investing cash flows: + Proceeds from bonds issued

2 years later: IS: Impairment loss -2M

BS: Fixed assets decline by 2M

Cash flows: Operating: impairment is a non-cash charge --> add back impairment loss to net income arrive at operating cash flow

Note you still have interest expense and depreciation as in year 1.

Year 5 (year of sale) Balance sheet -Remove PP&E -Remove accumulated depreciation + Cash

IS: Either gain or loss on asset sale depending on what book value of asset is

Cash flows: Operating: Add back/subtract loss/gain on asset sale as this is non-cash item. Investing: Cash inflow from asset sale

i hate audit SSits:

bl00211 identified the right gaps in your analysis.

I'd rewrite it as:

Raising capital through bonds:
IS- interest expense
CF- inflow in Financing on raising the bonds, outflow from Operations for interest, outflow from Financing on repayment (plus potentially inflow for any refinance)
BS - cash at bank increases (not capex - capex is not a b/s item); borrowings increase (split between current and non-current depends on tenor of the bonds and whether it's bullet or amortising)

Buying the pp&e
IS - nothing in Year 0, depreciation afterwards
CF- outflow in Investing activities (not financing) on acquisition
BS - increase in PP&E (again, capex is not a BS item, so no decrease), decrease in cash at bank, no change in liabilities, accumulated depreciation will accrue over life of the PP&E

Value lowered by 2mm
IS - $2m impairment on recognition
BS - reduction in PP&E on the $2m impairment
CF - no impact

Sell equipment
IS - Any difference between sale value and book value (PP&E balance net of accumulated depreciation) is booked as gain/loss on sale
BS - reduction in PP&E, increase in cash at bank
CF - increase in Investing activities

awesome summary. one thing i would add tho is that when you take the impairment charge on the PP&E, the CF is impacted via lower Net Income which comes through Cash Flows from Operating Activities

I agree what you said about statement of cashflow being impacted through lower net income due to impairment loss; only thing to add is that yes NI will decline but you are adding back the non-cash loss/expense to NI. Impairment loss will also be a tax shield on the income statement.