You're company A and you raise capital through bonds to buy PP&E, after two years it is determined your value of the purchased equipment is actually lower by $2MM. You sell the equipment 5 years later. Tell me what happens to statements in each of the three stages.
My noob take on it:
raising capital through bonds:
IS- nothing ( in year 0, but then interest expense afterwards)
CF- increase in Financing activities
bs- cap ex increases, liabilities increase
buying the pp&e
IS- nothing
CF- decrease in financing activiities
bs- cap ex decrease, pp&e increase, Liabilities stay the same
value lowered by 2mm
Lost on this
Sell equipment
Lost
I understand there will be interest expenses and depreciation each year, but I left those out to simplify the concept
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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
You would impair the PPE by the two million which would decrease your carrying value of the equipment and show up on the IS.
As for the sale, you would need the carrying value of the PPE (historical price-depreciation) and see if there is any difference between that and the selling price. If there is then you would have a recognized gain or loss. As for the BS impact, you would show a decrease in PPE and increase in cash.
The other impact you should think about is the BS impact of the depreciation expense.
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
Thanks, this is great stuff!
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 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.
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