Technical Question
Hi all,
Could someone provide answers to the following 2 questions - I was asked this in an interview and while I vaguely remember the answers it would be nice to have confirmed:
Q1: How does an increase of 10 of deferred revenue affect the 3 statements?
Q2: How does an increase of 10 of PIK interest affect the 3 statements?
Generally you can google these or look in the guides -- both of these are in there
Q1:
IS: No change since no revenue was recognized
CFS: Increase in operating cash flow of 10
BS: Cash up 10, Deferred revenue (a liability) up 10
In this one you're receiving cash for future services so you want to reflect that
Q2:
IS: Recognize cash expense of 10, after tax income of 6
CFS: Net income flows in, add back 10 since you're not paying anything out, cash net up 4
BS: Cash up 4, Debt up 10, Net income down 6
Thanks a lot man! Can you just elaborate on Q1: why would there be an increase of 10 on the cash flow section?
Deferred revenue is when the customer pays for something, but the service provider has not yet performed the service from a GAAP perspective (e.g. customer buys a magazine subscription for 12 months). Customer pays $120 for a 12 month subscription, and magazine company recognizes $120 in deferred revenue. This doesn't go on IS because no service has been performed by GAAP, so nothing has been earned. $120 in cash have been received, so you have to put that on the BS and CFS. Each month, you send the magazine to the customer, earn $10 worth of revenue because a service has been performed, and the deferred revenue balance goes down by $10 each month and revenue and equity go up by $10 each month.
doesn't PIK interest lump into the principal of the debt? by "adding back 10" do you mean under the debt line items/CFF?
The 10 is added back on CFS as it is a non cash expense. It is added to debt on BS as PIK interest accrues on the existing balance.
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