Multi-step Accounting Question...help :(
At the beginning of the year, you finance 200 million dollars of inventory by taking on 200 million dollars of debt. The debt is amortized 20% at the end of the year and the interest on the debt is 5% cash, 5% paid in kind. At the end of the year you sell your inventory for 400 million dollars in revenue at 200 million dollars in cost. Walk me through how these changes impact the 3 financial statements at both the beginning and end of the year.
Here is my stab:
Beginning of the year: No Change on IS. Cash down $200m because increase of inventory but then that change is reversed because it was funded through $200m debt so no change on the CFS, Inventory (assets) up 200m and Debt (liabilities) also up 200m so BS balances.
End of year: IS: +200m from sale of inventory but -20m from interest payments. Pre tax up 180m and assuming a tax rate of 20% Net Income up $144m.
CFS: Cash initially up $144m, add decrease in inventory so cash now up $344m, 5% of the interest was PIK so you also add that back so now cash up $354m. Move down to CF from financing where you pay 20% of debt so cash down $40 thus net change in cash is $314m
BS: Cash Up $314m but Inventory down $200m so cash (assets) is up a net $114m. On Liabilities side, debt is down a net $30m (-$40m (repayment)+$10m (PIK)), and then NI flows into retained earnings which is up $144m thus L+SE= $114m (144-30) thus the BS balances.
Beginning of Year:
No changes to IS CF: 1. CFF is up $100M 2. CFO is down $100M BS: Assets: Inventory up $100M Liabilities: Debt up $100M
End of Year: IS: Revenue +$400M COGS: +200M Operating expense: (.2)(200M) = +40M (This is the debt being paid off, which is what debt amortization is) Interest expense: (.1)(200M) = +20M
Pre-Tax Income: +140M Net Income (assuming 40% tax rate): +84M
CF: Net Income: +84M CFO: (.05)(200M) = +10M (this is the Payment in kind, non cash expense) CFF: (.2)(200M) = -40M (this is paying back 20% of principal) CFO: +200M as inventory is gone Change in cash: 84 + 10 - 40 + 200 = +254M
BS: Assets: Cash = +254M Inventory = -200M Assets = +54M
Liabilities: Debt is down 40 M Debt is up 10 M (from payment in kind) Debt = -30M
Retained Earnings = +84 M Liabilities + SE = 84 M - 30 M = 54M
Assets and Liabilities/SE balance
I do want to note that I wouldn't expect this during a SA or 1st year analyst interview unless they give you paper and a pen as there is too much to think about simply in your head.
Hope this helps.
Looks perfect, except paying off principal is not included on the income statement.
Look at Byakko and you'd have the same thing.
why is debt amortization not included in the IS? I think I'm not understanding the intuition here -- wouldn't repaying debt affect the amount of taxable income? so why not include in the IS? thanks!
This isn’t a hard question tbh. Idk about not expecting something like this. You should always have a pen and paper ready regardless. I received similar multiple step accounting questions throughout recruiting.
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