It's a common question - what effect does a depreciation expense have on all three financial statements? I can solve that one, but what other accounts or expenses are commonly asked about?
For example, what effect does capex have on all three statements?
I know it decreases cash flow from investing, increases PP&E on balance sheet, but what about income statement?
financial statements interview questions
In investment banking interviews, it is common for an interviewer to ask how would XYZ change affect the three financial statements. The most common question is "what is the impact of a $10 increase in depreciation on the three financial statements?"
We answer this question below:
- Income Statement - Increase in expense by $10 to represent the increase in depreciation. Pre-tax income is down by $10. After tax (assuming a 40% tax rate), net income will be down $6.l
- Statement of Cash Flows - Net Income flows onto the statement of cash flows as down $6. Then depreciation is added back due to the fact that it is a non-cash expense. -$6 + $10 = cash up $4
- Balance Sheet - Cash is up by $4 on the assets side but PPE is down by $10 as depreciation is making that less valuable. Assets are down by $6. On the SE and Liabilities side, net income flows into retained earnings, making it down $6.
How Does Depreciation Impact Balance Sheet Position?
Without taking into account the income statement and cash flow statement impacts that flow through to the balance sheet, depreciation lowers the balance of the property, plant, and equipment.
Answering Financial Statements Questions
There are numerous iterations of this question. We list some of the common ones below.
- $10 Purchase of Inventory
- $20 Sale of Inventory
- $20 Sale of Inventory on Account
- $10 Increase in Capex
- $10 Write Down of $110 Asset
There can realistically be any number of these questions and the only way to prepare for these questions it to really understand the three statements and think through any number of manipulations. Understanding the links between the statements are critical - you can learn more about this in the video below.
We review one of these questions posed by the OP below:
The income statement is unaffected as the purchase of new capital assets does not affect the current operating period. On the statement of cash flows, cash is lowered by $10 as the company has to shell out $10 to purchase or improve their assets. On the balance sheet, cash is down by $10 which is then offset by PPE increasing by $10. Assets are therefore unchanged. There is no impact to the SOCF or BS.
Read More About Accounting Interview Questions
- Accounting Question: COGS Increases by $10 and Revenue goes up $20?
- Crash course on the 3 financial statements
- Deferred revenue decreases by 10, 3 statements?
Preparing for Investment Banking Interviews?
The WSO investment banking interview course is designed by countless professionals with real world experience, tailored to people aspiring to break into the industry. This guide will help you learn how to answer these questions and many, many more.