Interview Question - PIK Interest AccountingSubscribe
During the technical interview portion, I was asked how a PIK note would flow through all the statements. Let me know your opinion on the below answer. Let's assume that it is a $100mm note with 10.0% interest.
Paid In Kind Interest Impact on the 3 Financial Statements
We review below the impact of a $100mm PIK note with 10.0% interest.
- Interest expense must be recorded (regardless of the fact that it is not being paid out in cash - interest expense up $10
- More interest expense results in a income tax shield of 4 dollars assuming a 40% tax rate. This results in a tax expense that is lower by $4
- Net Income is down by $6
Statement of Cash Flows
- Net Income is down by $6 from the income statement
- PIK interest is then added back as it is not a cash expense (paid out in the form of additional debt)
- Net Cash is up by $4
- Assets side of the balance sheet is up by $4 due to the cash flowing in from the statement of cash flows
- Liabilities side of the balance sheet is up by $10 assuming that there is additional debt principal issued for the interest payment
- Shareholder's Equity is down by $6 flowing in from net income on the income statement
What is Payment-In-Kind Interest?
"Paid-in-Kind" or "Payment in Kind" interest is a type of security that pays its interest or dividend in the form of a more of the principal form (IE bond principal or equity). This is preferred for companies that do not have / want to use cash to make payments to investors.
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