Multi-step accounting question help please

A company purchases some PPE for 200 with a useful life of 5 years. They use 100m debt and 100m cash, the debt has an interest rate of 10% and repayments of $20 per year and there is a 30% tax rate. Walk me through what happens at the time of purchase, after one year passes and when the company sells the equipment for 100 at the end of the 2nd year.

Purchase:
Income statement: no change
Cash flow statement: Cash is down $100 because the company buys 200m of equipment in investing activities but raises 100m in financing activities
Balance sheet: Cash down 100; PPE up 200, so assets down up overall of 100. Debt is up 100 on the L/SE side and it balances.

After 1 year:
Income statement: Interest is up $10; Depreciation is up $40; Therefore, EBT is up $50 and there is a $15 tax implication leaving net income down $35
Cash flow statement: NI is down $35; Depreciation is added back at $40; loan is repaid at $20; net impact on cash is -$15
Balance sheet: Cash is down 15; PPE down 40; net impact on assets of -$55. Debt is down by $20 and retained earnings is down 35; net impact on L/SE is -55 and it balances

Sale of asset at end of year 2:
Income statement: Interest is up $10; Depreciation is up $40; loss on sale of equipment -100; EBT -$150; Net income down by -105
Cash flow statement: Net income -105; Depreciation added back at $40; loan repaid $20; cash from asset 100; Cash is up $15
Balance sheet: Cash is up 15; PPE down 140; assets overall down by -125. Debt down by -40; Deferred tax liability up by 20; Retained earnings down by 105; net impact on L/SE is -125 and it balances

Did I get this correct? the sale at end of year 2 confuses me a bit.

 

For the sale at the end of year 2, the gain on sale should be calculated as sale price (100) - the book value of the PPE. At the end of year 2, the book value of PPE is original value of 200 - two years of depreciation (80) = 120. Thus, the gain (loss) on sale would really be 100 - 120 = -20. This makes sense because according to your depreciation schedule, the PPE should have 3/5 of its life remaining, so 3/5 of its value would be 200*3/5 = 120, but you only got 100 for it, so it is an accounting loss of 20.

 

Your year 2 should be:

Income statement: Interest is up $10; Depreciation is up $40; loss on sale of equipment -20; EBT -$70; Net income down by -49 Cash flow statement: Net income -49; Depreciation added back at $40; loss on sale added back at $20; loan repaid $20; cash from asset 100; Cash is up $91 Balance sheet: Cash is up 91; PPE down 160; assets overall down by -69. Debt down by -20; Retained earnings down by 49; Net impact on L/SE is -69 and it balances

Progress is impossible without change...
 
Most Helpful

I believe year two should be the following:

I/S Dep expense -40 , Interest expense -8, Loss on sale -20, EBT -68 Net Income: -47.6

CF Net income -47.6, Add back depreciation +40, Add back loss on sale +20, Add the cash from sale +100, Subtract the payment of debt -20 CF: +92.4

BS Cash +92.4, PP&E -120, Depreciation -40. Net assets are down 67.6 Debt balance -20, Retained earnings -47.6 Net L/SE are down 67.6

My logic behind the $8 interest expense comes from the fact that each year you pay off $20 of the debt principal. Thus the 10% interest rate is calculated using a lower principal amount of debt each year (in this case it would be 10% * 80 since you lowered the principal by paying $20 in year 1).

 

OP this answer is correct. Great explanation. Would you be able to do this in your head if asked in an interview?

 

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