Wall Street Prep: Advanced Accounting Exam Questions &
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If a company issues $100 million in debt and uses $50 million
to purchase new
PP&E, walk me through how the three statements are
impacted in the initial t
year of the purchase and at the end of year 1. Assume a 5%
annual interes
rate on the debt, no principal paydown, straight-line
depreciation with a useful
life of five years and no residual value, and a 40% tax rate. -
ANSWER-Initial
Purchase Year (Year
0)
IS: There'll be no changes as neither capex nor issuing debt
impact the income
statement.
CFS: The $50 million outflow of capex will be reflected in
the cash from
investing section of the cash flow statement, while the $100
million inflow from
the debt issuance will be reflected in the cash from
financing section. The
,ending cash balance will be up by $50
million.
BS: On the assets side, cash will be up by $50 million and
PP&E will increase
$50 million from the PP&E purchase, making the assets side
increase by $100
million in total. On the L&E side, debt will be up $100 million,
which will offset
the increase in assets and the balance sheet remains
in balance.
End of First Year (Year 1)
IS: Since the capex amount was $50 million with a useful life
assumption of five years (straight-line to a residual value of
zero), the annual depreciation will be $10 million. Next, the
interest expense will be equal to the $100 million in debt raised
multiplied by the 5% annual interest rate, which comes out to
$5 million in annual interest expense. The pre-tax income will
be down by $15 million and assuming a 40% tax rate, net
income will be down $9 million.
CFS: Net income will be down $9 million, but the non-cash
depreciation of $10 million will be added back, making the
ending cash balance increase by $1 million.
BS: On the assets side, cash is up by $1 million and PP&E will
decrease by $10 million because of the depreciation. Since
equity is also down $9 million due to net income, both sides
will remain in balance.
, For long-term projects, what are the two methods for revenue
recognition? - ANSWER-i. Percentage of Completion Method: In
the percentage of completion method, revenue is recognized
based on the percentage of work completed during the period.
This method is used far more common since it's in a company's
best interest to record partial revenue once earned. Two
conditions must be met to use this method: the collection of
payment must be reasonably assured, and the total project
costs with the estimated completion date are required to be
provided. 2.
ii. Completed Contract Method: The completed contract method
recognizes revenue once the entire project has been
completed. This method is rarely used in the US, as it would
result in a company underreporting revenue that has been
earned under the accrual-based system.
If a company has continuously incurred goodwill impairment
charges, what do you take away from seeing this in their
financials? - ANSWER-Goodwill on the balance sheet remains
unchanged unless it's impaired, meaning the purchaser has
determined that the acquired assets are worth less than initially
thought. While goodwill impairment can be attributed to
unforeseeable circumstances, impairments as a common
occurrence may raise concerns regarding the management
team's history of overpaying for assets or their inability to
integrate new acquisitions.
Correct Answers | 100% Verified Solutions | Already Graded
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If a company issues $100 million in debt and uses $50 million
to purchase new
PP&E, walk me through how the three statements are
impacted in the initial t
year of the purchase and at the end of year 1. Assume a 5%
annual interes
rate on the debt, no principal paydown, straight-line
depreciation with a useful
life of five years and no residual value, and a 40% tax rate. -
ANSWER-Initial
Purchase Year (Year
0)
IS: There'll be no changes as neither capex nor issuing debt
impact the income
statement.
CFS: The $50 million outflow of capex will be reflected in
the cash from
investing section of the cash flow statement, while the $100
million inflow from
the debt issuance will be reflected in the cash from
financing section. The
,ending cash balance will be up by $50
million.
BS: On the assets side, cash will be up by $50 million and
PP&E will increase
$50 million from the PP&E purchase, making the assets side
increase by $100
million in total. On the L&E side, debt will be up $100 million,
which will offset
the increase in assets and the balance sheet remains
in balance.
End of First Year (Year 1)
IS: Since the capex amount was $50 million with a useful life
assumption of five years (straight-line to a residual value of
zero), the annual depreciation will be $10 million. Next, the
interest expense will be equal to the $100 million in debt raised
multiplied by the 5% annual interest rate, which comes out to
$5 million in annual interest expense. The pre-tax income will
be down by $15 million and assuming a 40% tax rate, net
income will be down $9 million.
CFS: Net income will be down $9 million, but the non-cash
depreciation of $10 million will be added back, making the
ending cash balance increase by $1 million.
BS: On the assets side, cash is up by $1 million and PP&E will
decrease by $10 million because of the depreciation. Since
equity is also down $9 million due to net income, both sides
will remain in balance.
, For long-term projects, what are the two methods for revenue
recognition? - ANSWER-i. Percentage of Completion Method: In
the percentage of completion method, revenue is recognized
based on the percentage of work completed during the period.
This method is used far more common since it's in a company's
best interest to record partial revenue once earned. Two
conditions must be met to use this method: the collection of
payment must be reasonably assured, and the total project
costs with the estimated completion date are required to be
provided. 2.
ii. Completed Contract Method: The completed contract method
recognizes revenue once the entire project has been
completed. This method is rarely used in the US, as it would
result in a company underreporting revenue that has been
earned under the accrual-based system.
If a company has continuously incurred goodwill impairment
charges, what do you take away from seeing this in their
financials? - ANSWER-Goodwill on the balance sheet remains
unchanged unless it's impaired, meaning the purchaser has
determined that the acquired assets are worth less than initially
thought. While goodwill impairment can be attributed to
unforeseeable circumstances, impairments as a common
occurrence may raise concerns regarding the management
team's history of overpaying for assets or their inability to
integrate new acquisitions.
