Fundamentals of Accounting

For operational BS changes… You have to think about; 1) when the product or service is delivered (if delivered, then on IS), and 2) when cash is received. To reconcile BS changes at the end, just add up the Asset changes and then add up the L&E changes and make sure they match. You can even verbally calculate the assets changes and the L&E changes separately.

When you apply a 40% tax-rate to pre-tax income, you have to use the 60% to see how much net income is down by.

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What are the 3 financial statements and why do we need them?

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How do the financial statements link together?

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What’s the most important financial statement?

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Could you usef only two financial statements to construct the third one? If not, why not?

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Give me examples of ways a company can inflate earnings?

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How might the financial statements of a company in Europe be different from those of a company based in the U.S.?

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When should a revenue or expense line item appear on the IS? Which two rules should it satisfy?

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What’s the difference between Assets, Liabilities, and Equity line items on the Balance Sheet?

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What two rules does an item need to satisfy to appear on the CFS?

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A company begins offering 12-month installment plans to customers so that they can pay for $1,200 products over a year instead of 100% upfront. How will its cash flow change?

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Do you always have to look at the CFS to find the full amount of depreciation?

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A company collects cash payments from customers for a monthly subscription service one year in advance. Why do companies do this, and what is the cash flow impact?

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Why is Accounts Receivable (AR) an Asset, but Deferred Revenue (DR) a Liability?

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How are Prepaid Expenses, Accounts Payable and Accrued Expenses different, and why are Prepaid Expenses an Asset?

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Your CFO wants to start paying employees mostly in Stock-Based Compensation, under the logic that it will reduce the company’s taxes, but not “cost it” anything in cash. Is the CFO correct?

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How do you fund a company’s operations via external sources and how do they impact the financial statements?

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Your company decides to sell equipment for a market value of $85. The equipment was listed at $100 on your company’s Balance Sheet, so you have to record a Loss of $15 on the Income Statement, which gets reversed as a non-cash expense on the Cash Flow Statement. Why is this Loss considered a “non-cash expense”?

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Your company owns an old factory that’s currently listed at $1,000 on its Balance Sheet. Why would it choose to “write down” this factory’s value, and what is the impact on the financial statements?

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The CFO of your firm recently announced plans to purchase “financial investments” (stocks and bonds). Why would she want to do this, and how will this activity affect the statements?

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Could a company have negative Common Shareholders’ Equity (CSE) on its Balance Sheet? If no, why not? If yes, what would it mean?

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Your firm recently acquired another company for $1,000 and created Goodwill of $400 and Other Intangible Assets of $200 on the Balance Sheet. Why does this happen?

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How do Goodwill and Other Intangible Assets change over time?

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How do Operating Leases and Finance Leases (Capital Leases) appear on the financial statements? Explain the high-level treatment as well as IFRS vs. U.S. GAAP differences.

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What’s the difference between Deferred Tax Assets and Deferred Tax Liabilities, and how are Net Operating Losses (NOLs) related to both of them?

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What are some items that are deductible for Book-Tax but not Cash-Tax purposes, and how do they affect the Deferred Tax line items?

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Suppose that you’re analyzing a company, and you want to project its financial statements. Before projecting anything, how would you simplify its statements first?

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Walk me through the financial statements when a company’s Operating Expenses increase by $100.

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A company’s Depreciation increases by $20. What happens to the financial statements?

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A company runs into financial distress and needs Cash immediately. It sells a factory that’s listed at $100 on its Balance Sheet for $80. What happens to the statements?

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A company decides to CHANGE a key employee’s compensation by offering the employee stock options instead of a cash salary. The employee’s cash salary was $100, but she will receive $120 in stock options now. How do the statements change?

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Walk me through the financial statements when a customer orders a product for $100 but doesn’t pay for it in cash. Then, walk through the cash collection.

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A company prepays $20 in utilities one month in advance. Walk me through what happens on the statements when the company prepays the expense, and then what happens when the expense is recognized.

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Walmart buys $400 in Inventory for products it will sell next month. Walk me through what happens on the statements when they first buy the Inventory, and then when they sell the products for $600.

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Amazon decides to pay several key vendors $200 on credit and says it will pay them in cash in one month. What happens on the financial statements when the expense is incurred, and then when it is paid in cash?

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Salesforce sells a customer a $100 per month subscription but makes the customer pay all in cash, upfront, for the entire year. What happens to the statements when cash upfront is collected?

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What happens after one month has passed, and the company has delivered one month of service for $100?

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A company issues $100 in common stock to new investors to fund its operations. How do the statements change?

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This same company now realizes that it has too much Cash, so it wants to issue Dividends or repurchase common shares. How do they impact the three statements differently? Compare $100 in Dividends with a $100 Stock Repurchase.

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A company that follows U.S. GAAP signs a 10-year, $1,000 Operating Lease on January 1 and pays a total of $100 in Rent throughout the year. Assume a 6% Discount Rate, and walk me through the financial statements over this entire year in a single step.

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A company that follows IFRS now signs a 10-year, $1,000 Operating Lease with a cash Rental Expense of $100 per year. Assume a 6% Discount Rate and walk me through the statements over the entire year.

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For Book purposes, a company records $20 in Depreciation. For Tax purposes, it records $40 in Depreciation. Walk me through the financial statements.

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A company has a factory shown at $200 on its Balance Sheet, but a hurricane hits the factory and destroys part of it, so the company records a $100 PP&E Write-Down. Walk me through the statements.

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1) A company buys a factory for $200 using $200 of Debt. What happens INITIALLY on the statements? 2) One year passes. The company pays 10% interest on its Debt, and it depreciates 10% of the factory. It also repays 5% of the Debt principal. What happens on the statements in this first year? 3) At the end of this first year, the company sells its factories for $220 and uses the proceeds to repay its remaining Debt principal, after realizing there is little demand for its products. Walk through this step SEPARATELY from the previous two. Assume that the Net PP&E balance is $180, and the Debt is $190 because of changes in the previous step

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Walmart orders $200 of Inventory and pays for it using Debt. What happens on the statements immediately after this initial transaction?

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A company issues $200 in Preferred Stock to buy $200 in Financial Investments. The Preferred Stock has a coupon rate of 8%, and the Financial Investments yield 10%. What happens on the statements IMMEDIATELY after the initial purchase?

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A company wants to boost its EPS artificially, so it decides to issue Debt and use the proceeds to repurchase common shares. Initially, the company has 1,000 shares outstanding at $1.00 per share and a Net Income of $300. What was the initial EPS? What happens IMMEDIATELY after the company raises $200 in Debt and uses it to repurchase $200 in common stock?

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1) Your company decides to acquire another company for $500, using 50% Debt and 50% Common Stock. The other company has $300 in Assets, no Liabilities, and $300 in Common Shareholders’ Equity. Assume that the purchase premium is distributed 50/50 between Goodwill and Other Intangible Assets. What happens to your company’s financial statements immediately after this acquisition takes place? 2) Now, walk through what happens on the statements in the one year following this acquisition. The acquired company contributes $200 in Revenue and $100 in OpEx, and the Interest Rate on Debt is 8%. Assume that the Other Intangible Assets have a useful life of 5 years.

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A company it writes down the entire $100 balance of Goodwill. Walk through this step.

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What is FCF?

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What does it mean if FCF is positive and increasing?

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What does FCF mean if it's negative or decreasing?

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Why might you have to adjust the calculation for FCF if you’re analyzing a company that follows IFRS rather than U.S. GAAP?

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What is working capital?

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What is change in working capital?

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A company has negative Working Capital. Is that “good” or “bad”?

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If a company has seasonal working capital, is that a deal killer?

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What happens to a company’s cash on CFS when working capital increases and then when it decreases.

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What does the Change in Working Capital actually tell you?

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What does it mean if a company's FCF is growing, but its Change in Working Capital is more and more negative each year?

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In its filings, a company states that EBITDA is a “proxy” for its Cash Flow from Operations. The company’s EBITDA has been positive and growing at 20% for the past three years. However, the company recently ran low on Cash and filed for bankruptcy. How could this have happened?

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How do you calculate Return on Invested Capital (ROIC), and what does it tell you?

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How do you calculate ROE? ROA?

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What are the advantages and disadvantages of ROE, ROA, and ROIC for measuring company performance?

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A company seems to be boosting its ROE artificially by using leverage to fuel its growth. Which metrics or ratios could you look at to see if this is true?

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What does it say about a company if its Days Receivables Outstanding is ~5, but its Days Payable Outstanding is ~60?

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What is the Cash Conversion Cycle (CCC), and what does it mean if, among a group of similar companies, one company’s CCC is 5, and another’s is 30?

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What is LIFO?

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What is FIFO?

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What are they differences betwen LIFO and FIFO during cost inflation?

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What is LIFO liquidation?

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What is the LIFO reserve?

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If you had to choose between the LIFO or FIFO method, which would you choose?

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Does a write-down of an asset create a DTL or DTA?

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Under what circumstances would goodwill increase?

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Why would goodwill be impaired and what does goodwill impairment mean?

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How do you decide when to capitalize vs expense a purchase?

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What is the difference between cash-based and accrual-based accounting?

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If depreciation is a non-cash expense, then why does it affect the cash balance?

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What is a CDO (collateralized debt obligation)?

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What is securitization?

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A pen costs $10 dollars to buy. It has a life of ten years. At the end of the second year, the pen runs out of ink and you have to throw it away. How much is it on the balance sheet?

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You sold an asset where you received $500 million in cash. How does this affect your three financial statements? (Ask interviewer for book value of asset = $400m)

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How would a $10 million increase in depreciation in year four affect the DCF valuation of a company?

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Suppose you purchase $100 million of equipment on December 31, 2001 with a debt issuance. Walk me through the impact of this event on the three financial statements during 2001 and 2002.

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Suppose you purchase $100 million of equipment (5 year useful life) on December 31, 2001 with a debt issuance. On January 1, 2003, the equipment breaks down and is worthless. Walk me through the impact of this event on the three financial statements.