Ringo Guide: Accounting

Are NOLs (net operating losses) created based off of negative book operating income or negative cash operating income? How does this impact NOLs in a stock acquisition?

Cash operating income. So, in a stock acquisition when the fair value of assets are written up, the NOL created balance wouldn’t include the negative affects of increased D&A since assets are written up for book tax, not cash tax.

Assume you bought a $100 investment using $100 of debt. What happens to you financial statements in 1 year assuming $10 interest income, $5 debt repayment, and $5 interest expense?

• IS - pre-tax income up by $5, assuming a 40% tax rate, NI is up by $3

• CFS - NI flows in up $3, subtract out $5 principal repayment in CFF, cash is down by $2

• BS - Assets are down by $2 from the lower cash. On the L&E side, liabilities are down by $5 from the debt repayment, and NI is up by $3 from the net income.

Both sides balance down $2

At what value is treasury stock recorded on the balance sheet?

Treasury stock is valued at cost, which is the price of the shares they bought back when they bought them back.

Can the marginal tax rate ever be lower than the effective tax rate?

Effective tax rate is what you actually pay in cash, while marginal is what you would theoretically pay on the next dollar of taxable income.

If you have deferred taxes that must be paid as a DTL unwinds, for example, you may be paying more in cash than your effective tax rate would suggest.

A company has had a positive EBITDA for the past 10 years but recently went bankrupt. How could this happen?

• Highly levered and couldn’t sustain interest payments, or maturities came due and they didn’t have the cash and can’t refinance (“credit crunch”)

• High non-recurring charges like a legal settlement or a failed acquisition

• Overextending on CapEx

A company has purchased $100 worth of bonds in another company. Interest rates fall and the market value of the bond increases to $110. What happens to the 3 financial statements after 1 year when the price of the bond changes?

It depends if the bond is HTM or AFS.

If it is AFS, the unrealized gain or loss is recorded in Other Comprehensive income in equity.

If it is HTM, nothing changes at all because the bond is held at amortized cost no matter what.

Could noncontrolling interest ever be negative?

In theory they could be if the company has negative net income or if the SubCo is paying out a lot of dividends.

Could you ever have negative shareholders Equity?

Yes.

Negative retained earnings

• Large treasury stock, dividends, losses of net income

Losses in OCI

Dividend recaps in an LBO since equity is taken out as cash.

Difference between accounts payable and accrued expenses?

Accounts payable is related to inventory and suppliers.

Accrued expenses are typically more recurring, operating expenses, and can be internal things like employee salaries.

Difference between Accounts Receivable and Deferred Revenue

AR - asset representing cash you will receive for products/services you have delivered.

DR - liability representing cash you have received for products/services you haven’t delivered.

Difference between capital and operating leases?

Under GAAP, capital leases are treated as debt-like instruments because they typically provide the opportunity for bargain ownership at the end, with the rental expense split between interest and depreciation elements.

Operating leases are handled with a single rental expense item, and are more so your standard rentals that you have to give back at the end.

Under IFRS, both operating and capital are treated like GAAP capital leases.

*** Operating leases are usually shorter than the actual life of the asset and lease payments are lower than the actual value of the asset. The lessee in an operating lease also bears little to no risk if the asset becomes obsolete by the time the lease ends. Operating leases also can typically be canceled while capital leases cannot.

Difference between cash based and accrual accounting?

Accrual accounting is required by GAAP and recognizes revenue only when the corresponding product/service is delivered and then matches the associated expenses, irrespective of when cash changes hands.

Cash based just measures when cash comes in and out of the business.

Difference between income taxes payable and a deferred tax liability?

A DTL is simply a timing difference where book taxes are higher than cash taxes.

Income taxes payable are taxes that the company truly owes due to the normal course of business and just has not paid yet.

Do companies have more incentive to report assets as operating or capital leases?

Companies have more incentive to report assets as operating leases because they don’t hurt pre-tax and net income as much as capital leases do in the early years due to the interest payments on large principal at the start.

Capital leases could increase your cost of debt, too, since they are treated as a debt-like liability.

But, if cost of debt stayed the same, actual cash out the door is the same under both, it’s just how the company desires to portray it.

Do DRDs (Dividend received deductions) cause a DTL or a DTA?

Neither, they are both book and cash tax deductible.

What is a dividends received deduction?

a U.S. federal tax provision that allows C corporations receiving dividends from domestic (and certain foreign) corporations to deduct a percentage of those dividends from their taxable income. This deduction prevents the same earnings from being heavily taxed multiple times across different corporate layers.

Equation for the DTA created by NOLs

NOL Used * Tax Rate = DTA

For retail companies that must maintain a high level of inventory, will your cash balance or net income be higher?

Likely, your net income will be higher, because the inventory isn’t recognized as an expense until it is sold, but the constant acquiring of inventory is a cash outflow on the CFS.

How are dividends from AFS securities and trading securities treated on the 3 financial statements?

They are recorded as Other Income on the incomes statement, increasing pre-tax income, and flow through like any other revenue source.

How are equity issuance fees treated?

Companies have the choice to expense them as they’re incurred, or net them against APIC.

How are gains and losses recorded when you deconsolidate a subsidiary?

FV of assets being sold - book value of assets - FV of minority interest

How does a dividend from an unconsolidated subsidiary affect the 3 financial statements?

Dividends received from the unconsolidated subsidiary are able to receive a DRD but are still partially subject to taxes. They don't show up on your income statement since they are embedded in your proportional share of the equity affiliates income. This income is then subtracted out from your cashflow statement and the dividends you recieved are added. This feeds into the cash flows statement so your net cash is up. Your cash balance on the balance sheet is up and your investment in affiliate (long term asset) account is down. Dividends are not recorded on the income statement as they are embedded in the proportional share of net income that you recieve from the subsidiary. When the subsidiaries net income is subtracted out on the cash flow statement, the dividends are added back under cash flow from financing activities

How does buying marketable securities affect net income?

Because marketable securities may have an impact for more than one given period, the purchase of them is reflected as a cash outflow under CFI, nowhere on the IS. Then NI change is only when they are eventually sold for a gain or loss.

If they were trading securities, then unrealized gains and losses would be recognized on the income statement.

How does changing WACC impact your IRR?

IRR is the discount rate at which NPV equals zero.

Changing WACC doesn’t impact it directly, but it can impact how good an IRR is. You want the IRR of an investment to exceed the WACC so that you are generating returns above the cost of capital you had to put in.

How does depreciation going up by $10 affect the financial statements

• IS: Pre-tax income down by $10, assuming 40% tax rate NI is down by $6.

• CFS: NI flows in down by $6, add back the $10 of depreciation since it is a non-cash expense. Cash is up by $4.

• BS: On assets side, cash is up by $4, Net PP&E down by $10 from the accumulated depreciation. On the L&E side, CSE is down by $6 from the loss of net income. Both sides balance down by $6.

How does forex impact your financial statements?

Translation losses/gains (revaluing an asset because of FOREX) with impact your balance sheet with assets and OCI. Transaction losses/gains will impact your income statement (when you sell and asset and forex causes a gain / loss) and therefore it would impact your cash balance and retained earnings

How does goodwill impairment/asset write downs affect deferred taxes?

It creates a DTA because the loss is not cash tax deductible until the asset is sold.

Goodwill never has a tax basis, so it doesn’t create a DTA or DTL. Instead, there is just a permanent difference between effective and marginal taxes.

How does income received from nonconsolidated companies create a DTL?

GAAP taxes all income from equity affiliates because it assumes this income will be paid out in a dividend in the future. But, book taxes only tax the dividends actually received.

So, there’s a DTL because cash taxes will be higher in the future as some of the earnings are actually paid out in dividends.

**The eventual dividends received deduction will also lower the effective tax rate below the marginal tax rate, which makes the DTL smaller when you first create it.

How does paying off principal on a debt balance affect the income statement?

Lower principal equals lower interest expense. Also, you may have to record losses on any unamortized fees or discounts, as well as if you had to pay a premium to par in order to repay early.

How does recording unrealized gains and losses on trading securities create a DTA/DTL?

Unrealized gains and losses on trading securities impact book taxes, but not cash taxes.

How do Net Operating Loses (NOLs) affect the three statements

The DTA they create impacts the statements, but the NOL itself sits off of the financial statements.

How do taxes differ between when AFS and trading securities are sold?

AFS securities won’t have accumulated deferred taxes that need to be unwound, while trading securities will.

How do the three statements link together

Expenses are subtracted from revenues to first arrive at net income on the balance sheet. This then feeds into the balance sheet in retained earnings and into the cash flow statement, where you add back D&A and adjust for non- cash expenses. Long term investments from the balance sheet and from financing activities then feed into the cash flow from investing and financing activities section of the cash flow statement to arrive at net change in cash. This then feeds into the cash balance on the balance sheet.

How do unconsolidated subsidiaries impact the balance sheet?

They impact the investments account on the assets side, which increases with net income and decreases with dividend payments and they also feed into retained earnings through CSE.

**Can be protected from taxes by a DRD. Undistributed earnings rise to a DTL

How do you account for the conversion of a convertible bond on your accounting books?

The liability and equity component of the bond both get transferred to CSE.

**Debt the liability component and then credit common stock/APIC. APIC and common stock will increase based off the exercise price of the convertibles, not the market value. Otherwise your balance sheet wouldn’t balance

How is convertible debt accounted for at issuance and conversion — pre- vs. post-2022 (ASU 2020-06)?

Pre-2022 (split model):

• At issuance: Split into two pieces. Liability = PV of coupons + principal, discounted at the straight-debt market rate. Equity (conversion feature) = proceeds − liability PV. Because the liability is booked below face, a discount accretes as interest expense over the bond's life (raising reported interest cost above the cash coupon).

• At conversion: Both the remaining liability carrying value and the equity component land in stockholders' equity (common stock + APIC).

Post-2022 (ASU 2020-06, single-liability model):

• At issuance: No split. Recorded as one liability at full carrying/face value, like a normal bond. No separate equity component, no discount accretion from splitting.

• At conversion: The single liability carrying value moves entirely into equity (common stock + APIC). Liability down, equity up.

One-line memory hook: Pre-2022 = split into debt + equity (PV at straight-debt rate); Post-2022 = one plain liability that flips to equity on conversion.

How do you calculate MACRS depreciation?

Have a table online from the IRS that you follow but it is an accelerated depreciation schedule in which most of the asset is depreciated in the early years of its life.

How do you calculate the interest expense and principal repayments of capital leases?

Interest expense is equivalent to the lease liability times the discount rate, which is found with the company’s cost of debt. The principal repayment is the rent expense minus the interest expense.

***A capital lease gives you the same total lifetime tax deductions as the equivalent rent expense, but front-loads them (higher depreciation + interest early), so you recognize the tax shield sooner rather than in a straight line.

How do you create an expense model for a company?

Start with different departments of a company and the # of employees in each, project average salary and benefits Project this forward by tying the number of employees to revenue growth and also projecting wage growth CAPEX and rent obligations can be tied to revenue or specific plans company has for growing going forward

How do you create a revenue model for a company?

Three main approaches:

• market share * market size

• growth rate

• ASP * products sold (looking at how many customers and how much they are buying)

How do you decide when to capitalize or expense an asset?

If the asset will benefit the company for longer than a single period, then you want to capitalize it.

How do you project Deferred Revenue, Accounts Payable, Accounts Receivable and Accrued Expenses?

• DR: % of revenue

• AP: % of COGS or % of operating revenue

• AR: % of revenue

• AE: % of OpEx or SG&A

How do you project Depreciation and Capital Expenditures

CapEx can typically be tied to revenue as in many businesses it is a large driver of growth. Then, you can either tie D&A to revenue too, or CapEx.

The more detailed way to do it would be to create a PP&E schedule, though, and project out specific CapEx needs and the resulting D&A

How do you record held to maturity securities on the balance sheet? How do you record unrealized gains and losses on these securities?

You record the security as a Long-Term investment asset at amortized cost on the balance sheet.

Unrealized gains and losses are not recorded.

How do you record the impact of a dividend you recieve from an unconsolidated subsiriary?

Inflow under CFF, increases cash, reduces investment account, unwinds DTL.

***The DRD does not result in a DTA or DTL since it is recorded for both book and tax purposes

How do you record the proportional income you are entitled to from an unconsolidated subsidiary?

Investment in equity affiliate account increases and your income in equity affiliate account increases. The taxes you record on this income represents an outflow of cash and a DTL since you pay taxes on the entire income for book purposes but only pay cash taxes on the dividends you receive

How do you record you intial investment in an unconsolidated subsidiary?

Cash outflow under CFI, investment in equity affiliate account created under assets.

How is GAAP accounting different than tax accounting?

1. GAAP accounting is accrual-based while tax is not

2. GAAP uses straight line while tax uses accelerated (MACRS) depreciation

3. GAAP does better with actually tracking assets and liabilities (impairments, unrealized gains and losses, etc.), while tax is only concerned with revenues and expenses and what you owe in the current period.

How is income attributable to noncontrollng interest and income from equity affiliate treated on the cash flow statement?

Income attributable to NCI is a cash inflow on the CFS because you control the cash and get to actually keep it.

Income from equity affiliate is an outflow because they actually own it and get to keep it.

How long does it take for a company to collect its accounts receivable balance?

Typically around 40-50 days but it depends on what types of goods the company sells and what type of customers it has.

How will a merger between two companies affect the combined companies pro forma balance sheet?

Cash decreases based off of any cash used to finance the deal. PP&E is stepped up. Old goodwill is written down and replaced by new goodwill. Other intangibles will also be written up. Capitalized financing fees will also be written up for debt issuances. Inter company AP will be written down if it exists. Debt will increase your LT liabilities (unless it is refinanced debt). DTLs could be created due to the stock acquisition. Sellers book value of equity is written off (APIC, RE, common stock etc). New shares issued by the acquirer would increase APIC and common stock.

How will capital leases and operating leases affect operating working capital?

Operating leases will offset each other since the ROU asset and liability decrease in lock-step and are always equivalent.

Capital leases affect long term assets and debt so they make no impact on operating working capital. Remember that working capital contains NON DEBT BEARING LIABILITIES

How will your net income be affected by whether or not securities are classified as AFS or trading securities?

Trading securities come with unrealized gains or losses on the income statement before being sold, while AFS securities unrealized moves bypass straight to AOCI on the balance sheet.

How would rising interest rates impact the 3 financial statements?

Depends, higher costs, might be able to pass them through to top-line, margins get squeezed a little, floating-rate debt added expense.

If a company buys $100 worth of factories with debt, how are the three statement affected after 2 years when the factory is written down to $0 after breaking down and the loan must be paid back. Assume 10% dep, 10% interest exp, and 10% principal repayments

Factory is worth $80 now, so:

• IS: interest expense of $9, depreciation of $10, and loss on PP&E of $80 decrease pre-tax income by $99. Assuming a 40% tax rate, net income is down by about $59.

• NI flows in down by $59, add back the $10 of depreciation and the $80 write down. So, cash is now up by $31. Then, you have to record the principal repayment of $90 on the debt, which makes your cash down by $59.

  • On the assets side, cash is down by $59, Net PP&E is down by $90 from the depreciation and write down, so Assets are down by $149. On the L&E side, liabilities are down by $90 from the debt repayment, and CSE is down by $59 from the NI loss, so both sides balance down by $149.

If a company buys $100 worth of factories with debt, how are the three statement affected after one year if there is interest of 10% and yearly depreciation of 10%?

The factories are now worth $90.

• IS: $10 of interest and $10 of depreciation decrease pre-tax income by $20. Assuming a 40% tax rate, net income is down by $12.

• That flows into the top of the CFS, where we add back the $10 of non-cash depreciation, so cash is down by $2.

• BS: On the assets side, Net PP&E is down by $10 and cash is down by $2. On the L&E side, SE is down by $12 from the loss of NI, and both sides balance.

If a company buys $100 worth of factories with debt, how are the three statement affected immediately?

No IS changes.

• CFS record a cash outflow under CFI for $100, and a cash inflow under CFF for $100, cash doesn’t change.

• On the BS, record Net PP&E up by $100 under assets, and long-term liabilities up by $100 from the new debt. Both sides balance.

If a company orders $10 of inventory with cash, how does it affect the financial statements?

• IS: No changes

• CFS: inventory up by $10 decreases cash by $10.

• BS: Cash is down by $10, but inventory offsets by increasing by $10. So there are no net changes.

Inventory must be expensed as it is sold in the form of a product or service according to the matching principle.

If a company sells a good and the customer pays with a credit card, how would this transaction look under accrual and cash based accounting?

Under accrual, you would record revenue and costs related to the sale, and then create an accounts receivable on the CS and balance sheet that would represent the cash you are owed.

Under cash, there is no record because no cash actually changes hands.

If a company sells inventory for $20 that they originally bought for $10, how does it affect the financial statements?

• IS: Revenue up by $20, COGS up by $10, pre-tax income is up by 10. Assuming a 40% tax rate, NI is up by $6.

• CFS: NI flows in up by $6. Inventory is down by $10, which is a cash inflow, so cash is up by $16.

• BS: Assets up from $16 of cash but down from $10 of inventory leaving. SE up by $6 from NI. Both sides balance up by $6.

If cash collected is not recorded as revenue, what happens to it?

Likely, it has been recorded as deferred revenue, since you still have the obligation to deliver the good or service that the customer paid you the cash for.

DR is a liability on the balance sheet that feeds into CFO as a positive inflow. As the company deliver the revenue, they have to pay taxes on it, which is why you have a liability.

Also, cash could be being received AFTER revenue was already recorded, like in the case of an AR.

If depreciation is a noncash expense, why does it affect the cash balance?

Because even though it is non-cash, it acts as a tax-shield. Since you pay less in taxes, it creates positive net cash.

If you are trying to create revenue / expense models, but the company's filing only give you very limited information, what would you do?

I would look at comparable companies or competitors to see if I could get more color on how businesses in the industry run. If I couldn’t get any useful color, I’d just project a total revenue growth rate and all expenses as a percentage of that.

If you have a strong brand name, how will this impact the financial statements?

Higher rev, higher gross magin (can charge more for your goods), lower interest expense, potentially a higher cash balance. Would also create a higher goodwill balance if the company was acquired.

If you sell an asset for a $100 loss, how does this impact the financial statements?

• IS: loss of $100 reduces pre-tax income by $100, at a 40% tax rate NI is down by $60.

• CFS: NI flows in down by $60. Add back the $100 non-cash loss. So, cash is up by $40.

• BS: Cash is up by $40, assets are down by $100. SE is down by $60 from the NI loss. Both sides balance down by $60.

If you use FIFO accounting and prices of goods have been increasing, will your ending inventory balance be higher or lower than if you used LIFO

Your ending inventory balance will be higher, which means your COGS will be lower, and cash flow will be lower too.

If you use LIFO accounting and prices of goods have been increasing, will your ending inventory balance be higher or lower than if you used FIFO

It will be lower, meaning COGS is higher, meaning cash flow is more positive.

In the short run, will a company with high capital expenditures have a higher cash balance or net income?

NI, because only the depreciation portion of the CapEx will hit the IS< while the cash balance is getting mhit with the entire outflow.

Is the effective tax rate based off of book or cash taxes?

The effective tax rate is based on actual cash paid out the door.

List the line items on all 3 financial statements

• IS: Revenue, COGS, gorss profit, Operating expenses, EBIT or operatiing income, other income and expenses, pre-tax income, provision for taxes, NI

• CFS: NI, D&A, SBC, operating working capital, CFO, PP&E purchases, sales of PP&E, purchase and sale of invesments, CFI, debt issuance, debt prinipal payments, equity issuance, dividends, CFF, ending cash balance

• BS: Balance Sheet: Assets: Cash, Marketable Securities, Prepaid Expenses, Accounts Receivable, Inventory, PP&E Liabilities: Accounts Payable, Notes Payable, Deferred Revenues, Long Term Debt Equity Retained Earnings Common Stock Paid-in Capital

True or false, all else being equal, operating leases tend to reduce pre-tax and net income more than capital leases?

False, because of the high interest expense at the start of the lease, the lease expense will typically exceed that of an operating lease. However, in the long run that would switch as the capital lease pays off more principal instead.

Overall, they net out as have the same aggregate negative impact on net income so overall, your tax burden is still the same. The only difference is when you recognize those taxes.

True or False? Assuming no additional acquisitions, goodwill will always remain constant on the balance sheet.

False. Public companies must test Goodwill for impairment periodically if the parent determines that they overpaid for the subsidiaries intangibles.

True or False? Dividends are tax deductible?

False, because they are paid out of NI which has already been taxed.

True or false? Dividends from an unconsolidated subsidiary impact your income statement?

False, they never touch book income statement. They touch CFO. The DRD also doesn’t have its own line item, it is embedded within the income tax expense line on the IS instead, which is how it flows through and unwinds the DTL

True or false? If a company owns more than 50% of a subsidiary, they consolidate their statements for TAX purposes

False. You must own more than 80% to consolidate for tax purposes

***For 50–80% ownership: you fully consolidate the subsidiary for book purposes but treat it like an equity investment for tax (taxed only on dividends received), and this book-vs-tax mismatch creates a DTL on the undistributed earnings.

True or False, NOLs are recorded on the income statement and reduce your book taxes.

False. NOLs do not impact your book taxes, they impact you cash taxes which is why they create an DTA. Your book taxes and net income are still the same.

***An NOL doesn't change your book tax expense or net income (those stay at the full rate); it only lowers your cash taxes, and this book-vs-cash gap is captured by a DTA recorded at NOL × tax rate—as the NOL is used, cash tax falls while deferred tax expense rises by the same amount (keeping total book tax constant), which is the mechanic that unwinds the DTA.

True or False? OCI is added to the other items in Stockholders equity to arrive a total SE value?

True.

True or False? Preferred Stock is listed under Shareholders Equity (CSE)

False, it is listed under a line item called “Equity” which is under the umbrella of stockholder’s equity in A = L + SE

True or false? ROA will be higher when using capital leases than operating leases?

Before ASC 842, only capital leases recorded an asset on the balance sheet, so their ROA would have been lower. Net Income may be higher or lower depending on the period in the lease.

With modern rules, both types have an asset, so the ROA would likely depend on the exact depreciation and expense patterns for both leases

True or False? ROE will always be higher when using operating leases than capital leases

False, NI may be higher or lower depending on how long the leases have been held. Shareholders equity should remain about the same, though.

True or False? ROIC using operating lease is higher than ROIC using capital leases?

NOPAT will likely be higher due to the depreciation but invested capital will also be higher due to the increase in debt. So finance leases → higher NOPAT (because interest is excluded from operating income) and higher invested capital (debt-like liability). Numerator up, denominator up → ROIC could go either way. Capital leases enter the denominator because of their debt-like nature, whereas operating leases don’t have this characteristic.

True or false? The current ratio will be higher when using capital leases instead of operating leases?

False. The ROU asset is long-term under both lease types, so neither adds current assets—but both add a current portion of the lease liability. Under ASC 842 (current rules): both finance and operating leases put a near-term lease liability in current liabilities, so both lower the current ratio by a comparable amount—capital leases aren't higher. Under old rules: operating leases were fully off-balance-sheet (no current liability at all), while capital leases added a current liability, so capital leases gave a lower current ratio. Either way the statement is False—capital leases never produce a higher current ratio than operating leases.

True or False? The Debt to Equity ratio is higher using capital leases instead of operating leases?

True, because capital leases are accounted for as debt-like items that increase the company’s debt obligations.

True or false? Working capital will be higher with operating leases than capital leases

False, leases are excluded in many cases from working capital due to their debt-like nature (even the operating leases)

**Actual rules:
Old rules: operating lease → no current liability → higher NWC. Capital lease → current liability → lower NWC. Statement would be True.

Modern (ASC 842): both carry a current lease liability, comparable size → NWC impact about the same → statement False

True or false? You can have a negative value for Paid in capital treasury?

False. Paid in capital treasury can never be negative. If you resell treasury stock for a loss, the Paid in capital - treasury stock account is decreased until it is equal to 0. Then any excess losses are allocated to retained earnings.

Walk me through the 3 financial statements

Income Statement, Balance Sheet, Cash Flow Statement

Walk me through the 3 financial statements when a write down of $100 occurs on an asset.

• IS: $100 loss reduces pre-tax income. Assuming a 40% tax rate, NI is down by $60.

• CFS: NI flows in down by $60. You add back the loss of $100 because it is non-cash, and create aa DTA of $40 because write-downs aren’t cash tax deductible until the loss is realized. So, your cash doesn’t change.

• BS: Net PP&E is down by $100, DTA of $40. CSE down by $60 from the loss. Both sides balance down $60.

Walk me through the major items on shareholders equity?

CSE includes:

• Common Stock - Par value of the total stock outstanding

• Additional Paid in Capital - The price a companies stock is trading at over the par value when it was originally issued & how much stock based compensation have been issued. Also tracks how many employee stock options have been exercised.

• Treasury Stock - The dollar amount of shares the company has bought back

• Retained Earnings = Previous RE + NI - D

Outside that:

• Also includes noncontrolling interest, preferred stock, AND OCI

What are capital leases funded with? What line item do they act as?

Act as a capital expenditure. They are always funded with debt

"Acts as a capital expenditure" → it creates a depreciable asset on the balance sheet, like buying equipment.

"Funded with debt" → you didn't pay cash; you took on a debt-like lease liability to acquire it.

Like buying PP&E with borrowed money

What are examples of non-reoccurring charges we add back to EBIT and EBITDA when looking at a company's financial statements?

• Legal fees or settlements

• Goodwill impairment

• restructurings

• asset write-downs

• bad debt expenses

• Disastere expenses

• changes in accounting procedures

To be added back to EBIT or EBITDA, it must sit above the operating income line item

Do gains and losses sit above or below operating income (EBIT)?

It depends on whether they're core-operating or non-operating.

Above the line (in EBIT) — operating-asset related:

• Gains/losses on sale of PP&E / asset disposals

• Impairments and asset write-downs

• Restructuring charges

Below the line (not in EBIT) — financial/non-operating:

• Gains/losses on sale of investments or marketable securities

• Gains/losses on debt extinguishment

• FX gains/losses (usually)

What are income taxes receivable?

Funds the company is expecting from the government because of over payments in previous periods.

Occurs when a company applies an NOL carry back, accidentally overpays, or some sort of credit or missed reduction.

What are PIK loans

PIK loans are loans that, instead of mandating the debtor pays an interest expense, the interest accrues to the principal balance they have to pay at the end and compounds.

What are some advantages of capital leases?

Value of your capital asset can appreciate over time which can allow you to own the asset at a bargain at some point in the future. (Would want to own something like a building that doesn't go out of style). You also recognize the tax benefits of the interest expense and depreciation more in earlier years than in later years (good because of the time value of money). Could also potentially decrease your WACC if you are at the right spot on the WACC curve.

What are the 3 methods for subsidiary accounting

Fair value (0-20%), Equity method (20-50%), Consolidation (50%+)

What are the 4 criteria for a capital lease? (only one must be met for it to be classified as a capital lease)

1. Transfer of ownership at the end of the term

2. Option to purchase the asset at a bargain price at the end of the term

3. If the term of the lease is greater than 75% of the asset’s useful life

4. If the present value of the lease payments is greater than 90% of the asset’s fair market value

What are the advantages/disadvantages of issuing debt vs preferred stock vs common stock?

• Debt: cheapest, interest is tax deductible, don’t have to give up ownership but recurring interest and principal payments where assets can be seized if you miss, introduces liquidity risks

• Preferred: still cheaper than equity, don’t give up ownership, can defer dividend payments, but dividends aren’t tax deductible and can be high

• Common stock: no recurring payments or liquidity risk, you receive the cash immediately but you give up ownership and it costs the most

What are the advantages of operating leases over capital leases?

• Higher net income earlier on

• Less cash upfront due to typically shorter contracts

• Less risk of object losing value or going out of style since you don’t have the risk of ownership

• Doesn’t impact cost of debt (used to also not impact the liabilities on the balance sheet)

What are the components of Net Working Capital?

Typically net working capital is characterized by the current operating assets and liabilities of a company, which include:

• inventory, AR, AP, DR, accrued expenses, prepaid expenses (probably don’t want to include notes payable because they are interest-bearing

NWC serves to measure the operational solvency of a business and whether it uses cash to grow, or generates cash as it grows

What are the criteria of a capital lease?

• Transfer of ownership at the end

• Bargain purchase option at the end

• Lease length is 75% or more of the asset’s useful life

• Lease value is 90% or more of PV of market value