Accounting & the three statements / ORIGINAL SCENARIO

Equipment and cash

A warehouse buys equipment for 144 cash at the start of the year. Walk through the first year across all three statements.

Amounts $m. Six-year straight-line life, no salvage. Book=tax depreciation. 25% tax shield usable immediately. No financing, WC or dividends. The company has sufficient other taxable income to absorb the deduction.

Try it before the answer →

Worked answer

depreciation: 144 ÷ 6 = 24
net Income: − 144 ÷ 6 × (1 − 0.25) = -18
cfo: 144 ÷ 6 × 0.25 = 6
cash: − 144 + 144 ÷ 6 × 0.25 = -138
net PPE: 144 − 144 ÷ 6 = 120
retained Earnings: − 144 ÷ 6 × (1 − 0.25) = -18

Depreciation reduces pre-tax income; apply the tax shield.

Add depreciation back to net income for CFO; record capex in CFI.

Cash plus net PP&E movement equals retained earnings movement.

Technical follow-ups

If there were no current cash tax benefit, what would happen to cash, and why?

If a six-year useful life changes to three years with the same tax capacity, what happens to first-year earnings and cash? Separate timing from lifetime economics.

Follow-up answer guide

Without a current cash tax benefit, CFO has no cash tax saving and cash falls by the full capex. Net income may still reflect deferred taxes if recognition criteria are met; ask the candidate to state that assumption.

A fresh retry

A warehouse pays 180 in cash for equipment at the start of the year. The equipment has a 6-year straight-line life and no salvage value. At a 30% tax rate, walk through the full first-year changes across all three statements.

Amounts $m. Six-year straight-line life, no salvage. Book=tax depreciation. 30% tax shield usable immediately. No financing, WC or dividends. The company has sufficient other taxable income to absorb the deduction.

Inspect replacement inputs

cost: 180
life: 6
tax: 0.3

Check the retry bridge

depreciation: 180 ÷ 6 = 30
net Income: − 180 ÷ 6 × (1 − 0.3) = -21
cfo: 180 ÷ 6 × 0.3 = 9
cash: − 180 + 180 ÷ 6 × 0.3 = -171
net PPE: 180 − 180 ÷ 6 = 150
retained Earnings: − 180 ÷ 6 × (1 − 0.3) = -21

Original fictional example. Not a report of a specific firm’s interview. Explanations need qualified human review.