Top Stories | Thu, 28 Nov 2024 11:38 AM

Top 30 Accounting Interview Questions and Answers

Posted by : SHALINI SHARMA

1. Explain the three mainfinancial statements.

The three main financialstatements are the Income Statement, Balance Sheet, and Cash Flow Statement:

• The Income Statement showsrevenue, expenses, and finally the Net Income, which is the last line.

• A balance sheet is a snapshotin time of the corporation's financial position. The asset is resources such asCash, Inventory, and PP&E; liability refers to obligations like debt,accounts payable; equity or shareholders' capital, respectively. Assets alwaysequal Liabilities plus Shareholders' Equity.

•The Cash Flow Statement willbegin with Net Income, adjusting for non-cash costs and changes in workingcapital then will record cash flow from investing and financing activities.Revealing the net change in cash during the period.

 

2. Can you name some key lineitems on each of the financial statements?

•Income Statement: Revenue, Costof Goods Sold (COGS), SG&A (Selling, General & AdministrativeExpenses), Operating Income, Pre-Tax Income, Net Income.

•Balance Sheet: Cash, AccountsReceivable, Inventory, PP&E (Property, Plant, & Equipment), AccountsPayable, Accrued Expenses, Debt, Shareholders' Equity.

•Cash Flow Statement: Net Income,Depreciation & Amortization, Stock-Based Compensation, Changes in OperatingAssets & Liabilities, Cash Flow from Operations, Capital Expenditures, CashFlow from Investing, Dividends Paid, and Cash Flow from Financing.

 

3. How are all threestatements related to one another?

•  Net Income from theIncome Statement feeds directly into Shareholders' Equity on the Balance Sheet,and it is also a starting point for the Cash Flow Statement.

• Balance Sheet items change isreflected by Cash Flow Statement under working capital.

• Cash flow from investing andfinancing activities in the Cash Flow Statement has a ripple effect on BalanceSheet items like PP&E, Debt, and Shareholders' Equity.

•Cash and Shareholders' Equity onthe Balance Sheet act as plugs in reconciling changes from the Cash FlowStatement.

 

4. If you could use only onefinancial statement to evaluate a company's health, which one would you chooseand why?

The Cash Flow Statement becauseit provides a clear picture of the actual cash generated by the company,independent of non-cash expenses, and reflects the company's true liquidity.

 

5. What two financialstatements would you choose to report on the company, and why?

The Income Statement and BalanceSheet. From these, you should be able to deduce the Cash Flow Statement -provided you have both "before" and "after" versions of theBalance Sheet for the same period.

 

6. As the Depreciation accountincreases by $10, outline how this would affect financial statements.

•Income Statement: OperatingIncome decreases by $10. Net Income declines by $6 under a 40% tax rate.

• Cash Flow Statement: Net Incomedips by $6 but adds back the $10 of Depreciation, a non-cash item, so Cash Flowfrom Operations increases by $4.

• Balance Sheet: PP&E reducedby $10; Cash increases by $4 and that puts Assets in reduction of $6.Meanwhile, on the other hand, Shareholders' Equity fell $6.

7. Why would Non-Cash Expense,Depreciation, affect cash flow?

Depreciation reduces taxableincome, which in turn lowers the taxes a company has to pay and impacts cashflow.

8. Where on the IncomeStatement would Depreciation typically be located?

Depreciation can be located as aline item, but can also be rolled into COGS or Operating Expenses; however, itdoes decrease Pre-Tax Income no matter where it is.

9. When Accrued Compensationrose by $10?

a. Income Statement: This wouldraise Operating Expenses by $10, thus lowering PreTax Income by $10 dollars. Ata tax rate of 40%, Net Income falls by $6.

b. Cash Flow Statement: NetIncome went down by $6 while the increase in Accrued Compensation by $10 dollarwould add $10 dollar to Cash Flow from operations. Net Change in Cash rose by$4 dollor.

•Balance Sheet: Cash increases by$4 under Assets, while Liabilities (Accrued Compensation) rises by $10, andShareholders' Equity drops by $6. The sides balance.

10. When Inventory increasesby $10 paid in cash, how will the statements be affected?

•Income Statement: None

•Cash Flow Statement: BecauseInventory is an asset, Cash Flow from Operations goes down by $10. Net Changein Cash decreases by $10.

•Balance Sheet: Inventoryincreases by $10 and Cash decreases by $10; this is a zero-sum for Assets.

11. Why is it that an IncomeStatement does not depict the changes in the level of Inventory?

Only at the time when such aninventory is sold is a change in the income statement observed. Otherwise,nothing has been accounted for under COGS.

12. Suppose a company acquires$100 of factories using debt.

•Income Statement: No effectimmediately.

•Cash Flow Statement: The outflowunder Investing Activities for $100 gets nullified by the inflow underFinancing Activities for $100. Net Cash remains at par.

•Balance Sheet: PP&E has goneup by $100, and Debt has gone up by $100 as well. This balances the sides.

13. If after one year the debthad 10% interest rate, and factories depreciated 10% per year what was theimpact on the statements?

•Income Statement: Depreciationreduces Operating Income by $10, and Interest Expense reduces Pre-Tax Income byanother $10, for a total of $20. Net Income declines by $12 with a 40% taxrate.

•Cash Flow Statement: Net Incomedeclines by $12, but adding back $10 of Depreciation causes Cash Flow fromOperations to decline by $2. Net Cash falls by $2.

•Balance Sheet: Cash decreases by$2, PP&E decreases by $10, and Shareholders' Equity falls by $12. Bothsides balance.

14. If factories are fullywritten off and the debt is repaid, what happens?

•Income Statement: A $80write-down reduces Pre-Tax Income by $80. After a 40% tax rate, Net Incomefalls by $48.

•Cash Flow Statement: Net Incomefalls by $48, but the $80 write-down is reinstated, and Cash Flow fromOperations rises by $32. A $100 debt repayment in Financing Activities reducesCash Flow by $100, causing Net Cash to decline by $68.

•Balance Sheet: Cash declines by$68, PP&E declines by $80, Debt falls by $100, and Shareholders' Equityfalls by $48. Both sides are balanced.

15. What takes place when cashbuys $10 worth of inventory that hasn't yet been sold?

• Income Statement: No change.

• Cash Flow Statement: Inventory↑ $10. That takes $10 out of the Cash Flow from Operations and reduces the NetCash to $-10

• Balance Sheet: The effect isthe same; but now Assets stay flat - Inventory ↑ $10 - Cash ↓ $10.

16. What occurs to thestatements now with the inventory being sold for a $10 cost of? $20?

• Income Statement: Revenue goesup by $20, COGS by $10, and Gross Profit by $10. Given that the tax rate is40%, Net Income increases by $6.

• Cash Flow Statement: Net Incomegoes up by $6 and Inventory decreases by $10, so Cash Flow from Operations goesup by $16. Net Cash goes up by $16.

• Balance Sheet: Cash goes up by$16, and Inventory decreases by $10, and Shareholders' Equity goes up by $6.Both sides are equal.

17. Can Shareholders' Equitybe negative? What does it mean?

Yes, it can happen in twosituations:

1. Leveraged Buyouts (LBOs):Dividend recapitalizations may lead to a negative equity balance.

2. Consistent Losses: Sustainedlosses may drain Retained Earnings, thus leading to negative equity.

It is not necessarily a badthing; however, in some cases, it might reflect financial distress.

18. What is Working Capital,and why is it important?

Working Capital is Current Assets– Current Liabilities. Positive Working Capital means that a company has enoughshort-term assets to pay its short-term liabilities.

Operating Working Capitalexcludes cash and debt to focus on the efficiency of operations.

19. What does negative WorkingCapital mean?

It depends on the circumstances:

1.Subscriptions or DeferredRevenue: High deferred revenue often leads to negative working capital.

2.Effective Operations: Retailersand restaurants often have negative working capital because customers pay inadvance.

3.Financial Crisis: Sometimes, itmay be a sign of liquidity issues or even bankruptcy.

20. What is the effect of a$100 asset write-off?

•Income Statement: Pre-Tax Incomedeclines by $100 and Net Income declines by $60 (40% tax rate).

•Cash Flow Statement: Net Incomefalls by $60, but the $100 write-down is added back as a non-cash expense,increasing Cash Flow from Operations by $40. Net Cash rises by $40.

•Balance Sheet: Cash rises by$40, the asset decreases by $100, and Shareholders’ Equity falls by $60.

21. Run a $100"bailout" of a company and its impact on the three financialstatements.

First, identify the nature ofbailout, if debt or equity or both? More frequently, it is an equity investmentby the government. And this is how it works.

• Income Statement: None.

• Cash Flow Statement Cash flowfrom financing increases by $ 100 because the government is investing, henceNet cash flow increases by $100.

• Balance Sheet: Increase in theassets is $100 because cash increases. But Shareholders' Equity also goes up by$100 to maintain the balance.

22. Describe a $100 write-downof owed debt-liability, and how this affects the three financial statements.

This will be reported in theIncome Statement as a positive.

•Income Statement: All $100 gainincreases Pre-Tax Income; with a 40% tax rate, the Net Income increases by $60.

•Cash Flow Statement: Net Incomeincreases by $60, but that is reduced by a debt write-off; therefore, Cash Flowfrom Operations reduces by $40. So, Cash Change reduces by $40.

•Balance Sheet: Cash is reducing,so assets would reduce by $40. This reduces liabilities by $100 by writing downdebt, and also increases Shareholders' Equity $60 by increasing Net Income.Both sides reduce equally in the amount of $40, balances it.

23.  When might a company collect cash from acustomer without recording it as revenue?

This is when the services are forfuture delivery. This includes:

1. Subscription-based softwareservices.

2. Annual Telecom ServiceAgreements.

3. Magazine subscriptions.

According to accountingprinciples, revenue should be recognized when the service is completed and notwhen the cash is realized.

24. In that case, cashcollected does not constitute revenue; then it shows up elsewhere?

The cash received is recognizedunder Liabilities as Deferred Revenue in the Balance Sheet. With each deliveryof the service, it becomes real revenue on the Income Statement, and thus thebalance of Deferred Revenue decreases.

25. Difference betweenaccounts receivable and deferred revenue.

Accounts receivable: Incomeearned but not yet received in cash.

• Deferred Revenue: Cash receivedupfront and not yet recorded as revenue.

26. Number of days it takes tocollect Accounts Receivable?

Usually, Accounts Receivable arecollected by the companies within 30-60 days. Companies handling high-valueitems would take more time periods, while the low value transaction would takelesser periods.

27. Difference betweencash-based and accrual accounting.

• Cash Based Accounting: Revenueand expenses are recorded when cash received or paid.

•Accrual Accounting: Earningrevenue, expensing though an expense it has to do with cash.

Most big companies apply accrualaccounting, but small businesses may find cash-based accounting more practical.

28. Illustration: Customerpurchases a TV by credit card – cash-basis versus accrual accounting.

• Cash-Based: Revenue is reportedwhen the company charges the card and receives approval for an allotment offunds that it then deposits into its account. Here, revenue will appear on theIncome Statement, and Cash will increase on the Balance Sheet.

• Accrual: When the income isearned and recognized, the first account to appear will be Accounts Receivablein the balance sheet. Eventually, cash will be received which is transferredfrom Accounts Receivable to Cash.

 

29. Why are companiesreporting both GAAP and non-GAAP Pro Forma earnings?

GAAP earnings typically havenon-cash charges (such as stock-based compensation and amortization ofintangibles) that represent pure accounting but not true operatingprofitability. Non-GAAP excludes such charges, naturally making it usually amuch more important value, thereby giving an idea of the reality of coreoperations.

30. Under what circumstancescan a company with 10 years of positive EBITDA go bankrupt?

Possible causes:

1. Huge capital expenditure notbeing captured in EBITDA reflects negative cash flow.

2. High interest paymentsrendering debt unaffordable.

3. Single payment that cannot berefinanced by the company and which caused liquidity crisis.

4. One time major expenses suchas legal fees consuming cash.

EBITDA excludes items likelong-term investments, interest, and periodic charges, which can also put acompany into bankruptcy.

• Total sales: 40 units × $30each = $1,200 revenue.

Using LIFO, COGS = $640 Mostrecent costs: Q4, Q3, Q2, part of Q1.

Using FIFO, COGS =$540 (oldestcosts: Opening stock, Q1 part of Q2).

Higher costs of products willincrease COGS and decrease ending on LIFO while the contrary event takes placefor FIFO.