Question:

A company makes a $100 cash purchase of equipment on Dec. 31. How does this impact the three statements this year and next year?

Answer hidden.

Answer:

First Year:

Let's assume that the company's fiscal year ends Dec. 31. This is important because we will assume no depreciation the first year.

Income Statement

A purchase of equipment is considered a capital expenditure (CapEx) which doesn’t impact net income. And since we are also assuming no depreciation, there is no impact to net income and no impact to the income statement.

Cash Flow Statement

There is no change to net income so nothing changes in cash flow from operations. The $100 increase in CapEx means there is a $100 use of cash in cash flow from investing activities. There is no change in cash flow from financing since this is a cash purchase so the net effect is a use of cash of $100.

Balance Sheet

Cash (asset) is down $100 and PP&E (asset) up $100 so no net change to the left side of the balance sheet and no change to the right side. We are balanced.

Second Year:

Here we will assume straight line depreciation over 5 years and a 40% tax rate.

Income Statement

We have $20 of depreciation, which results in a $12 reduction to net income.

Cash Flow Statement

Net income is down $12 and depreciation up $20. No change to cash flow from investing or financing activities. Net effect is cash up $8.

Balance Sheet

Cash (asset) is up $8 and PP&E (asset) is down $20, so the left side of the balance sheet is down $12. Retained earnings (shareholders' equity) is down $12 and we are balanced.

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