CFA Level 1: Jumbotron's Accountant Mistakes and Financial Implications

Jumbotron's Accountant Mistakes and Financial Implications

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Question

Jumbotron's accountant has mistakenly understated depreciation by 125 and understated accounts payables by 65. Jumbotron's tax rate is 40%. Which of the following is/are true?

I. Assets are overstated by 125 -

II. Income is overstated by 125 -

III. Current liabilities are understated by 65

IV. Operating cash flow is understated by 125

Answers

Explanations

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A. B. C. D.

Explanation

If depreciation is understated by 125, the income is actually overstated by 125*(1-tax rate) = 75. The understatement of accounts payables does not affect the income statement; it understates the reported current liabilities. It also affects the operating cash flow. Note that operating cash flow = net income + noncash expenses - non-cash revenues - cash reductions in operating accounts Since income is overstated by 75, a non-cash expense (depreciation) is understated by

125 and another non-cash expense (accounts payable) is understated by 65, operating cash flow is understated by -75 + 125 + 65 = 115.

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