How To Represent An Asset Purchase

What we are going to do in this section is focus on getting all the rough tabular knowledge that we have about the effects of taxation on decisions and move all that knowledge back into something that everyone else can read. What we are going to be doing is imbedding the knowledge back into an income statement and cash flow form.

The main point of this is to use standard accounting conventions that we have in accounting in order to alleviate any question concerning the sign you are dealing with and how to interpret a column you those are all taken care of when you are back into an accounting framework. It is also important as this is the way in which you are going to be communicating with other people. You cannot just throw up a rough spreadsheet and have it work out so everyone knows what is going on. What you really need to do is get into are dealing with a format that people are used to seeing items in – an income and cash system is the way to look at that because people can identify what this part is supposed to be and you can easily see the kind of cash projections that are there.

So… let us start with our income statement which is at the top of the spreadsheet. What we are going to do is simulate the purchase of a vehicle in the form of a ten-thousand dollar, ($10,000) car. What we are going to be doing here is identifying in the income statement what changes in the income statement because we are purchasing the car. So, we are looking at all the consequences of this particular purchase. So what we have here in the operating revenue is something which says one-thousand dollars, ($1000.) What that means is that because we purchased the car, we’ve decided because of that particular purchase that we are going to see an increase in sales because we got it. Maybe this new vehicle has motivated the sales person so that they are going to be much better at selling our product, maybe this has something to do with the person getting there from place to place faster and faster and is able to see more customers, but the point is we have decided that because we have purchasing this vehicle, we are actually going to have an increase in sales of $1000. That is what I am pointing out right here in the notes column - this positive number of $1000 means that we are going to see an increase in sales under operating revenue, (Operating Revenue 2010 = Operating Revenue 2010 – Operating Revenue 2011.) Now this -1500 that I placed down here in the operating expense, which is the pair to the operating revenue, says that because we are purchasing another vehicle, perhaps to replace another vehicle, we have a reduction in expenses of $1500. It could be that this new vehicle that we purchased is more fuel efficient or the insurance is lower or there are fewer maintenance expenses, but the idea is that is something that is going to be less expensive to operate by about 1500 per year. Please note that negative numbers mean we are seeing a kind of decrease there. Now what I have done is taken this 2000 which the first year’s depreciation of the vehicle and included it there, (in cell D4) which is one of those important parts of the income statement. Now what I have done in this cell is just simply taken the revenue, that 1000 increase in operating revenue less the two expenses, (operating and depreciation) that we’ve included so far in the income statement.
(Note: Taxable Income = Operating Revenue – (Operating Expenses + Depreciation) = 1000 – (2000-1500) = 1000-500 = $500, or D5 = D2 – sum[D3:D4])

Now that, ($500 in cell D5) is supposed to be our taxable income. The tax line that I have here we are just using a rule of thumb tax of 50%, so use that if you are not quite sure it is just one of our two rules of thumb, and all I have done here is say that our taxes are going to be one-half our taxable income. Please note that in real life, taxes do not work out that way… in fact, what you are going to notice is that when you are constructing these income and cash flow statements that some of you are going to be focusing on certain sections. For example, the economist may be out there trying to figure out what the operating revenue is going to be. their estimating demand function is such, the engineer is going to focused on the expense changes that are there because we are dealing with this particular changes and the MBA types are looking at all the different ways that they can arrange these purchases so that they can to minimize their tax liability. Please not that the tax thing is not quite going to be as formulated as I am depicting it in real life which is part of the reason I am using a rule-of-thumb tax rate. Now the net income, (cell D7 = Net Income = D5-D6 = Taxable Income – (50%)) is just going to be the taxable income less the taxes and that is the benefit that is there to the owners. Now the net income feeds into the other part of the income and cash flow statement which is the cash flow component and this thing because we are just looking at something very simple which is just the purchase of the vehicle has only two of its three components: cash from operations and the cash from investments, so the first source that we are going to have right here is our next income which is literally just the net income that was there before at the bottom of the income statement and we also have the source of cash from depreciation and it flows back in because it’s that special expense that the check never goes anywhere it is still available for us as cash so these are two sources of cash. What you are going to notice is that positive numbers mean there there is more cash available so here we are dealing with this increase in cash available to us because we purchased the vehicle. The other category that we are going to have is going to be investments and what we said is that we can have this special account for our car, we spent 10,000 cash and we see this negative number here, (cell D14 = -10,000) which indicates cash flowing out. Remember the convention on cash systems is that positive numbers mean cash flowing in to the firm, negative numbers mean cash that is flowing out. The bottom of the cash flow statement, (net cash flow = -7750, or formula for cell D16 =SUM(D11:D14) is just going to be the sum of the sinks and sources of cash, literally, what you are doing is just adding up that SOURCE of cash that income statement, that source of cash depreciation, and that sink of cash which is just the car. And that is our base that we are looking at on our income and cash flow statement. We will be making some interesting adjustments to it later…

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