adjusted CFO

The images are not showing – probably because you’re using your private dropbox account.

http://imgur.com/ might work better.

@vincentt thanks. So would you show me your calculation, hence answer?

Ok @vincentt, I may not have the full context here as it refers to a specific practice question and your question is not entirely clear, which is understandable as you wanted to avoid having to add the whole shebang.

As you rightly say on the treatment of interest expense in IFRS vs. US GAAP, you need to adjust the CFO to compare 2 companies under different accounting regimes. The adjusted CFO just adds back interest expense to a company reporting under GAAP to make a GAAP company’s CFO equivalent to a competitors CFO that reports under IFRS (assuming it’s classified under CFF in this case).

I don’t have the details of the question, but the principle of adjusting CFO is to be able to “take out the noise” in the operating cashflow, so to speak, to see the “true” operating cashflow generated from the underlying business (not how it is financed). So the impact of non recurring, one-off items needs to be excluded. I don’t have further info to comment on the rest I’m afraid.

My answer would be 17. There is no need to add after tax interest expense just because all other companies are also reporting under US GAAP. The only thing you need to adjust is the non-recurring expense, so it’s comparable to other US GAAP companies in other industries. Am I right?

It’s all about comparing apples with apples. So it’s a trick question if you memorize blindly!

@vincentt

I believe that in this exercise you are not supposed to adjust for the interest expense precisely because the statements are already in GAAP.

IF they were under IFRS and the interest was put in financing activities, THEN you would adjust that as well in order to compare to US GAAP companies (which must put it in operating).

Since here it is already done in GAAP, you adjust just for non-recurring activities.

Hope this makes sense!!

perhaps @vincentt. But after all these practice questions, you’ll know all the tricks 🙂

@vincentt if you include references to the material you’re referring to for future questions that would help us zero in on a great answer 🙂

I need further context to help for this question but hopefully @Diya’s answer helps.

I think you are talking about question 20 for chapter 35? Hopefully I’m right because my answer is based on that.

The definition of adjusted CFO actually requires two adjustments:
1) for the nonrecurring cash flow component
2) for the difference in accounting standard which can be adjusted by
[(net cash interest outflow)(1-tax rate)] when an IFRS company decides to classify
their interest as CFF

Refer to page 173 of chapter 35 the first paragraph talks about adjusting for non-recurring cash flow.

The question now is, does it add back to US GAAP or IFRS’s CFO?

Logically, I would think they should add it back to US GAAP’s CFO especially when IFRS classify interest expense under CFF (so both CFO are clean, without interest expense charges).

Yup this is it. Same as what I mentioned previously.

As you rightly say on the treatment of interest expense in IFRS vs. US GAAP, you need to adjust the CFO to compare 2 companies under different accounting regimes. The adjusted CFO just adds back interest expense to a company reporting under GAAP to make a GAAP company’s CFO equivalent to a competitor’s CFO that reports under IFRS (assuming it’s classified under CFF in this case).

@Sophie thanks for the clarification. Or I’d be adding the interest adjustment incorrectly! #-o

Ah, perhaps you’re getting confused with the signs +-. Think of it as absolute would be less confusing.

If under IFRS, interest was put in CFF, and you want to adjust IFRS’ CFO number to match US GAAP’s methodology, then you have to remove interest expense from CFF and place it in CFO. So in this case, you add back interest expense in CFF (because you want to ‘neutralise’ the effect of it here) and shift it to IFRS CFO, by deducting interest expense from CFO.

We have discussed the case of adjusting US GAAP CFO to compare like-with-like with IFRS CFO (assuming interest expense classified in CFF), whereby you adjust US GAAP CFO by adding back interest expense.

I suppose what @lulu123 meant by adjusting is comparing like with like. Try not to think of it as hard formula per se, but the principle behind. Hope this helps @vincentt!

Sure I get what you mean @vincentt. And thats not over analysing. Normally the question will let you know what they want to compare, hence you can apply the relevant method. If I have to pick one, usually it is method 1.