The Daily Technical #56: What is PIK interest?

Good morning. Welcome to the 56th edition of The Daily Technical. You’re here for one reason so let’s dive in.

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OVERVIEW OF YESTERDAY’S QUESTION
How does selling a building with a book value of $6 million for $10 million impact the three financial statements?

Income Statement
If I sell a building for $10 million with a book value of $6 million, a $4 million gain from the sale would be recognized on the income statement, which will increase my net income by $4 million.

Cash Flow Statement
Since the $4 million gain is non-cash, it'll be subtracted from net income in the cash from operations section. In the investing section, the full cash proceeds of $10 million are captured.

Balance Sheet
The $6 million book value of the building is removed from assets while cash increases by $10 million, for a net increase of $4 million to assets. On the L&E side, retained earnings will increase by $4 million from the net income increase, so the balance sheet remains balanced.

However, the gain on sale will result in higher taxes, which will be recognized on the income statement. This lowers retained earnings by $1 million and be offset by a $1 million credit to cash on the asset side.

Common Mistakes

1. Neglecting to subtract taxes from the gain. Always adjust for the tax impact to ensure accuracy.

2. Unbalanced assets and retained earnings adjustments. Ensure all changes are consistently reflected across the balance sheet components.

3. Forgetting to adjust the non-cash gain in the operating section of the cash flow statement. 

TL;DR

• Income Statement: Recognize a $4M gain on the sale, increasing pre-tax income. Taxes reduce this by $1M (assuming a 25% tax rate), leaving a net income increase of $3M.

• Cash Flow Statement: Subtract the $4M gain from net income in operating cash flow. Add $10M cash proceeds in investing activities for a net cash inflow of $10M.

• Balance Sheet: Cash increases by $10M; the building (asset) decreases by $6M. Retained earnings increase by $3M (net income gain after taxes). Net assets rise by $4M, keeping the balance sheet balanced.

TODAY’S QUESTION
What is PIK interest?

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THAT’S A WRAP
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