Is this a possible errata? On page 123 in Financial Analysis the example shows that if economic expense is less than employer contribution, you would adjust CFO upwards and CFF downwards by the after-tax difference. However, in question 6, page 132 in the practice problems the answers they give is: Kensington’s economic pension expense for the period was 135 million. The company’s contributions to the plan for the year were 693 million. The 558 million difference between these numbers can be viewed as a reduction of the overall pension obligation. To adjust the statement of cash flows to reflect this view, an analyst would reclassify the 558 million (EXCLUDING income tax effects) as an outflow related to financing activities rather than operating activities. Why is it excluding income tax effects? Another question: If employer contribution is greater than the economic pension expense the difference should be treated similar to an excess principal pmt on a loan so you would adjust CFO up (cash inflow) and decrease CFF (cash outflow) by the difference. And this adjust would exclude income tax effect (this answer is similar to question 6) I had thought that you the difference would be adjusted to be after tax?
I don’t think these adjustments would be made after tax, because you are just reclassifying a cash flow. Tax is based on the composition of the income statement and will be the same whether it is CFO or CFF.
Thanks Soddy. I’m looking at the Solution given in the example on page 123 and there it is: Solution to 2 (asking how would cfo and cff be adjusted to the diff in co. contribution and econ pension cost): The company’s contribution to the pension plan in 2007 was 67 (48 after tax) greater than the 2007 economic pension expense. Interpreting the excess contribution as similar to a repayment of borrowing (financing use of funds) rather than as an operating cash flow increases the company’s cash outflow from financing activities from 1,741 to 1789 and increases the cash inflow from operations by 48. So they are adjusting the cashflows with after-tax… whereas the problem in EOC says “excluding tax effect” <>