1/3/15

I was going through some merger model videos, and it said that the PP&E write up creates a deferred tax liability because the pre-tax income on GAAP basis is lower than the pre-tax income on the tax book (because of higher D&A). Therefore, the taxes payable on your income statement is lower than what you pay in the tax book.

I referred to some of the old forum posts, but I was still unclear on the concept (cannot attach links because I am considered a new user)

Investopedia says - "A deferred tax liability occurs when taxable income is smaller than the income reported on the income statements" -

This statement by investopedia contradicts the videos I watched. Based on investopedia's definition, the write-up creates a deferred tax asset.

Could someone please shed some more light on how deferred taxes occur in an acquisition?

Thanks in advance!!

Comments (21)

1/3/15

Yeah so lets take for example and acquisition in which some of the assets BV's are significantly different that their Market Values. So in this hypothetical case the company doing the acquiring will write up the assets from their previous lower BV. However it is important to note that this write up only effects the company's accounting books and is not counted in anyway in tax accounting. This causes the taxes being paid on the book accounting and tax accounting to differ and that is when DTA/DTL's come into play.

So if you had a write up on assets, that will increase the amount of Depreciation on you income statement therefore reducing the amount of taxes that you pay. But since this is not accounted for in tax accounting, the actual taxes you must pay in your book accounting are less than the taxes on cash tax accounting. Hence the creation of a differed tax liability since you are recording a lesser amount of taxes but you are in reality paying more in taxes.

This DTL is created to capture this difference and normalize the tax and book accounting over time. Hope this helps, I have been going hard for my ib interviews lol

The WSO Advantage - Investment Banking

Financial Modeling Training

IB Templates, M&A, LBO, Valuation +

IB Interview Prep Pack

30,000+ sold & REAL questions.

Resume Help from Actual IB Pros

Land More IB Interviews.

Find Your Perfect IB Mentor

Realistic IB Mock Interviews.

1/3/15

Thanks! I understood your explanation of the need to normalize the tax and book accounting. But I'm still thrown off by investopedia's definition of DTL, since it suggests that a DTA is created.

1/3/15

Thanks! I understood your explanation of the need to normalize the tax and book accounting. But I'm still thrown off by investopedia's definition of DTL, since it suggests that a DTA is created.

1/4/15

I honestly have no idea why they would say that the DTA and DTL accounts count different things. For example in the DTA account, you also include things like nol's. This is too accounting intensive so I can't go that deep into this stuff. If you are preping for interviews as a SA I think the above explanation should be sufficient. If you find out why let me know!

1/4/15

I honestly have no idea why they would say that the DTA and DTL accounts count different things. For example in the DTA account, you also include things like nol's. This is too accounting intensive so I can't go that deep into this stuff. If you are preping for interviews as a SA I think the above explanation should be sufficient. If you find out why let me know!

The WSO Advantage - Investment Banking

Financial Modeling Training

IB Templates, M&A, LBO, Valuation +

IB Interview Prep Pack

30,000+ sold & REAL questions.

Resume Help from Actual IB Pros

Land More IB Interviews.

Find Your Perfect IB Mentor

Realistic IB Mock Interviews.

1/4/15

Here is how it works:

-DTL = (Intangible Asset Write-Up + Tangible Asset Write-Up) * Buyer Tax Rate

However in an asset or 338(h)(10) purchase the DTL is $0 because the tax basis of the acquired assets matches what's on the books, so there's no temporary tax difference.

-Goodwill = Equity Purchase Price of Seller - Seller Book Value + Seller's Goodwill (It's written off completely) - Intangible Asset Write-Up - Tangible Asset Write-Up - Write-Off of Seller's Existing DTL + Write-Down of Seller's Existing DTA + New DTL Created.

So to answer your question, if the goodwill before the DTL is $100 and the DTL is $20, the goodwill with the DTL factored in would be $120. New DTL getting created should raise the goodwill.

Think about it like this: DTL is a liability. If liabilities go up by $20, you need another $20 on the Assets side to balance it... so Goodwill needs to go up by $20 to plug the hole.

A couple other notes:

-As far as I know, existing DTLs are always written down to $0 regardless of the transaction type (Asset vs. Stock vs. 338(h)(10) ). I don't know if this is a hard-and-fast accounting rule but this is how you see it in models and how I do it in models as well.

-DTAs are written down by the Buyer Tax Rate * Seller's nol Write-Down. In an asset or 338(h)(10) purchase you assume the entire NOL balance is written down to $0, but in a stock purchase you only write down the NOLs that you CANNOT use post-transaction, i.e. the existing balance minus the allowed annual usage * NOL expiration years. If that number is negative, you just assume $0 for the write-down because you're going to use up all the NOLs anyway.

Hope this helps.

1/4/15

Thanks dosk17. Appreciate the help. If anyone knows the reasoning behind DTL writedowns, please share. Thanks!

1/4/15

-

1/4/15

I also understand the concepts behind new DTL creation and write down of existing DTAs related to NOLs.
However, similarly to freeforall, I don't understand why Target's Existing DTL is entirely writen down.
Is there any accountant or tax specialist that could explain us why does this happen?

Appreciate the help.

1/4/15

Here is my thought:
DTL exist because there is a difference between the target's tax-base and the IRS's. After M&A, the assets of the target are re-evaluated at a fair market price so the previous difference is reconciled. Therefore, the DTL of the target should be completely written off.

1/4/15

Anyone?!?!?

1/4/15

Assuming that the purchaser can somehow make use of a deferred tax liability of say $50 million, he still won't pay for the net savings since there needs to be margin to be worth it. Is there any history whether this typically might be 20% or 30% or any other number?

1/4/15

In an asset sale theoretically the asset which was depreciated on an accelerated basis will result in taxable gain and the basis will be written up to fair market value since the gain was calculated on that basis. That logic doesn't apply to all types of DTA and DTL sources.

1/4/15
  1. Combine all the major line items, ie. Revenues, Operating Expenses Etc. Adjust Pre-Tax Income for Foregone Interest on Cash; Additional Interest Expense from New Debt; Sometimes additional amortization from intangibles created during acquisition. Tax rate would be buyer's tax rate
    Changes in shares outstanding for new shares issued for calculating new EPS;
  2. I would say that commonly, market value of assets tends to be higher than book value (historical value), which would create deferred tax liabilities as these assets have to be written up during the acquisition.

Not 100% on these, maybe someone could weigh in....

1/4/15

My thoughts would be as follows:

1. The gain on disposal on your tax books would be larger than on your reporting books so that would reverse the DTL. As for the exact accounting treatment, I think you reclass the DTL to a current liability account like current tax liability.

2. If the source of the DTL is a difference in depreciation between tax and reporting purposes, then if the asset has been fully depreciated, the DTL balance must be 0, since deferred tax assets/liabilities are temporary and will be reversed naturally once the asset has been fully depreciated in both books.

Just my 2 cents, but for more insight maybe check out FAS 109 for USGAAP or IAS 12 for IFRS.

1/4/15

1. I think I get the jist of what you're saying, but if someone can show me how it strings together using the numbers in the example I gave, that would give me more detail.

2. Maybe I'm misunderstanding things, but in the case of an asset write-up, the difference in depreciation is permanent, right? Aren't we starting with a higher depreciation base on the accrual books, which means that over the assets life there will be more total depreciation (which means a greater tax shield in total)? I don't see how all of the DTL will get reversed out...I just see it accumulating over time until the asset is sold.

1/4/15

"Success means having the courage, the determination, and the will to become the person you believe you were meant to be"

1/4/15
Add a Comment
WallStreet Prep Master Financial Modeling