Best Response

Take a step back and think about pretax income first; after a merger, there have been write-ups, then book value > tax value, which leads to higher D&A, like you said. Therefore, pretax book income will be lower than pretax tax income, which means that on your books, you'll recognize a lower dollar amount of taxes than you actually pay to the IRS. Thus, we create a DTL to bridge the gap between financial and tax accounting. Basically, the DTL recognizes what the acquirer must eventually pay the IRS in excess of the lower taxes it will report on its income statement for accounting purposes.

Basically, your first statement is wrong ("My understanding is that a DTL is created when cash taxes balance sheet will not balance unless you also decrease the DTL account by the difference between cash paid out and book tax expense.

Hope this helps.

 

Separate from the D&A you're talking about, the DTL is based on the fact that there is a fair market value on the books that shareholders/corp will eventually have to pay taxes on.

So say the tax basis for the company was $100mm and it is bought for $300mm in a tax free stock deal. Tax basis remains at $100mm, but FMV (what is recorded on books) is $300mm. You have a "realized gain" of $200mm, but have not yet "recognized" the gain. So the deferred tax liability is related to the deferral of taxes on the $200mm gain that has not been "recognized". Calculated as the gain x the buyer's tax rate. Eventually the taxes are paid once gains are recognized

 
wookie102:
Separate from the D&A you're talking about, the DTL is based on the fact that there is a fair market value on the books that shareholders/corp will eventually have to pay taxes on.

So say the tax basis for the company was $100mm and it is bought for $300mm in a tax free stock deal. Tax basis remains at $100mm, but FMV (what is recorded on books) is $300mm. You have a "realized gain" of $200mm, but have not yet "recognized" the gain. So the deferred tax liability is related to the deferral of taxes on the $200mm gain that has not been "recognized". Calculated as the gain x the buyer's tax rate. Eventually the taxes are paid once gains are recognized

Sorry to bring up an old post, but I am a bit confused. In the second part - I don't understand the concept of how the DTL is related to the deferral of taxes on the $200mm gain that has not been "recognized".

Does the corp have to create additional DTL for writing up assets in an acquisition (does the acquirer incur a gain on a tax basis when it writes up an asset in an M&A deal)? When does the corp eventually "recognize" the gain on a book basis?

I thought a DTL entry on the B/S is created solely for the anticipation that the corp will have future cash payments for taxes owed on a cash basis, excess of what is recorded on a book basis due to increased D&A.

 

When the assets are eventually sold, the gain recognized for books will be, in this case, 200MM less than the gain recognized for tax, because your tax basis has not been written up, but your book basis has (obviously in a taxable or an (h)(10) acquisition, the DTL will not be present). Remember, deferred taxes are about matching the timing of tax recognition for financial statements items to those items in the financial statements. thus, when you have the gain down the road, you would owe 70MM (give or take - 200*.35) more than the amount of the gain for book purposes times the effective tax rate.

 

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