Asset write down/up -- DTA and DTL
These are the explanations for DTA/DTL creation from asset write-up/down. Is the explanation for asset write-down & DTA correct?
- Asset write-up, which increases depreciation/ decreases pre-tax income on the IS (save on taxes), will produce a DTL.
- Asset write-down, which increases pre-tax income on the IS (pay more taxes), will produce a DTA
For an asset write down, wouldn't pretax income decrease?
Maybe I don't fully understand the question but after a business combination you fair value your assets/liabilities. After that process is complete if you effectively "wrote down" your inventory (for example) as the fair value was less than book cost, then you would inherently recognize less cost when you sell that inventory in the future, thus increasing margin > net income.
Similar to PPE, if you wrote down the value of PPE (fair value book cost) due to a business combination the cost basis of the asset decreases and thus deprecation decreases and income increases.
The reason a DTA may be created in this situation is because your book cost was reduced but for tax purposes the tax basis may have stayed at the original cost pre acquisition which would result in higher future taxable deductions.
I went over the subject a few days ago, and I'm not 100% confident, but this is my understanding. With asset write-down, depreciation (on the accounting book) decreases, thus pretax income (on the book) increases. But for tax-purpose accounting (for the government), asset write-up/down isn't reflected unless there's some kind of asset purchase or Section 338 transaction, so depreciation remains unchanged. The write-down itself is recorded as a loss on income statement, but it's not tax-deductible, thus no change in tax.
So with asset write-down, on the company's accounting book, it is supposed to pay more tax due to decreased depreciation, but in reality, it pays less tax because the government's tax purpose accounting doesn't take the write-down into consideration. So on the book, the amount the firm pays less than its projected tax translates into DTA. I'd welcome any feedback/correction.
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