Hardest Technical I've Gotten At a BB
Got this question at an interview and still don't know the answer:
Interviewer: Do asset write-ups and write-downs affect pre-tax income, or only asset write-downs? Me: Both write-ups and write-downs will affect the income statement by increasing or decreasing operating income and thus net income Interviewer: So how come asset write-ups in a merger model decrease pre-tax income? Me: Because depreciation from the write-up lowers pre-tax income Interviewer: But wouldn't the asset write-up be incorporated to increase pre-tax income? Me: .................
Asset write-ups in a merger roll into goodwill.
Was this asked by an MBA associate?
It means this question is very nuanced and clearly a tryhard type of question an insecure MBA associate would ask. Spot on.
Both PPE and identifiable intangibles can be written up to fair value. That write-up will add D&A to acquirer’s IS in the acquisition year and future years.
Its a difference of M&A scenario vs. just an operating company.
M&A scenario. Buyer acquires seller, and assets get written up to fair value. Asset writedowns generally not relevant in the M&A context; I suppose its possible but I haven't heard of it. So assets get written up, and that means their depreciation/amortization will also be higher in future years. That's the impact to the income statement, higher D&A. The one-time act of writing up assets doesn't affect IS, its the ensuing act of depreciation/amortizing the assets that affects IS.
Non-M&A scenario. Now we're just talking about one company, no buyer involved. Company writes down assets because it determined they're not worth as much as they thought. Impairment. That write-down is immediately reflected on the IS. If you write-up the assets (much more rare) that would also be reflected on IS.
So when we're just talking about a company, write-ups and write-downs immediately go to IS for the full amount. But when we're talking about a buyer acquiring a company, the standard write-up doesn't go right to IS (and why should it? You still paid what you paid for the business, regardless of write up). The impact to IS happens later, when D&A is higher bc of the writeup.