How does write-up of intangible assets flow thru 3 statements?
Let's do you write-up intangible assets by 100 as part of goodwill (in a M&A or LBO deal). How does that flow through the 3 statements? Is this below correct:
IS:
Write-up increases PT Income by 100
At 25% tax rate, NI increases by 75
CFS:
NI is increased by 75
The write-up is non-cash, so subtract 100
DTL goes up by 25 (thus 25 cash in-flow) since we cash taxes < book taxes since we aren't really paying taxes on the write-up
Net change in cash is 0
BS:
Cash doesn't change
Assets increase by 100 from intangible assets going up by 100
Equity increases by 75 from retained earnings from NI
Liabilities increases by 24 since DTL increases by 25
Or, is it better to understand the DTL being created since future Cash Taxes > future Book Taxes (when we amortize the intangibles in future years)?
Based on the most helpful WSO content, your understanding of how the write-up of intangible assets flows through the three financial statements is largely correct. Here's a bit more detail:
Income Statement (IS): - The write-up increases Pre-Tax Income by 100. - With a 25% tax rate, Net Income (NI) increases by 75 (100 - 25).
Cash Flow Statement (CFS): - NI is increased by 75. - The write-up is a non-cash item, so you subtract 100. - Deferred Tax Liability (DTL) increases by 25, which is a cash inflow because cash taxes are less than book taxes since you aren't really paying taxes on the write-up. - The net change in cash is indeed 0.
Balance Sheet (BS): - Cash doesn't change. - Assets increase by 100 from the intangible assets going up by 100. - Equity increases by 75 from retained earnings from NI. - Liabilities increase by 25 since DTL increases by 25.
Regarding your last point, it's indeed important to understand that a DTL is created because future Cash Taxes will be greater than future Book Taxes when you amortize the intangibles in future years. This is because the tax authorities will allow you to deduct less than what you are deducting for book purposes, leading to higher cash taxes in the future.
Sources: Asset Write Up Impact on Balance Sheet - IBD Technical Question, 21 Finance Interview Questions and Answers, The Three Most Common Technicals, Patents - Three Financial Statements
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