Deferred Tax Liability Question

dedderss's picture
Rank: Baboon | 102

So I think that I have a pretty solid understanding of deferred tax liabilities so far... From what I understand, any writeup of PPE/Intangible assets will cause the pretax net income to be lower and thus cause a lower book tax than what the company actually has to pay in cash taxes (for a stock deal).

I began to think about this a little further and became confused though.
- We come up with the value of the deferred tax liability by taking the total amount of the writeups and multiplying it by the tax rate.
-The DTL decreases each year because we are paying more cash taxes than what we record for book taxes on our income statement.
-I am confused because the DTL goes down each year on our balance sheet because of the higher cash taxes that we are paying but I don't see the DTL showing up on the CFS for any of the models that I've looked at. My logic would be that the year over year decrease in DTL balance should also be shown on the CFS as our cash is reduced by the difference between the book and cash taxes we are actually paying. Although I couldn't find anyone on here or elsewhere discussing a line for the reduction of DTL on the Cash Flow Statement so maybe I am thinking about this incorrectly?

If someone could provide some insight on this I'd really appreciate it.

Comments (6)

Jun 15, 2018

Hi Dedderss,

I don't follow all of your comments above, but I have extensive experience in this area. Let me know if this doesn't cover what you needed.

At the most basic level, a DTL on PPE is computed by taking the difference between the book and tax bases of your PPE, and multiplying it by the Company's tax rate. In the case of a stock deal, under GAAP, PPE is written up (or down) to its fair market value - i.e. the book basis is increased/decreased. However, for tax purposes, the basis remains unchanged. So if there was a "write-up" then the DTL will increase since the book basis will now be even higher than the tax basis pre-acquisition. It shows as a DTL since that additional book basis will turn as depreciation which will drag down GAAP net income, but that additional depreciation will be thrown out ("not deductible") for tax purposes, because the additional basis which is kicking off the depreciation simply doesn't exist for tax purposes. As a technical point, the additional DTL that is established when purchase accounting occurs is recorded through goodwill, so DTLs that are established in purchase accounting generally do not impact the P&L.

On the cash flow statement in operating cash flows, income tax expense generally hits in two places. Non-cash deferred tax expense/benefit is thrown out, and the change in income taxes payable gets added/subtracted based on how it changed during the period.

More in your terms, if a DTL goes down, AND that change runs through the income statement as deferred tax benefit (remember, not all DTL changes hit the P&L), then that benefit will be subtracted from net income in arriving at cash flows from operating activities.

Let me know if you need more help.

    • 2
Jun 15, 2018

Thanks a lot that was really helpful, especially your discussion of book bases of assets being increased while tax bases remains the same.

Going back to the CFS - I understand that deferred taxes will be added because they are not paid in cash as well as an increase in income tax payable increasing our cash balance.

I don't think I worded my question right but I'll give you a more concrete example of my question: Let's just say that while doing purchase accounting we write up our Intangible Assets and PPE by 100 which results in a DTL of 40 (40%*100). Our depreciation from the write-ups is 20 per year so we are left with 80 in book taxable income. For the first year, our book tax expense is now 32 (80X40%) while our cash tax expense 40 (100X40%) resulting in 8 dollars more that the company must pay in cash. So now we reduce the DTL by 8. **My question is that since we are reducing the DTL by 8 (our new DTL balance in year 2 will be 40-8=32) how does the balance sheet end up balancing? My intuition is that cash would also go down 8 on the asset side because of the additional cash taxes have to pay but i don't see a line for "reduction in DTL" on the CFS.

Can't thank you enough for the first post. Any help on how I should think about this would be greatly appreciated.

Most Helpful
Jun 15, 2018

No problem at all. As a minor nit on your example, the $100 PPE write up would not hit the P&L, it would just adjust the goodwill recorded. I'll run with what you have though, and presume there was $100 of book net income, before depreciation expense.

Per your example, when the DTL is reduced by $8, the accounting entry is:
Dr. DTL $8
Cr. Deferred Tax Benefit $8

The deferred tax benefit will ultimately get closed to retained earnings, and the balance sheet will balance. On the cash flow statement, the $8 will be shown as "Deferred Tax Expense/(Benefit)" and will be subtracted from net income in arriving at cash flows from operating activities.

As an FYI, the entry to record the "current" or "cash" taxes would be:
Dr. Income Tax Expense - Current $40
Cr. Income Taxes Payable (or cash) $40

Presuming the current tax expense was recorded as a payable, the cash flow statement would show a "Change in Income Taxes Payable" line that adds back the $40 to net income in arriving at cash flows from operations, as the cash has not yet been remitted to the government.

Let me know if you need additional help.

    • 3
Jun 15, 2018

Thanks so much, really appreciate it. No more help needed you really cleared everything up.

Jun 16, 2018

Just trying to get one final picture of what the balance sheet will look like after a year.

A: Cash down 8 from "deferred tax expense/benefit"
L: DTL down 8
E: Retained earnings up 8 from deferred tax benefit

Just a little confused at how to balance this because you mentioned that the retained earnings increases as our DTL decreases to balance out the L+E side (8-8=0) but you also mentioned that our cash increases by 8 on the CFS which creates an imbalance.

Jun 16, 2018
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