Hardest Technical I've Gotten At a BB

Why would asset write-up increase pre-tax income? Doesn't make sense to me.

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In the context of a merger, there are two main types of transactions - (1) asset sales and (2) stock sales. In both cases, assets will be written up to FMV, with excess of the purchase price allocated to goodwill. This transaction-related write-ups do not affect the income statement. However, in an (1) asset sale, the book value of asset differs from the taxable value of the asset (i.e. book value =/= taxable value). The taxable value is written up, but book value remains unchanged. This leads to deferred tax liabilities which is amortized each year, reducing net income.

asset writeup refers to accounting treatment, as in tax, it should be called basis step up. No matter which transaction structure you use, there will be asset writeup to the fair market value (FMV) in M&A from accounting standpoint, though tax treatment may differ. The excess btw FMV and purchase price would lead to goodwill, and there should be no impact on IS. Only if the writeup leads to FMV in excess of your purchase price, then it’s called bargain gain, which will result in positive accounting income (and naturally, no goodwill is created in this scenario). I’m not sure why the asset would need to be written down during the M&A process. If the value of the assets is already below book, shouldn’t it be impaired already? The only situation I see is when you acquire such assets at even steeper discount, so a write down will be more than offset by the discount, and you will still have a bargain gain in this situation.

Correct me if I’m wrong, but here are my thoughts:

The point of D&A is to receive the tax benefit from purchases, but spread over a period of time. The government wants to incentivize growth, without incentivizing insane capital expenditures to avoid taxes.

Typical reasons for an asset write-up: you either write the asset up because you purchased the company and wrote it up to fair market value (so you can capitalize the expense, if it’s categorized as an asset sale. If it’s a stock sale then you create a DTL), you accidentally wrote down the book value too heavily and realize you need to write it up (no change here, except you will create a deferred tax liability because you already received the tax benefit you would’ve received from D&A, but on a more accelerated timeline), or you’re writing the asset up because of maintenance CapEx. You can only receive taxable benefit from the new CapEx at this point, not from the increase in useful life, so the useful-life writeup will potentially create a deferred tax liability; if anything, your original asset just has a longer period of time to depreciate over (asset worth $100 with 5 years left, add $20 maintenance capex to increase useful life and you’ll now depreciate $120 over 10 years).

You can’t just blatantly answer if a write-up will affect taxes, because the question is WHY did the write-up happen? If you physically paid more for the write-up to happen (M&A categorized as an asset sale, capitalizing maintenance CapEx for some reason) then it WILL affect pre-tax income, but the same as any other capitalized expense would. It’s not taxable yet though, so it affects cash flow, but not from taxes. It wouldn’t make any sense to just remove expenses from the income statement, like reversing D&A because of a write-up.

Any thoughts? Does this sound correct?

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You buy a company. The assets get written up. There is additional depreciation from that. OP seems to have answered that correctly.

The write-up doesn't increase income.