I don't understand how DTL is created in asset write up
Okay, I understand why a DTL is created during accelerated depreciation, however, I don't understand why DTLs are created in an asset write up.
So for accelerated depreciation, it makes sense because you are allowed to have much depreciation at the beginning, and thus, you pay less cash taxes to the government. However, for your GAAP income statement, depreciation is the same. Therefore, you are paying less taxes right now, but in the future, you will have to pay it back once depreciation is lowered. Therefore, a liability is created since you owe money.
However, I don’t understand it for asset write ups. So my understanding: when you write up an asset, you are allowed to report that on your GAAP income statement, but not for your tax return. Therefore, you end up paying more in cash taxes then you are reporting on your GAAP income statement. Therefore, as the years go on, you actually decrease the DTL. HOWEVER, I am confused as to why THE DTL WAS EVEN THERE IN THE FIRST PLACE? I want to understand conceptually why the DTL is even there (I understand how to calculate it.)
Hi Baloney,
The tax code is complex, but let me answer assuming the P&L benefit from the GAAP asset write up is not immediately picked up as income for tax purposes, and is instead recognized upon disposition of the asset / through adding back the incremental GAAP depreciation on the write up.
In this case, you would have income for GAAP but not for tax, and a DTL would be created for the future additional taxes. When you finally sell the asset, you would pick up the write up as an incremental tax gain on disposal (because your tax basis would be lower than your book basis). You also start reversing the DTL as incremental GAAP depreciation on the write up is added back to GAAP income in computing taxable income.
Your statement that "Therefore, you end up paying more in cash taxes then you are reporting on your GAAP income statement. " is not true in the year of the write up if you are reporting the income for GAAP but not on the tax return. If this was your only book to tax difference, your taxable income would be lower than your GAAP income, resulting in less cash taxes (initially).
Hope that helps.
Not sure I quite understand. If you put on more depreciation on your GAAP I/S, aren't you reporting less taxble income, and thus, lower paying a lower tax than your actual tax return report, which doesn't include the depreciation.
I understand your angle now. An asset write up for GAAP looks like this:
Dr. Asset Cr. P&L Benefit
If this is not recognized immediately for tax purposes, then your GAAP income is higher than your taxable income looking at this in isolation. As additional GAAP depreciation starts being generated on the additional basis, that depreciation is added back in computing taxable income, thus starting to reverse the DTL created on the initial write up. Your taxable income is increased due to throwing out the GAAP depreciation on the write up, not decreased.
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