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Deferred Tax Accounting in an Acquisition Is Essential

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Deferred Tax Accounting in an Acquisition Is Essential Vol. 25 No. 12 December 2013 300th Issue! Attention to Detail: Deferred Tax Accounting in an Acquisition is Essential By Glenn Richard James, JD, CPA acquisition are not likely to Accounting standards require that deferred taxes constitute a useful proxy for be recorded on every difference between the book the tax basis of those assets and tax basis of assets and liabilities acquired in and liabilities. an acquisition save one: the excess of goodwill It is important to note recorded for financial statement accounting over that there are special issues the tax basis of goodwill acquired. involved in the fair valuation The principles can be tricky to apply, especially of liabilities. Certain in situations where the deal is structured as an asset liabilities are not recognized purchase versus a stock purchase, or when there as such for income taxes, is a bargain purchase price. In either structure, and, consequently, will always give rise to an each asset and liability acquired is separately fair opening deferred tax asset. For example, there valued to determine the basis of acquired assets is no tax liability for an ASC 840 (formerly FAS and liabilities at the acquisition date; and there is 13) rental obligation or a capital lease obligation no limit on the fair value of net assets acquired. in respect of a lease treated as an operating lease However, for income tax purposes, only the asset for income taxes. Then there are the liabilities for purchase structure gives rise to a fair valuing of deferred taxes, which are ignored and do not cause assets, and even then the net value of assets acquired the recognition of further temporary differences. is limited to the purchase price. Conversely, in a The opposite side of any entry to record deferred stock purchase, assets and liabilities come over taxes will be to the goodwill asset or the bargain at the seller’s tax bases immediately prior to the purchase gain, whichever is present. The net transaction. deferred tax entry will result in an adjustment as When determining the basis differences of follows: recording a net deferred tax asset will assets and liabilities acquired in a transaction, the decrease goodwill or increase a bargain purchase crucial next step is to determine the tax bases of gain; recording a net deferred tax liability will assets and liabilities acquired, which must then be increase goodwill or decrease, or eliminate a compared to the fair values to determine opening bargain purchase gain. temporary differences and then the deferred tax An example should be useful. Assume a stock amounts in respect of those differences. In either purchase structure for a cash purchase price of structure, the book basis of assets and liabilities in $3,500,000. The tax basis in loans acquired is the accounts of the target immediately prior to the $3,000,000. The loans are carried on the seller’s books at a net value of $2,500,000. Fair value of Page 12 Michigan Banker • December, 2013 those loans is determined to be $2,400,000. There Thus, the transaction generates goodwill of is an ASC 840 lease obligation of $100,000. $40,000 and not the $400,000 of goodwill that Deposit account liabilities have a tax basis of would be calculated by looking only at the $2,000,000 and a fair value of $1,900,000. “visible” assets acquired and liabilities assumed Securities have a tax basis of $3,000,000 and a fair other than deferred taxes, nor is it the $40,000 of value of $2,700,000. There are no other temporary bargain purchase gain that would be calculated differences. The seller has recorded a net deferred by including the seller’s net deferred tax asset as tax asset of $440,000. The proper tax rate to apply an asset acquired. in determining deferred taxes and liabilities is As can be observed in the example, getting 40%. the deferred taxes wrong can easily move the result of the transaction from bargain purchase to Analysis Tax Fair Temporary goodwill and prove an embarrassment to the deal Basis Value Difference negotiator. Make sure it doesn’t happen to you. Loans $3,000,000 $2,400,000 $600,000 Securities 3,000,000 2,700,000 300,000 Deposits (2,000,000) (1,900,000) (100,000) ASC 840 liability - 0 - (100,000) 100,000 Glenn Richard James, a partner with BDO Net $4,000,000 3,100,000 $900,000 USA LLP, is a financial services tax professional. Deferred taxes at 40% 360,000 His practice experience includes federal and Net assets acquired $3,460,000 state corporate income, franchise and shares Summary tax planning, incentive compensation planning Purchase price paid $3,500,000 and design; taxation of and accounting for Net fair value of assets acquired 3,460,000 share based payment; and financial instrument Goodwill $40,000 taxation. “New opportunities? We can barely keep up with the new regulations.” People who know Financial Institutions, know BDO. The Financial Institutions Practice at BDO Industry consolidation. Depressed yields and margins. Uncertain economy. We understand the complex issues you face, whether you are a de novo or a multi-billion-dollar institution. BDO provides you with a team experienced with institutions of all sizes and complexities and skilled at providing audit, tax and regulatory compliance services. Accountants and Consultants www.bdo.com/fi nancial-institutions © 2012 BDO USA, LLP. All rights reserved. Michigan Banker • December,Seiter&Miller 2013 000757 Pub. WIB conference program Size 7.5x4.75 Issue 2012 Page 13 Art Director: sd/lg Copywriter: ms Account Executive: em Date: 02/03/12.
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