A

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40

DEFERRED TAXES AND ACCELERATED DEPRECIATION An Example

2006 P&L for tax purposes Sales Costs Depreciation PBT Taxes (40%) PAT Cash flow PAT Add back depreciation Cash flow 1000 500 300 200 80 120 2006 P&L for reporting purposes Sales 1000 Costs 500 Depreciation 250 PBT 250 Taxes (40%) 100 PAT 150

120 <-- =B8 300 <-- =B5 420 <-- =B12+B11

Balance Sheet
2005 Assets Cash Other current assets FA at cost Accumulated depreciation Net fixed assets Total assets Liabilities and equity Current liabilities Deferred taxes Debt Equity Stock Accumulated retained Total liabilities and equity 2006 0 0 500 0 500 500 420 <-- =B18+B13 0 <-- =B19 500 250 <-- =B22+E5 250 670

0 0 0 200 300 500

0 20 <-- =E7-B7+B28 0 200 450 <-- =B32+E8 670 The PLUG! Without this, the asset side of the balance sheet grows by 420 - 200= 220, whereas the liabilities/equity side grows by 180.

Assumptions: 1. All COGS in cash 2. All Sales in cash 3. No new assets purchased 4. No debt repaid or taken out 5. No dividends paid or stock sold or repurchased

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 <-- =B18+B13 18 19 20 21 22 23 24 25 26 27 <-- =E7-B7+B28 28 29 30 31 32 33 34 35 36 37 38 39 40

Cash balances grow by the cash flow (determined by the tax P&L) Depreciation is reported from the shareholder P&L

Accumulated retained earnings grow by the PAT from the shareholder P&L

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38

DEFERRED TAXES AND ACCELERATED DEPRECIATION The next year--asset is fully depreciated
2007 P&L for tax purposes Sales Costs Depreciation PBT Taxes (40%) PAT Cash flow PAT Add back depreciation Cash flow 1000 500 200 300 120 180 2007 P&L for reporting purposes Sales 1000 Costs 500 Depreciation 250 PBT 250 Taxes (40%) 100 PAT 150

180 <-- =B8 200 <-- =B5 380 <-- =B12+B11

Balance Sheet
2007 Assets Cash Other current assets FA at cost Accumulated depreciation Net fixed assets Total assets Liabilities and equity Current liabilities Deferred taxes Debt Equity Stock Accumulated retained Total liabilities and equity 2007 420 0 500 250 250 670 800 <-- =B18+B13 0 <-- =B19 500 500 <-- =B22+E5 0 800

0 20 0 200 450 670

0 0 <-- =E7-B7+B28 0 200 600 <-- =B32+E8 800 Accumulated depreciation is zero in 2007--the firm's actual taxes paid are higher by $20 than taxes reported to shareholders.

D DEPRECIATION preciated 1
2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 <-- =B18+B13 18 19 20 21 22 23 24 25 26 27 <-- =E7-B7+B28 28 29 30 31 32 33 34 35 36 37 38

Cash balances grow by the cash flow (determined by the tax P&L)

Depreciation is reported from the shareholder P&L

Accumulated retained earnings grow by the PAT from the shareholder P&L

A 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42

TAXES PAYABLE
2003 Profit & Loss Sales Costs Depreciation PBT Taxes (40%) PAT Cash flow PAT Add back depreciation Increase in taxes payable Cash flow 1000 500 300 200 80 120

120 300 20 440

Balance Sheet
2002 Assets Cash Other current assets FA at cost Accumulated depreciation Net fixed assets Total assets Liabilities and equity Current liabilities Taxes payable Debt Equity Stock Accumulated retained Total liabilities and equity 2003 0 0 500 0 500 500 440 <-- =B19+E14 0 <-- =B20 500 300 <-- =B23+E5 200 640

0 0 0 200 300 500

0 20 <-- =E7-H3 0 200 420 <-- =B33+E8 640

Assumptions: 1. All COGS in cash 2. All Sales in cash 3. No new assets purchased 4. No debt repaid or taken out 5. No dividends paid or stock sold or repurchased

Taxes payable are the difference between taxes reported in the P&L and taxes actually paid.

LE

1 2 3 Actual taxes paid 4 5 6 7 8 9 10 11 <-- =E8 12 <-- =E5 13 14 <-- =SUM(E11:E13) 15 Cash balances grow by 16 the cash flow 17 18 <-- =B19+E14 19 20 Depreciation is reported 21 from the shareholder P&L 22 23 24 25 26 27 28 29 Accumulated retained 30 earnings grow by the PAT 31 from the shareholder P&L 32 (there are no dividends) 33 34 35 36 37 38 39 40 41 42

60

A 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Company A Assets Cash Current assets Plant property and equipment At cost Accumulated depreciation Net PP&E Total Assets Liabilities and equity Current liabilities Debt Equity Common stock Accumulated retained earnings Total liabilities

C Company B Assets Cash Current assets

GOODWILL ACCOUNTING
10,000 12,000 500 1,000

10,000 -3,000 7,000 29,000

Plant property and equipment At cost Accumulated depreciation Net PP&E Total Assets Liabilities and equity Current liabilities Debt Equity Common stock Accumulated retained earnings Total liabilities

1,600 -250 1,350 2,850

10,000 3,000 2,000 14,000 29,000

800 1,000 1,000 50 2,850

Company A buys assets of Company B and assumes B's debt. 22 Price = Book value of equity
23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 Purchase price Assets Cash Current assets Plant property and equipment At cost Accumulated depreciation Net PP&E Total Assets Liabilities and equity Current liabilities Debt Equity Common stock Accumulated retained earnings Total liabilities 1,050

9,450 <-- =B4+E4-B23 13,000 <-- =B5+E5

11,350 -3,000 8,350 30,800

<-- =B8+E10 <-- =B9 <-- =B30+B31 <-- =B32+B27+B26

10,800 <-- =B14+E14 4,000 <-- =B15+E15 2,000 <-- =B17 14,000 <-- =B18 30,800 <-- =SUM(B36:B40)

A 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Company A Assets Cash Current assets Plant property and equipment At cost Accumulated depreciation Net PP&E Total Assets Liabilities and equity Current liabilities Debt Equity Common stock Accumulated retained earnings Total liabilities

C Company B Assets Cash Current assets

GOODWILL ACCOUNTING
10,000 12,000 500 1,000

10,000 -3,000 7,000 29,000

Plant property and equipment At cost Accumulated depreciation Net PP&E Total Assets Liabilities and equity Current liabilities Debt Equity Common stock Accumulated retained earnings Total liabilities

1,600 -250 1,350 2,850

10,000 3,000 2,000 14,000 29,000

800 1,000 1,000 50 2,850

Company A buys assets of Company B and assumes B's debt. Price > 22 Book value of equity
23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 Purchase price Assets Cash Current assets Plant property and equipment At cost Accumulated depreciation Net PP&E Goodwill Total Assets Liabilities and equity Current liabilities Debt Equity Common stock Accumulated retained earnings Total liabilities 2,000

8,500 <-- =B4+E4-B23 13,000 <-- =B5+E5 Assumption: The book value of B's assets is an accurate reflection of their 11,350 <-- =B8+E10 market value. -3,000 <-- =B9 8,350 <-- =B30+B31 950 <-- =B23-SUM(E17:E18) 30,800 <-- =B32+B27+B26+B33

10,800 <-- =B14+E14 4,000 <-- =B15+E15 2,000 <-- =B17 14,000 <-- =B18 30,800 <-- =SUM(B38:B42)

A 1

D Total on postacquisition balance sheet

COMPUTING THE FIXED ASSET ACCOUNTS

Pre-acquistion 10,000 1,600 -3,000 -250 7,000 1,350 Post-acquistion fair-market value 10,000 1,500 -3,000 0 7,000 1,500

2 3 Fixed assets at cost 4 A 5 B (revalued) 6 Accumulated depreciation 7 A 8 B (set to zero) 9 Net fixed assets 10 A 11 B 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Acquisition price Book value of B's equity B's current assets Fair-market value Book value Excess B's fixed assets Fair-market value Book value Excess Goodwill

11,500

-3,000

8,500

COMPUTING THE GOODWILL

2,000 1,050

1,200 1,000 200 <-- =B19-B20

1,500 1,350 150 <-- =B24-B25 600 <-- =B15-B16-B21-B26

E 1

OUNTS

2 3 4 5 <-- =C5+C4 6 7 8 <-- =C8+C7 9 10 11 <-- =C11+C10 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

A 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Company A Assets Cash Current assets Plant property and equipment At cost Accumulated depreciation Net PP&E Total Assets Liabilities and equity Current liabilities Debt Equity Common stock Accumulated retained earnings Total liabilities

C Company B Assets Cash Current assets

GOODWILL ACCOUNTING
10,000 12,000

10,000 -3,000 7,000 29,000

Plant property and equipment At cost Accumulated depreciation Net PP&E Total Assets Liabilities and equity Current liabilities Debt Equity Common stock Accumulated retained earnings Total liabilities

10,000 3,000 2,000 14,000 29,000

Company A buys assets of Company B and assumes B's debt. 22 Price > Book value of equity
23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 B's assets are revalued Purchase price Revaluation of B's assets Current assets worth Fixed assets worth Assets Cash Current assets Plant property and equipment At cost Accumulated depreciation Net PP&E Goodwill Total Assets Liabilities and equity Current liabilities Debt Equity Common stock Accumulated retained earnings Total liabilities 2,000

1,200 1,500

8,500 <-- =B4+E4-B24 13,200 <-- =B5+B27

11,500 -3,000 8,500 600

<-- =B8+B28 <-- =B9 <-- =B35+B36 <-- =B24-SUM(E17:E18)-(B27-E5)-(B28-E10)

Goodwill = + Excess of purchase price over B's BV of equity - Excess of revaluation of B's assets over their BV

30,800 <-- =B37+B32+B31+B38

10,800 <-- =B14+E14 4,000 <-- =B15+E15 2,000 <-- =B17 14,000 <-- =B18 30,800 <-- =SUM(B43:B47)

E 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21

500 1,000

1,600 -250 1,350 2,850

800 1,000 1,000 50 2,850

22 23 24 25 26 27 28 29 30 31 32 over s of purchase price 33 34 s of revaluation of B's 35 36 37 38 39 40 41 42 43 44 45 46 47 48

A 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41

MINORITY INTEREST
Company A
Profit and loss Sales COGS Depreciation Interest PBT Taxes PAT Retained Assets Cash CA NFA Total assets 1000 500 100 50 350 140 210 210 Liabilities CL Debt Equity Total liabilities Profit and loss Sales COGS Depreciation Interest PBT Taxes PAT Retained Assets Cash CA NFA Total assets

Company B
100 55 8 2 35 14 21 21

100 500 1000 1600

300 500 800 1600

10 50 100 160

Consolidation--100% ownership
Profit and loss Sales COGS Depreciation Interest PBT Taxes PAT Retained 1100 555 108 52 385 154 231 231 <-- =B11+G11 Assets Cash CA NFA Total assets 110 550 1100 1760 Liabilities CL Debt Equity Total liabilities 330 520 910 1760

Consolidation--90% ownership
Profit and loss Sales COGS Depreciation Interest PBT Taxes PAT Minority interest Retained 1100 555 108 52 385 154 231 <-- =B10+G10 2.1 <-- =10%*G10 228.9 <-- =B39-B40 Assets Cash CA NFA Total assets 110 550 1100 1760 Liabilities CL Debt Minority interest Equity Total liabilities 330 520 11 899 1760

H 1

Company 2 B
3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41

Liabilities CL Debt Equity Total liabilities

30 20 110 160

<-- =D14+I14 <-- =D15+I15 <-- =D16+I16 <-- =D17+I17

<-- =10%*I16 <-- =D16+I16-G35