Can someone help me out with this on impairment. In the notes, it says that an impairment will lower deferred tax liability, because it moves depreciation in the financial statements closer to the tax return depreciation. Does this mean that depreciation is increased to make tax expense lower, subsequently lowering deferred tax liability? Which of course cant be true right? because impairment reduces assets and reduces depreciation in the process.
Are you talking about DTA or DTL? Your subject line is different from your post’s.
Apologies, deferred tax liability.
DTLs are created becuase you take more depreciation for books than you take for tax. impairment, at the end of the day, is just a fancy word for taking extra catch-up book depreciation. An asset’s cost ultimately rusn the income statement as expense. Whether it trickles in as depreciation, or goes in as a combination of depreciation and impairment, makes no difference since it all adds up in the end to the same dollars over time. So if you are doing this catch-up in the form of impairment, the difference that exists between book and tax depreciation at the outset will shrink faster.
So in other words, depreciation increases because of impairment? Am right to say, DTL is caused when tax expense is greater than tax liability. in order for the outset to “shrink” faster, tax expense must be reduced==> pre-tax income must be reduced & all this will happen when depreciation (due to impairment) increase?
Here’s an example. Let’s say you have an asset that cost $30K (no residual) that book purposes you say has a 5 yr life, but for tax it falls into the 3-year life category. Annual book depr $6K, annual tax depr is $10K. cumulative difference in depreciation taken each year: Yr 1 (4k) Yr 2 (8k) Yr 3 (12k) Yr 4 (6k) Yr 5 zero Deferred taxes are those numbers times tax rate. Suppose in year 4 you decied that the asset was worthless, so in additon to the normal $6k depreciation, you wrote it of by taking a $6K impairment. (This would make the year 4 amount zero in the table above). You might break it out on a separate line in the income statement, but at the end of the day it is just the extra depeciation to bring the net book value of the asset down to zero. As I said, think of impairment as just extra depreciation over and above the normal schedule you put in place up front, that gets its own fancy line and title in the income statement, but still becomes part of the accumulated depreciation contra account on the balance sheet.