In reorganizing the financial statement to obtain invested capital, why do I have to specifically deduct the deferred tax liability related to acquired intangibles from acquired intangibles? Why can’t I simply account for the adjustment when calculating the operating net deferred tax asset/liability for the purpose of obtaining invested capital? Why is this direct net off exercise only applicable to acquired intangibles?
Here is the excerpt from the textbook Valuation, Measuring and Managing the value of companies by Tim Koller:
“To evaluate goodwill and acquired intangibles properly, you need to make two adjustments. First, subtract deferred tax liabilities related to the amortization of acquired intangibles. Why? When amortization is not tax deductible, the accountants create a deferred tax liability at the time of the acquisition that is drawn down over the amortization period (since reported taxes will be lower than actual taxes). To counterbalance the liability, acquired intangibles are artificially increased by a corresponding amount, even though no cash was laid out. For UPS, acquired intangibles are small, so the reduction is minor. For companies with significant acquired intangibles—for example, Coca-Cola the adjustment can be substantial.”