Basically, two coumpanies acquire another company, one under the Purchase method, the other one using the Pooling Method. FMV of Assets is 100,000 greater than book value. Do we have a difference in cash flow? In Problem 5, Reading 22, should we assume that the tax rate is 0%? If not, then we would have tax savings due to the additional depreciation. Those tax savings would cause cash flows to be greater under the Purchase method.
In Pooling method, we pool the assets of C1 with the assets of C2 to form a (virtual) C3. C3 (Assets) = C1 (Assets @ BV) + C2 (Assets @ BV) In Purchase method, it’s more like an Acquisition, with the Target and the Acquirer, and while doing that purchase, the Acquirer Assets at BV are added to the Target Assets at MV. A(Assets) = A(Assets @ BV) + T (Assets @ MV) So the Assets under the Purchase methods are going to be greater than the assets under the Pooling methods and will lead to additional depreciation and hence higher Depreciation Expense, lower Taxable Income and less cash flowing out of the door. - Dinesh S
Dinesh, I think lower taxable income related to higher cash flow. Or did you mean lower ‘Income tax’ outflow!! I could be wrong.
There will only be difference in CF if the difference is assigned to depreciable assets. What if 100% of the difference is assigned to Good Will? Impairment hits B/S and not I/S so there won’t be lower Net Income and thus no tax savings. Anyone care to correct me?
Impairment loss is recorded on the Income statement as a separate line item!!!
Really? Whew anish you saved me from a potential dumb mistake on the test right there.
You got it =) Hopefully the questions on the test will be much better worded than this original question!!
I think purchase gives high cash flow Cashflow = EBIT (1-tax rate) + depreciation dep is higher in purchase method
In the original question posted above, if you assume that there is a positive tax rate then you get higher cash flow, as dinesh and itfaster noted above because a higher cost base for the assets leads to higher depreciation expense, lower taxable income, lower income tax expense, and a dinesh put it, "less cash flowing out of the door. " As far as the goodwill comments above, I hope that they were side comments not related to this question. It specifically states FMV of assets > BV. It’s pretty much a given that purchase price exceeds BV in all acquisitions (yes, there are exceptions), and as the problem is stated above they are not talking about purchase price, just FMV vs BV, which means we have a write-up of depreciable assets. Whether or not the purchase price exceeds the BV+$100K which would give rise to goodwill is not given and is not relevant to the question asked.