How do DTLs and DTAs affect the Balance Sheet Adjustment in an M&A deal?

You take them into account with everything else when calculating the amount of Goodwill & Other Intangibles to create on your pro-forma balance sheet. The formulas are as follows:

Deferred Tax Asset = Asset Write-Down * Tax Rate

Deferred Tax Liability = Asset Write-Up * Tax Rate

So let’s say you were buying a company for $1 billion with half-cash and half-debt, and you had a $100 million asset write-up and a tax rate of 40%. In addition, the seller has total assets of $200 million, total liabilities of $150 million, and shareholders’ equity of $50 million.

Here’s what would happen to the combined company’s balance sheet (ignoring transaction/financing fees):

• First, you simply add the seller’s Assets and Liabilities (but NOT Shareholders’ Equity – it is wiped out) to the buyer’s to get your “initial” balance sheet. Assets are up by $200 million and Liabilities are down by $150 million.

• Then, Cash on the Assets side goes down by $500 million.

• You have an asset write-up of $100 million, so Assets go up by $100 million. 

• Debt on the Liabilities & Equity side goes up by $500 million.

• You get a new Deferred Tax Liability of $40 million ($100 million * 40%) on the Liabilities & Equity side.

• Assets are down by $200 million total and Liabilities & Shareholders’ Equity are up by $690 million ($500 + $40 + $150).

• So you need Goodwill & Intangibles of $890 million on the Assets side to make both sides balance.