Incremental Depreciation & Amortization

Now that we have allocated the purchase price, let’s see what incremental depreciation and amortization expenses arise from the associated asset write-ups. We chose to calculate incremental D&A in a new section of our model called “Tax Schedule”, in anticipation of using these figures for other tax-related calculations later. However, you could have performed these calculations separately in another section of your model. What is more important is how we computed these figures.

We need to know the incremental D&A expenses for both book and tax purposes. Recall that for tax purposes, IRC Section 197 requires that all intangible assets, including goodwill, be amortized over 15 years when there is a step-up in the acquired assets for tax purposes (i.e. in an asset deal). Also, goodwill is never amortized for book (i.e. GAAP or accounting) purposes. The different treatment in depreciation and amortization of the asset write-ups leads to different taxable income figures for book and tax purposes.

Note how the calculation of D&A is complicated a bit by our stub period. Here we assume that some incremental depreciation and amortization occurs in the stub period, meaning that we have to be more precise in our calculations than simply dividing the asset write-ups by their depreciation or amortization periods, as applicable.

It is not unusual for a company to divest non-core assets following an LBO, in an effort to become more streamlined and reduce operating costs. Note that we have included lines here for gains/losses on asset sales. We have assumed here that no such asset sales occur following the LBO, but we will later add a section to our model that accounts for asset sales and link these cells to that section. We will also link the “Book Taxable Income” cells to the income statement when we finish building it.