ASC 805-740: Deferred Tax Liability Transactions & Journal Entries Explained

Posted In | ASC Education | Gridlex Academy

The Accounting Standards Codification (ASC) 805-740, also known as the Business Combinations - Income Taxes, is a comprehensive guidance on how to account for income taxes in business combinations. This article focuses on the deferred tax liability transactions arising from a business combination, breaking down the process with relevant journal entries to help you understand the intricacies of ASC 805-740.

 

Deferred Tax Liability (DTL) in Business Combinations

In a business combination, the acquiring company is required to recognize and measure the identifiable assets acquired, liabilities assumed, and any non-controlling interest in the acquired company at their fair values on the acquisition date. Deferred tax liabilities represent the anticipated future tax consequences resulting from the difference between the tax bases and fair values of the assets and liabilities recognized in the business combination. The acquiring company needs to establish a deferred tax liability for the taxable temporary differences identified during the business combination. Temporary differences arise when the tax basis of an asset or liability differs from its carrying amount on the balance sheet.

 

Journal Entries for Deferred Tax Liability Transactions

To illustrate the journal entries for deferred tax liability transactions in a business combination, let's assume Company A acquires Company B in a share-for-share exchange transaction. Company A issues 1,000,000 shares at $10 per share to acquire all outstanding shares of Company B. The fair value of Company B's net identifiable assets is $8,000,000, and its tax basis is $6,000,000. The enacted tax rate is 25%.
 

Step 1: Record the acquisition of Company B

First, Company A will record the acquisition of Company B by debiting its Investment in Company B account and crediting its Common Stock and Additional Paid-in Capital accounts.
 

Journal Entry:

Dr. Investment in Company B $10,000,000

Cr. Common Stock $1,000,000

Cr. Additional Paid-in Capital $9,000,000

 

Step 2: Recognize the deferred tax liability

Next, Company A needs to recognize the deferred tax liability arising from the difference between the fair value and tax basis of Company B's net identifiable assets.
 

The taxable temporary difference is calculated as follows:

Fair value of net identifiable assets - Tax basis of net identifiable assets

$8,000,000 - $6,000,000 = $2,000,000
 

The deferred tax liability is computed as follows:

Taxable temporary difference × Enacted tax rate

$2,000,000 × 25% = $500,000
 

Journal Entry:

Dr. Investment in Company B $500,000

Cr. Deferred Tax Liability $500,000

 

ASC 805-740 provides guidance on the accounting treatment of income taxes in business combinations. Understanding how to recognize and record deferred tax liabilities is crucial for accurate financial reporting and compliance with accounting standards. By following the steps and journal entries provided in this article, you will be better equipped to handle deferred tax liability transactions in your business combinations.