How do you calculate the deferred tax impact of a fair value uplift on inventory in a business combination? What happens when the inventory is subsequently sold?
A core Group Accounting interview question — asked in analyst and associate interviews across IB, PE, and the Big 4.
THE SHORT ANSWER
The fair value uplift increases the carrying amount of inventory, creating a temporary difference. A deferred tax liability (DTL) is recognized at the acquisition date at the applicable tax rate. When the inventory is sold, the temporary difference reverses, and the DTL is reversed through the income statement (as a tax expense reduction). This ensures the group's tax charge reflects the higher cost of goods sold. The journal entry: Dr goodwill (or other asset), Cr DTL on acquisition; later, Dr DTL, Cr deferred tax expense on sale.
WHAT INTERVIEWERS LISTEN FOR
- ✓DTL recognized on fair value uplift at acquisition
- ✓Reversal of DTL when inventory is sold
- ✓Impact on tax expense in group accounts
COMMON MISTAKES
- ✗Ignoring deferred tax on fair value adjustments
- ✗Not reversing DTL upon sale
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