Accelerated Depreciation and DTLs, Explained
The question
A manufacturing company reports $100M of pre-tax book income. Its tax depreciation exceeds book depreciation by $40M. The statutory tax rate is 25%. Compute the deferred tax liability increase for the year. Explain why this DTL does not represent a near-term cash outflow for the company.
General educational practice only. This is not an actual, confidential, leaked, or firm-provided interview question. Check important technical details against primary learning materials.
Study explanation
The increase in the deferred tax liability is the temporary difference multiplied by the tax rate: $40M × 25% = $10M. This DTL arises because the company paid $10M less in cash taxes today than the book tax expense; it will be paid in future periods when the asset becomes fully depreciated for tax while book depreciation continues.
For a growing company that consistently invests in new PP&E, new originating differences can exceed reversing differences, causing the DTL balance to grow or remain stable, effectively acting as a permanent, interest-free source of financing. It is not a current payable, and the exact timing of reversal may be years away.
Follow-up pressure:
- If the tax rate were to decrease to 21% next year, how would the existing DTL balance be adjusted? Walk me through the income statement impact.
- Suppose the company's capital expenditures slow dramatically and it stops acquiring new assets. Walk me through what happens to the DTL balance over the following three years.
- Would a valuation allowance ever be recorded against a DTL? Why or why not?
Income statement
| Revenue | 1,000 |
| COGS | (600) |
| Gross profit | 400 |
| SG&A | (180) |
| EBITDA | 220 |
| D&A | (40) |
| EBIT | 180 |
| Interest expense | (20) |
| Pre-tax income | 160 |
| Taxes | (40) |
| Net income | 120 |
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The rest of this topic
Depreciation, write-downs and the tax shield