Fair value step up
AccountingThe increase in an acquired asset's carrying value when it is restated from the seller's historic cost to fair value at completion.
Also written: step up, asset write up
A step up is the difference between what an asset cost the seller years ago and what it is worth on the day the buyer acquires it. Property, plant and equipment, real estate and inventory are the usual candidates, and assumed debt is restated too where its fair value differs from its carrying amount.
Inventory has a basis that surprises people. The fair value of finished goods is broadly the price at which it will sell less the cost of selling it and a normal margin for the selling effort, so acquired inventory is written up to close to its selling price. As it is sold in the first quarter or two after completion, cost of sales carries the higher figure and gross margin is compressed, and then the effect disappears entirely.
Long lived assets behave the opposite way. The write up is depreciated across the asset's remaining life, so it depresses reported profit for years, and none of it is cash. The cash was spent once, at completion, as part of the price.
The tax treatment depends on how the deal was structured. In a share purchase the tax base does not move with the book value, so the extra charge is not deductible and a deferred tax liability is recognised. In an asset purchase the tax base does step up, so the extra depreciation is deductible where local rules allow and the saving is genuinely cash.
Worked example
Inventory carried at 30 is written up to 38 at completion. As it sells over the next two quarters, cost of sales is 8 higher than the seller would have recorded and gross margin is temporarily depressed by that amount.
A property write up of 100 depreciated over ten years adds 10 a year of charges, every year, with no cash effect.
In a share deal that 10 saves no tax at all and a deferred tax liability of 25 was recognised on the write up. In an asset deal the same 10 is deductible and saves 2.5 of cash tax a year at a 25% rate.