Negative goodwill, also known as a “bargain purchase,” occurs in a business combination when the price paid for a company is less than the fair market value of its identifiable net assets. In other words, negative goodwill arises when a company is acquired for a price lower than the combined value of its tangible and intangible assets, after subtracting liabilities.
Negative goodwill might occur in situations where the seller is in distress and needs to sell quickly, such as in bankruptcy proceedings, during an economic downturn, or due to regulatory orders. It could also occur if the buyer is able to negotiate a particularly favorable purchase price.
According to the accounting standards (IFRS 3 and US GAAP ASC Topic 805), when negative goodwill arises, it should not be recorded as goodwill on the balance sheet. Instead, the acquirer should reassess the identification and measurement of the acquiree’s identifiable assets, the measurement of the fair value of the consideration transferred, and the identification of any non-controlling interest in the acquiree.
If after that review the negative goodwill remains, then under IFRS it is recognized in profit or loss, but under US GAAP it is recognized as an extraordinary gain in the income statement. However, these treatments are rare, and any bargain purchase is often scrutinized by auditors and regulators to ensure all assets and liabilities have been accurately accounted for and valued.
Example of Negative Goodwill
Company A decides to acquire Company B. The fair market value of Company B’s identifiable net assets (assets minus liabilities) is calculated to be $1 million. This means that if Company B were to sell off all its assets and pay off all its liabilities, it would be left with $1 million.
However, Company A is able to negotiate a purchase price of $800,000 for Company B. This could be because Company B is under financial distress and needs to sell quickly, or for other strategic reasons.
As per accounting standards, Company A will first reassess whether all assets and liabilities of Company B were properly identified and valued, and whether the purchase price was correctly measured. If, after this reassessment, the negative goodwill still exists, Company A will recognize this as an extraordinary gain (according to US GAAP) or in profit or loss (according to IFRS) in its income statement.