Badwill

What is Badwill?

Badwill, also known as Negative Goodwill, is referred in the case of mergers and acquisition transaction when a company purchases a target company for a price less than its fair market value. Reasons to companies to sell below fair value or book value include financial distress, huge debt, hostile takeovers, uninformed sellers or no potential acquirer.

Explanation

Whenever an acquirer company buys a target company and pay a consideration value that is higher than its fair market value, the difference is termed as GoodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price.read more. The key reason an acquirer pays the price over its market value is because of the target company’s intangible assets such as brand value and customer distribution network. However, sometimes companies acquire distress companies where the fair value of all the assets is more than the consideration paid to acquire those assets.

Badwill

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Causes of Badwill

There are several reasons companies sell their assets or business for the sale consideration amount that is way less than the fair market value of the assets, such as:

Causes of Badwill

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Accounting Treatment of Badwill

In the United States, The Statement of Financial Accounting Standards (SFAS) 141 Business CombinationBusiness CombinationA business combination is a type of transaction in which one organization acquires the other organization and therefore assumes control of the other organization's business activities and employees. In simple terms, it is a consolidation of two or more businesses to achieve a common goal by eliminating competition.read more is applied for the accounting treatment of the Badwill.

According to the SFAS 141,

Many countries recognize the Negative Goodwill or Badwill according to the International Financial Reporting Standard (IFRS) 3 along with Accounting Standard Codification (ASC) 805 that contains the guidance note for the recognition of Negative goodwill. The accounting treatment is the same as stated above for IFRS 3 as it combines the contents of SFAS, SEC regulations, and FASB positions.

Journal Entries of Badwill

The acquiring company can recognize the negative goodwill as “Extraordinary gain” or “Bargain Purchase Gain” by following Journal Entry:

Journal

DateParticularsFolioDebitCredit
XXXValue of all the Assets Acquired$0.00
To Bank$0.00
To Extraordinary Gain on Bargain Purchase$0.00
(Brief narration of the transaction)

Example

Let us say, ABC Inc. acquired the entire business of XYZ Inc. for a consideration value of US $ 500 million. On the date of acquisition, the fair market value of XYZ Inc. net assets (including Property, plants, and EquipmentProperty, Plants, And EquipmentProperty plant and equipment (PP&E) refers to the fixed tangible assets used in business operations by the company for an extended period or many years. Such non-current assets are not purchased frequently, neither these are readily convertible into cash. read more and other current assets minus non-current liabilities as well as current liabilities) was the US $ 650 million.

As the fair market value of the net assetsNet AssetsThe net asset on the balance sheet is the amount by which your total assets exceed your total liabilities and is calculated by simply adding what you own (assets) and subtract it from whatever you owe (liabilities). It is commonly known as net worth (NW).read more of XYZ Inc. is more than the consideration value paid by ABC Inc., the transaction can be termed as Bargain PurchaseBargain PurchaseBargain purchase happens when a company acquires another company at a price less than the fair market value of its assets.read more with the Badwill amounting to the US $ 150 million. (US $ 500 million minus the US $ 650 million)

ABC Inc. can recognize the value of negative goodwill of US $ 150 by recording the following journal entry:

Journal

DateParticularsFolioDebitCredit
XXXNet-Assets Acquired$650.00
To Bank$500.00
To Extraordinary Gain on Bargain Purchase$150.00
(ABC Inc. acquired XYZ Inc.)

Conclusion

Badwill occurs when the acquiring company acquires the net assets of the target company for a considerable price that is lower than the fair value of the company’s assets. These transactions take place when the target company is in financial distress, or have a significant debt with no positive, consistent cash flowsCash FlowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more to meet the financial obligation or through a hostile takeover.

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This has been a guide to what is Badwill and its definition. Here we discuss the causes, accounting treatment, journal entries of badwill along with an example. You can learn more about financing from the following articles –

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