Negative Goodwill

What is Negative Goodwill?

The negative goodwill arises in the financial statement of the company purchasing another company when the fair value of net identifiable assets is greater than the purchasing price paid for the purpose of acquiring the company.

We note from above, Aareal Bank completed the acquisition of Westlmmo for Euros 350 million, acquiring a Euro 4.3 billion performing European commercial real estate loan book. This transaction added value to Aareal Banks as Euro 150 million was recorded as Negative Goodwill upon closing the deal.

Aareal Bank - Negative Goodwill - 1

How to Interpret Negative Goodwill?

Negative Goodwill is a term coined in the context of one company taking over another. It’s again occurring to the former when the consideration paid for an acquisition is less than the fair market value of its net tangible assets. In literal terms, Negative Goodwill implies a bargain purchase.

Now the critical aspect to ponder here, why would someone be willing to sell the entity’s assets below its fair market value? Any wise person would think the assets can be disposed of at its fair market price, then why question for Negative Goodwill will arise in the very first place.

Well, let’s look into this. There may be a circumstance which may force such a situation namely:

  1. Forced or distress saleDistress SaleDistressed sale refers to the immediate sale of stocks, real estate, or other assets for a price lower than its intrinsic value or at a financial loss because of an economic threat, medical emergency, debt payment, or any other reason.read more
  2. Recognition or measurement exceptions for particular items discussed under IFRS 3
  3. Errors in the valuation of assets and controlling or non-controlling interestNon-controlling InterestIt generally projects curves on the data sets. For example, to forecast population growth, forming a non-linear relationship between time and growth.read more in any entity

Negative Goodwill is again for the acquirer entity and should be recognized as its books, but before that acquirer must review the calculations to ensure that everything is arithmetically correct and there is no mistake made in the calculation of various elements as Negative Goodwill does not arise normally. After all, buying a business costlier than the market price and being in a notion that we have acquired the same at a profit is not a wise idea.

Once it is confirmed that the net result is again on the acquisition, the resulting gain should be recognized in the books (Profit & Loss Account) of the acquirer company.

Any change in the management or control of the company, a valuation of the assets must be performed according to generally accepted accounting standardsGenerally Accepted Accounting StandardsGenerally accepted accounting principles (GAAP) are the minimum standards and uniform guidelines for the accounting and reporting. These standards prohibit firms from engaging in unethical business activities and enable for a more accurate comparison of financial reports to investors.read more. This exercise is commonly referred to as a purchase price allocation. It is called so because the purchase price of the acquired company is allocated across all tangible and intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. read more acquired. Generally, the value of the acquired company is greater than the value of the acquired assets. It may also be understood as the whole company is greater than the sum of its partsSum Of Its PartsSum of the Parts Valuation is a valuation method wherein each of the subsidiary or segment of a Company is separately valued & then all of them are added together to estimate the business’s total value. read more. That additional value of the whole company over and above is referred to as Goodwill. There are certain transactions in which the total value of the parts put together (individual assets) acquired in a transaction exceeds the price paid for the total company. It is commonly known as “bargain purchase.”

Positive Goodwill Example

For understanding Negative Goodwill, it’s helpful to understand Positive Goodwill beforehand. In a typical acquisition scenario, acquired tangible assets include accounts receivable, inventory, fixed assets, i.e., machinery, plant, and equipment, etc. There may be a number of intangible assets in addition to tangible assets that form a part of the acquisition and are seen as value drivers. These intangible assets can be a brand name, patents, or a certain technology, licenses, positive customer relationships having the capability to have an additional business pull. For passing the test of allocation, it is mandatory to have a legal and enforceable contract to use these assets in favor of Acquirer Company. After allocating value to all of these assets, any excess amount left over is considered as Positive Goodwill.

The following example will show the purchase price allocation for $ 5 million acquisition:

Tangible Asset:Fair Value of Assets
Receivables$ 1,500,000
Plant & Machinery$ 1,000,000
Land & Building$ 100,000
Intangible Assets:
Patents$ 500,000
Trade NamesTrade NamesA trade name is an official name under the company to promote its brand, services or product and is different from the registered company’s name. A company owner has numerous choices for a trade name. It is commonly known as ‘doing business as (DBA) in the United States.read more$ 1,100,000
Unallocated Intangible Assets:
Goodwill$ 800,000
Purchase consideration$ 5,000,000

As can be seen from the above example that the fair value of the assets taken over is USD 4.2 million. It effectively means that the price paid over and above the fair value of the assets is Positive Goodwill, i.e., USD 0.8 million.

Also, have a look at Impairment of Assets | Goodwill Impairment

Negative Goodwill Example

While most of the time, business acquisition transactions happening would result in Positive Goodwill, there may be some instances where the fair value of the assets taken over is more than the price paid for the acquisition. This scenario typically results in Negative Goodwill and generally termed “Bargain Purchase.” Using the same example used earlier, if the purchase price/deal price is USD 4 million instead of USD 5 million, the purchase allocation would be as follows:

Tangible Asset:Fair Value of Assets
Receivables$ 1,500,000
Plant & Machinery$ 1,000,000
Land & Building$ 100,000
Intangible Assets:
Patents$ 500,000
Trade Names$ 1,100,000
Unallocated Intangible Assets:
Goodwill$ (200,000)
Purchase consideration$ 4,000,000

This type of scenario calls for additional analysis, which we will look in to very shortly.

Signs of Negative Goodwill

Several indications suggest that a transaction may be a bargain purchase. Some indicative signs of bargain purchasesBargain PurchasesBargain purchase happens when a company acquires another company at a price less than the fair market value of its assets.read more include:

  1. The acquired company has incurred financial losses in the recent past or has been being in debt and is not able to service its debt
  2. The netbook value of the assets taken over is more than the purchase price paid for the acquisition.
  3. The transaction has been carried out secretly, and a possibility of higher value has not been explored.
  4. A single bidder has taken advantage of the situation and the absence of other bidders.
  5. The deal has been finalized in haste and within a brief period.
  6. The seller was compelled to sell the business against his will or in a desperate situation.
  7. The existence of a very fact that the acquirer has more knowledge of the acquired business

There should be a very strong reason as to why a transaction is a bargain transaction, and the same should be documented properly as to why a bargain purchase is representative of the fair market value of assets taken over. If the purchase price allocation cannot be articulated precisely as to why the purchase price allocation should have Negative Goodwill, this will call for a re-evaluation of the fair value of every asset. In the absence of the above, it may be concluded that the fair value of the overall business is more than the purchase price.
It would simply mean that the transaction did not happen at the fair value. In such a situation, the concluded fair value is the amount allocated to the acquired assets, and any excess amount over and above the fair value of the business would be treated as extraordinary gains.

Conclusion

The prime most implication of a bargain purchase is the gain to the buyer if it is a purchase below the fair value of the acquired assets. A bargain purchase gain should be recognized at the time of acquisition and recorded as an extraordinary income at the date of acquisition. However, it is essential to note that this is again for the purpose of accounting only. It would in no way be included in the calculation of income subject to taxes.

Negative Goodwill Video

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