Definition of Negative Goodwill
Negative goodwill can be defined as a term used in case where one company purchases or acquires another company(usually an bankrupt or a distressed company which is in immediate need of cash) at a price valuation which is lower than the fair market value of business and can be mathematically referred to as the difference in between sum value of money paid for acquisition reduced by fair market value of acquired company’s net assets.
Explanation
Negative goodwill is also commonly referred to as bargain purchase and is generally favourable to the acquiring company. Reporting requirements of negative goodwill varies according to the generally accepted accounting principles (GAAP). Concept of negative goodwill is opposite to that of goodwill where companies pay a higher premium than the fair value of the assets. Accounting standard requires companies to quantify the value of intangible assets like the company’s reputation, customer base, licenses and patents whereas negative goodwill, the value of intangible assets is recorded as a gain on the side of the buyer.
Examples of Negative Goodwill
Following are the examples are given below:
Example #1
A company named Adam’s mark buys the net assets of company Johny International for $100 million. But the fair value of net assets in the market was $150 million. This deal occurred because the company Johny international was in urgent need of cash and the only company that was willing to buy the assets of Johny international was Adam’s mark. Johny international was already in debt and there was no other entity willing to pay even much for the company except Adam’s mark. In this case, company Adam’s mark records the difference of $50 million between its purchase price and the actual fair value of the assets of Johny international. This difference is marked as negative goodwill.
Example #2
Due to market conditions and huge debts, Mercedes decided to sell its business to Audi and wind up its business operation in purchase consideration of million $35,00,000 the asset allocation was as follows –
|
Particulars |
Amount in Million ($) |
| Furniture | 2,00,000 |
| Land and Building | 26,00,000 |
| Receivables | 7,00,000 |
| Plant and Machinery | 8,00,000 |
| Patients | 7,00,000 |
| Licence | 10,00,000 |
| Long term debts | 15,00,000 |
| Current liabilities | 5,00,000 |
Net Assets Value is calculated using the formula given below:
Net Assets Value = Total Assets – Total External Liabilities
- Net Assets Value = $60,00,000 – $20,00,000
- Net Assets Value = $40,00,00
Whereas purchase consideration was $35,00,0000.
Therefore, difference of $5,00,000 will be recorded as negative goodwill.
Accounting for Negative Goodwill
Different accounting GAAPs provide different treatments of bargain purchase value i.e. negative goodwill value. Under some GAAPs, the difference of net assets acquired and purchase price is allocated to toe cost of fixed assets(long term assets) except some assets. The value remaining after such allocation is been transferred to profit and loss A/c as an extraordinary gain. However, some GAAPs, directly recognize this difference in P&L A/c while other may recognize it as a capital gain which will be added to the capital reserve balance.
According to IFRS and US GAAP, negative goodwill must be considered and accounted for in the acquiring company’s financial statement in the income statement, negative goodwill is recognized as ‘gain on acquisition’ in the income statement of the company that has acquired the business or assets. This will be reported under non-cash sources of income.
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Accounting Entry for Assets acquired with Negative goodwill:
| Date | Particulars | Debit($) | Credit($) |
| –/–/– | Fair Value of Net Assets AcquiredDr. | 40,00,000 | |
| To Consideration Paid | 35,00,000 | ||
| To Negative Goodwill | 5,00,000 | ||
| (Being business acquired with negative goodwill recorded) | |||
| –/–/– | Negative Goodwill A/c Dr. | 5,00,000 | |
| To Plant, Property and Equipment, Intangibles A/c | 5,00,000 |
Negative Goodwill in the Balance Sheet
Here we discuss the negative goodwill in the balance sheet:
From the Acquiring Company’s Perspective
As per the prevailing US GAAP accounting guidelines, goodwill is recorded as an asset in the balance sheet of acquiring company whereas negative goodwill does not find place in Balance sheet as it gets reduced from the value of plant, property and equipment, intangible property value acquired. However, in case if after value of PPE and intangibles becomes zero, it gets recognized as an extraordinary gain in income statement.Accordingly, negative goodwill does not find any place balance sheet.
However, in some GAAPs, negative goodwill amount is directly recognized as extraordinary gain. In such case also, it does not gets treated as a Balance sheet item. However in past times, some GAAPs used to provide negative goodwill as an item of balance sheet where it was recognized as an addition to capital reserve. However now it is recognized as gain in P&L A/c in the year of acquisition.
From the Sellers Prospective
A seller sometimes sells his business at lower than its original price due to many circumstances this leads to the creation of negative goodwill in the books of accounts of seller. Usually, goodwill is an asset and is a part of the asset section in the balance sheet but in case of negative goodwill, it gets treated as an liability which will be reduced from the value of assets transferred. Negative goodwill can also be shown in the balance sheet as a negative amount in asset side of the balance sheet from sellers point. While for a buyer it is the gain arising from the purchase of an asset which must be recorded in the income statement and must be transferred to profit.
Advantages
Some of the advantages are:
- Negative goodwill is advantageous for a buyer as it allows them to buy net assets of a business at a price that is lower than the market rate.
- It helps in cost savings as negative goodwill represents the discount availed in acquiring a running/ distressed business while the acquisition of business will also generate synergy to acquiring company.
Conclusion
Negative goodwill occurs when a firm is acquired at a bargained price usually when the owner of the company is in dire need of cash and thus is willing to sell its assets at the readily available value being offered irrespective of its original fair value in the market. Negative goodwill remains fruitful for the buyer and is recorded in the income statement of the buyer.
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