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Definition of Negative Goodwill

Negative goodwill can be defined as a term used in a case where one company purchases or acquires another company(usually a bankrupt or a distressed company that is in immediate need of cash) at a price valuation that is lower than the fair market value of a business and can be mathematically referred to as the difference in between sum value of money paid for acquisition reduced by the fair market value of acquired company’s net assets.

Explanation

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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 urgently needed cash, and the only company willing to buy the assets of Johny International was Adam’s Mark. Johny International was already in debt, and no other entity was willing to pay much for the company except Adam’s mark. In this case, the 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 marks 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

License 10,00,000

Long term debts 15,00,000

Current liabilities 5,00,000

Net Assets Value calculates 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

Therefore, a difference of $5,00,000 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 between net assets acquired and the purchase price is allocated to the cost of fixed assets(long-term assets) except for some. The value remaining after such allocation actively transfers to the profit and loss account as an extraordinary gain. However, some GAAPs, directly recognize this difference in P&L A/c, while others may recognize it as a capital gain that 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 recognizes as ‘gain on acquisition’ in the company’s income statement that has acquired the business or assets. This report is under non-cash sources of income.

Accounting Entry for Assets Acquired with Negative Goodwill:

Date Particulars Debit($) Credit($)

–/–/– Fair Value of Net Assets Acquired Dr. 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 From the Acquiring Company’s Perspective

As per the prevailing US GAAP accounting guidelines, goodwill is recorded as an asset in the acquiring company’s balance sheet, whereas negative goodwill does not find a place in the Balance sheet as it gets reduced from the value of plant, property, and equipment, intangible property value acquired. However, after the value of PPE and intangibles becomes zero, it gets recognized as an extraordinary gain in the income statement. Accordingly, negative goodwill does not find any place balance sheet.

However, in some GAAPs, negative goodwill is directly recognized as an extraordinary gain. In such cases, it is not treated as a Balance sheet item. However, in past times, some GAAPs provided negative goodwill as an item of the balance sheet, which it recognizes as an addition to capital reserve. However, now it is recognized as a gain in P&L A/c in the year of acquisition.

From the seller’s Prospective Advantages

It helps in cost savings as negative goodwill represents the discount availed in acquiring a running/ distressed business. At the same time, acquiring the business will also generate synergy for acquiring the company.

Conclusion

Negative goodwill occurs when a firm is acquired at a bargained price, usually when the company’s owner 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. The buyer actively benefits from negative goodwill, and it records in the income statement of the buyer.