Definition
Negative Goodwill on Consolidation refers to a scenario in mergers and acquisitions where the price paid to acquire a company is less than the fair value of its net identifiable assets and liabilities. This situation indicates that the purchaser has made a bargain purchase and, under accounting standards, must recognize it separately on the balance sheet.
Examples
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Example 1: Company A acquires Company B for $1 million. Upon acquisition, the fair value of Company B’s net identifiable assets and liabilities is evaluated and determined to be $1.2 million. In this case, the negative goodwill amounts to $200,000 ($1.2 million - $1 million).
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Example 2: Company X purchases Company Y for $5 million. The fair value of Company Y’s net identifiable assets is $6 million. The resulting negative goodwill is $1 million.
Treatment
According to the Financial Reporting Standard Applicable in the UK and the Republic of Ireland, negative goodwill should be recognized and separately disclosed on the balance sheet immediately below the goodwill heading. It must then be recognized in the profit and loss account over the periods in which the non-monetary assets acquired are depreciated or sold. Any remaining negative goodwill in excess of the values of the non-monetary assets should be written back in the profit and loss account over the expected benefit period.
The relevant International Financial Reporting Standard, IFRS 3: Business Combinations, also provides guidelines for recognizing and handling negative goodwill.
Frequently Asked Questions (FAQs)
What is Negative Goodwill?
Negative goodwill occurs when the acquisition cost of a company is less than the fair value of its net identifiable assets and liabilities, reflecting a bargain purchase that needs to be accounted for according to specific financial reporting standards.
How is Negative Goodwill Treated in Financial Statements?
Negative goodwill is initially recognized and disclosed on the balance sheet below the goodwill heading. Subsequently, it is written off through the profit and loss account over the depreciable periods of the acquired non-monetary assets or immediately recognized if it exceeds the value of such assets.
Why Does Negative Goodwill Arise?
Negative goodwill arises typically due to distressed sales, strategic acquisitions at significantly lower prices, or errors in initial valuation leading to a purchase price substantially lower than the fair value of the assets acquired.
What Standard Governs the Recognition of Negative Goodwill?
The recognition and treatment of negative goodwill are governed by IFRS 3: Business Combinations.
Can Negative Goodwill Be Viewed as a Gain?
Yes, negative goodwill can be viewed as a gain in the acquirer’s financial statements, providing immediate profits or benefits when properly accounted for.
What Impact Does Negative Goodwill Have on Profit and Loss Accounts?
Negative goodwill positively impacts profit and loss accounts by being incrementally written off, leading to possible gains over multiple periods.
Related Terms
- Goodwill: An intangible asset arising when one company acquires another for a purchase price exceeding the fair value of net identifiable assets and liabilities.
- IFRS 3: The International Financial Reporting Standard that guides the accounting for business combinations and includes protocols for handling goodwill.
- Identifiable Assets: Assets that can be separated and sold, transferred, licensed, rented, or exchanged.
- Balance Sheet: A financial statement that lists a company’s assets, liabilities, and shareholders’ equity at a particular point in time.
- Profit and Loss Account: A financial statement summarizing revenues, expenses, and profits over a specific period.
Online References
Suggested Books for Further Studies
- “International Financial Reporting Standards (IFRS) - A Practical Guide” by Hennie van Greuning
- “Business Combinations and International Accounting” by Matthew Tsamenyi
- “IFRS for Dummies” by Steven Collings
- “Introduction to Financial Accounting” by Charles T. Horngren and Gary L. Sundem
Accounting Basics: “Negative Goodwill on Consolidation” Fundamentals Quiz
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