Bargain purchases in business acquisitions
April 5, 2015
History of accounting standards has had several interactions of rules related to accounting for goodwill. Goodwill is a premium paid for a company over its assets and liabilities. There are situations, however, when a buyer pays less than what the assets and liabilities of the company are worth. This creates a bargain purchase.
When one company buys another come, the rules of business combination are applied. There are steps that should be followed in accounting for business combinations. For example, it is important to determine if there is indeed a business combination (instead of an asset purchase) from the accounting standpoint; what entity represents the buyer (sometimes it may not be as clear as one would imagine); identify assets acquired (including intangible assets that weren’t recorded on the books before the acquisition) and liabilities assumed, etc. One of the last steps in accounting for a business combination is arriving at the amount of goodwill, if any, arising from the transaction.
Goodwill is an intangible asset that is equal to the excess of the purchase price over the net of the fair value of assets acquired and liabilities assumed in a business combination.
Goodwill = Purchase Price – (Assets Acquired – Liabilities Assumed)
The opposite situation may also be true: the purchase price is lower than the net of the fair values of assets acquired and liabilities assumed. This situation results in negative goodwill and is called a bargain purchase.
Bargain Purchase: (Assets Acquired – Liabilities Assumed) > Purchase Price
Bargain purchases are not as common, but they take place. They can happen, for example, when an entity in bankruptcy is selling off parts of its business. The parts being sold may be sold at a deep discount that attracts other companies (inventors). The assets acquired may be worth more than what they are being sold for, creating a bargain purchase.
According to US GAAP, bargain purchase gains are recorded in the income statement as an acquisition-date gain.
US GAAP also indicates that a few more procedures should be performed if there is an indication a transaction will result in a bargain purchase. These procedures are:
a) Perform a completeness review of the identifiable tangible and intangible assets acquired and liabilities assumed to reassess whether all such items have been correctly identified. If there is a bargain purchase, there is a risk that certain assets have not been identified and accounted for.
b) Perform a review of the procedures used to measure all of the assets acquired and liabilities assumed to ensure proper accounting rules were followed (e.g., asset fair values were correctly determined).