The purpose for recording goodwill is that a company may be willing to pay more than another company's value to acquire it. This is because the target company has beneficial qualities that it doesn't record on its financial statements, such as a good reputation with its customers and suppliers. In some acquisitions, the company pays less than another company's value to buy it, effectively establishing a negative value for its goodwill.
Negative goodwill is rare because the target company can usually get a buyer to pay at least market price for its assets. If a transaction appears to involve negative goodwill, the buyer should assess the market value of the target's assets again to ensure that the original valuation is correct.
The accounting standards for negative goodwill altered due to the modification of SFAS 141, Business Combinations, a financial reporting statement the Financial Standards Reporting Board released in 2007. The previous rule was for the buyer to assign negative goodwill to certain categories of the target's assets that are more difficult to value, such as buildings, equipment and real estate, reducing the value that the buyer reports for these assets. The new rule states that the buyer does not apply negative goodwill to any individual assets, so the buyer has to report all of the difference between the target's value and the sale price as a gain.
This change in accounting standards affects the buyer's financial statements after a merger or an acquisition. If the buyer purchases a target for $200 million less than its value, instead of reporting that the target's company headquarters is worth $100 million, even though the target valued it at $300 million, the buyer records the building at the full $300 million value. This means that the buyer lists $200 million more in assets on its balance sheet after completing the transaction.
Negative goodwill appears separately from the operating income that the buyer reports on its financial statement because it is an extraordinary gain that does not occur every year. According to Georgia Tech University, if a company earns $200 million because it sells more of its inventory, this increases its stock price by more than if it reports a $200 million gain based on negative goodwill from an acquisition. The acquirer also does not collect $200 million in cash by recording negative goodwill.
- Georgia Tech University; Changes in Accounting For Negative Goodwill: New Insights into Bargain Purchase Transactions; Eugene E. Comiskey and Charles W. Mulford; April 2011
- Georgia Tech University; Negative Goodwill: Issues of Financial Reporting and Analysis Under Current and Proposed Guidelines; Eugene E. Comiskey and Charles W. Mulford; October 2007
- Financial Accounting Standards Board: Summary of Statement No.141 (Revised 2007)
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