Badwill

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What is Badwill?

Badwill, also known as Negative Goodwill, is referred to in the case of mergers and acquisition transactions when a company purchases a target company for a price less than its fair market value. Companies selling below fair value or book value include financial distress, huge debt, hostile takeovers, uninformed sellers, or no potential acquirer.

What is Badwill?

Badwill, often referred to as Negative Goodwill, arises when a company is acquired at a price below its fair market or book value. This situation commonly arises due to financial challenges or as a necessary step in an acquisition process.
The accounting treatment for Badwill in the United States follows the guidelines outlined in Statement of Financial Accounting Standards (SFAS) 141 Business Combination.
Negative Goodwill or Badwill is addressed under the framework of International Financial Reporting Standards (IFRS) 3 and Accounting Standards Codification (ASC) 805.

Explanation

When an acquirer company buys a target company and pays a higher consideration value than its fair market value, the difference is Goodwill. An acquirer pays the price over its market value because of the target company’s intangible assets such as brand value and customer distribution network. However, sometimes companies acquire distressed companies where the fair value of all the assets is more than the consideration paid to acquire those assets.

Causes of Badwill

There are several reasons companies sell their assets or business for the sale consideration amount that is way less than the fair market value of the assets, such as:

Financial Distress: If a company is in distress and reporting losses in past years consistently or has negative Free Cash Flows consistently in the past years, the chances are the company's valuation may fall below the market value of its assets.
Huge Debt: If there is a significant level of leverage in a company with no consistent positive cash flows to meet the financial obligations, it can lead to the sale of the entity's assets for a lower value than its market price.
No Potential Acquirer: If a company wants to sell its business or a division but faces difficulties finding the buyer, this may cause the target company to accept the lower sale consideration.
Hostile Takeovers: Hostile takeovers refer to the acquisition of the target company by the acquirer without the consent of its Board of Directors. These takeovers occur in a forced way, either by filing a lawsuit, making a tender offer to the target company's shareholders, or gaining ownership in the open market. Hostile takeovers are the opposite of friendly takeovers wherein both the acquirer and seller mutually agree to the acquisition of the business, thus, sometimes closing the deal with low sale consideration value resulting in the bad will.
Uninformed Seller: Sometimes, the seller isn’t aware of the potential growth and market value of its business and accepts the lower valuation of its business due to the lack of awareness.

Accounting Treatment of Badwill

In the United States, The Statement of Financial Accounting Standards (SFAS) 141 Business Combination is applied for the accounting treatment of the Badwill.

According to the SFAS 141,

If the fair value of the assets acquired is more than the consideration price paid for the acquisition of the assets, the resulting difference is termed Negative Goodwill.
In the books of accounts of the acquirer, the value of Negative Goodwill is allocated to reduce the cost of non-current assets acquired to zero.
After reducing the cost of non-current assets to zero, the remaining value of badwill is recognized as an Extra-Ordinary Gain in Income Statement.

Many countries recognize the Negative Goodwill or Badwill according to the International Financial Reporting Standard (IFRS) 3 and Accounting Standard Codification (ASC) 805, which contains the guidance note for recognizing Negative goodwill. The accounting treatment is the same as stated above for IFRS 3 as it combines the contents of SFAS, SEC regulations, and FASB positions.

Journal Entries of Badwill

The acquiring company can recognize the negative goodwill as “Extraordinary gain” or “Bargain Purchase Gain” by following Journal Entry:

Journal

Date	Particulars	Debit	Credit
XXX	Value of all the Assets Acquired	$0.00
	To Bank		$0.00
	To Extraordinary Gain on Bargain Purchase		$0.00

(Brief narration of the transaction)

Example

Let us say ABC Inc. acquired the entire business of XYZ Inc. for a consideration value of US $ 500 million. On the date of acquisition, the fair market value of XYZ Inc.'s net assets (including Property, plants, and Equipment and other current assets minus non-current liabilities and current liabilities) was US $ 650 million.

As the fair market value of the net assets of XYZ Inc. is more than the consideration value paid by ABC Inc., the transaction can be termed as Bargain Purchase with the Badwill amounting to US $ 150 million. (US $ 500 million minus the US $ 650 million)

ABC Inc. can recognize the value of negative goodwill of US $ 150 by recording the following journal entry:

Journal

Date	Particulars	Debit	Credit
XXX	Net-Assets Acquired	$650.00
	To Bank		$500.00
	To Extraordinary Gain on Bargain Purchase		$150.00

(ABC Inc. acquired XYZ Inc.)

Conclusion

Badwill occurs when the acquiring company acquires the net assets of the target company for a considerable price that is lower than the fair value of the company's assets. These transactions occur when the target company is in financial distress or has a significant debt with no positive, consistent cash flows to meet the financial obligation or through a hostile takeover.

Frequently Asked Questions (FAQs)

1. How does badwill impact financial statements?

Badwill, also known as negative goodwill, arises when an acquiring company purchases another company for less than its net assets' fair value. It is recorded as a gain on the acquiring company's financial statements, potentially boosting net income. This can distort the financial health perception and needs careful consideration to avoid misinterpretation of the company's true performance.

2. How does badwill affect stock price?

Badwill, or negative goodwill, can initially boost a company's stock price due to its recognition as a gain on financial statements, potentially enhancing reported earnings and creating positive investor sentiment. However, factors like the acquired company's performance, integration success, and investor perception influence the long-term impact on the stock price. While badwill's immediate effect on stock price can be positive, its significance over time hinges on broader market dynamics and the company's ability to translate the acquisition into sustained value.

3. What is the difference between badwill and goodwill?

Badwill and goodwill represent opposite concepts. Goodwill is a company's positive intangible value due to factors like brand recognition and customer loyalty, potentially boosting a company's value. Badwill, however, reflects the potential gain realized when acquiring a company at a bargain price, leading to immediate financial benefits but potentially raising questions about the deal's terms and future prospects.