Negative Goodwill and Bargain Purchases in Merger Models (16:09)

QUESTION:

“Can you explain what happens in an M&A deal if the Equity Purchase Price is less than the seller’s Common Shareholders’ Equity?”

“Do you get ‘negative’ Goodwill? What is the accounting treatment for this type of bargain purchase?”

SHORT ANSWER:

No, you never create “negative Goodwill” because it cannot exist under either IFRS or U.S. GAAP. Instead, you take the absolute value of the Goodwill created and record it as an Extraordinary Gain on the Income Statement.

You have to put a MAX(0 around the Goodwill calculation to do this. You reverse the Gain on the CFS and reverse the extra taxes the company paid on the Gain. On the Balance Sheet, Cash, Retained Earnings, and the DTL or DTA will be affected by these changes.

Part 1: Why Bargain Purchases?

Bargain purchases are most common for distressed sellers, when the company is running out of Cash, has high Debt and other obligations, and needs to sell or liquidate quickly. A buyer who likes the seller’s intangibles or other aspects of it might come in and offer a better-than-liquidation price that is still less than the seller’s Common Shareholders’ Equity.

In our example here, Starbucks likes Coco Cream Donuts’ brand, customer list, and intellectual property, but doesn’t believe its Tangible Assets are worth all that much, so it allocates 60% of the Equity Purchase Price to those Intangibles.

In the purchase price allocation process, it writes off the seller’s Common Shareholders’ Equity and Goodwill, adjusts its PP&E and Intangibles, and creates a new DTL.

Instead of recording negative $203 million of Goodwill, it records 0 and shows an Extraordinary Gain of $203 million on the combined Income Statement instead.

Part 2: Accounting Confusion, and a Simpler Method

Under the old method, you allocated the negative Goodwill proportionally to the acquired company’s Assets until there was nothing left – and if some amount remained, you recorded that amount as an Extraordinary Gain.

However, you no longer do this under U.S. GAAP or IFRS, and the rules changed a long time ago. You just record the Gain now.

A simpler method for doing this is to simply Credit the Gain to the combined Shareholders’ Equity in the Balance Sheet adjustments – the Balance Sheet will balance immediately after the deal takes place, and the setup is much simpler and easier to explain.

Part 3: Real-Life Example

Back in 2009, Westamerica Bancorporation paid almost nothing for Country Bank, even though its Net Assets were $48 million.

The company recorded a Gain on Acquisition of $48 million on its Income Statement, reversed it on the Cash Flow Statement, and reversed the taxes on this Gain as well.

These types of deals were common in the last financial crisis because there were so many distressed sellers that desperately needed to sell.