BadwillExplained & Defined

Written By:
Lisa Borga

What is Badwill?

Badwill, which is sometimes called negative goodwill, happens when a business buys another business or an asset for less than the net fair market value.

Generally, this occurs if the business being purchased has particularly poor prospects for the future.

Explaining Badwill

If one business purchases another business for an amount that is above the market value of the liabilities and assets of the business being considered, the excess amount the business pays will be recorded as goodwill on the business’s balance sheet.

If a company has a strong brand, it has an increased chance of being purchased for a greater price than the market value of its liabilities and assets due to the value of its brand name as well as any other intangible assets that appeal to its customers.

The amount of value that the company has beyond its fair market value is considered goodwill.

This is classified as an intangible asset.

Sometimes businesses are purchased for an amount that is below fair market value.

This tends to happen to companies with severe financial problems.

When this happens, the company that purchases this company will record the amount they paid below the market value as badwill on its balance sheet.

This is an intangible asset.

Badwill can sometimes mean the negative effect that a company experiences when investors find out that the company did something that did not conform to generally accepted business practices. This is usually not calculated as a dollar amount and recorded.

However, lost revenue, customers, and possibly market share may occur as a result of the badwill.

Additionally, it could result in legal action against the company.

How To Account for Badwill

The Financial Accounting Standards Board regulates the accounting treatment for badwill.

Statement No. 141 covers the accounting for badwill, which it describes as the difference between the price paid to purchase an asset and the asset’s fair market value if the amount paid is below fair market value.

The value of negative goodwill needs to be recorded on the purchaser’s balance sheet so that the cost of the acquired non-current assets can be lowered to zero.

After this is done, if there is any badwill remaining, it should be recorded on the company’s income statement as an extraordinary gain.

When accounting for badwill in countries other than the United States, the International Financial Reporting Standards 3 covers the accounting of negative goodwill in the same way as SFAS 141.

Negative Goodwill Example

Company X acquired Company Y at the cost of $500 million.

When Company X purchased Company Y, Company Y had a fair market value of $600 million.

Company X was able to acquire Company Y for a good price since the cost of the company was less than the fair market value.

The $100 million difference between the price that Company X paid to acquire Company Y and the fair market value of Company Y at the time of the purchase is negative goodwill.

Causes of Badwill

There are a number of reasons why a company may be forced to accept a sales price that is below its fair market value.

These reasons include:

• Financial Difficulties: The valuation of a company will be based in part on its financial performance over a period of time. If a company has performed poorly in recent years or suffered from other financial issues, it is possible that its valuation could drop below the value of the assets on its balance sheet.
• Excessive Debt: If a company has been highly leveraged and does not have consistently high enough revenue to meet these obligations, it may be sold for below its fair market value.
• Difficulty Finding Buyers: If the owners of a company wish to sell the business or a division of it but are unable to find many buyers, they may have to accept a sale price below the fair market value.
• A Hostile Takeover: If the purchaser chooses to perform a hostile takeover, the sale price may fall below the fair market value due to the way in which the sale takes place. In a hostile takeover, the purchaser does not negotiate the sale with the board of directors of the company but instead acquires it in a forced manner. This could be through lawsuits, offers to shareholders, or purchasing of shares on the open market. Any of these mechanisms may result in a purchase price that is below the fair market value.
• Lack of Awareness: In some cases, the owners of a company may be unaware of the actual value of their assets and accept a purchase price that is below the fair market value.

Key Takeaways

• Badwill or negative goodwill, as it is sometimes called, happens if a business buys either another business or an asset for an amount below the net fair market value.
• When businesses are bought for an amount below the fair market value, it is generally because they have serious financial difficulties.
• Badwill is quite different from goodwill which occurs when an asset or business is bought for an amount above its fair market value. This occurs when the price takes into account qualitative factors, such as a positive brand image.
• The Financial Accounting Standards Board’s Statement No. 141 (SFAS 141) regulates the way that badwill is accounted for.
• Goodwill, as well as badwill, are considered intangible assets.