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Definition: Bargain Purchase
A bargain purchase implies financial assets being acquired for less than fair market value. It is also known as negative goodwill, as the asset purchase occurs at less than fair value price. Technically when an acquiring company incorporates an acquire company whose fair value is greater than what is paid for it, the acquirer is said to have had a bargain purchase. A bargain purchase is hence a business combination where a corporate entity is acquired by another for a ‘bargain price’ lesser than fair market value of acquiree’s assets. In such cases the goodwill of the acquired company will be a negative figure, characteristic of a bargain purchase, i.e negative goodwill.
In simple words, a bargain purchase happens when the fair value of net purchased assets exceed the quoted purchase price. In this situation we recognise gain in P&L statements.
A bargain purchase situation can arise during liquidity crisises, distress, for example after the 2008 market crash, many bargain purchase opportunities existed in buying out distressed companies.
Bargain Purchase Example:
1. Company PQR purchases the assets of Company MNO for $50 million. The assets are actually worth $75 million, but PQR gets a bargain deal because MNO needs immediate cash and PQR is the only willinf buyer. The net difference between purchase price and fair market value is $25 million.
PQR records this as a bargain purchase/negative goodwill on its Profit & Loss statement.
2. Person A once sold a car worth Rs 500000 for 390000 because he was moving out. the purchaser B had a bargain purchase of Rs 110000, since he bought the car for less than its fair market value.
Significance & Impact of bargain purchases:
• Bargain purchases gains are recorded as extraordinary gains on the acquirer’s income statement.
• Bargain purchases indicate assets were sold in dire, distressed situations.
• On economy improvement, number of bargain purchases will decline as, market multiples grow & strategic financial buyers return to the markets. But, turbulent industries such as banking and housing will continue to see frequent bargain purchases.
• Bargain Purchases impacts are both from both perspectives of book and tax accounting.
• From a book perspective, gain on bargain purchases creates difference between book and tax values that is recognized on an asset by asset basis.
• From a tax perspective, bargain purchase gains are treated as regular income.
Valuations and Bargain Purchases - Transactions initially appearing as bargain purchase can be due to errors in asset valuation of the target firm. Hence the transaction price must be the best indicator of the fair value for tangible and intangible company assets.
Computing Goodwill and Bargain Purchase under IFRS 3
• To calculate goodwill from bargain purchases, subtract purchase price from the price of net assets acquired. Goodwill can be expressed as follows:
Goodwill = Transferred consideration + Non-controlling interest amount + Fair value of prior equity interests - Net recognized assets
If the difference above is negative, the resulting gain is a bargain purchase in profit or loss. The opposite of goodwill is negative goodwill.
• The initial cost of the goodwill is measured at the date of the acquisition of the subsidiary.
• Negative goodwill is recognised in the consolidated profit and loss statements straight away, & not spread out and amortised.
• Gain from bargain purchases is immediately recognised under profit or loss under IFRS 3.
• Business combinations current accounting rules require the acquirer to record the difference between fair values of acquired net assets and purchase price as a profit in its P&L statement, hence boosting the acquirer's equity.
• Costs of acquisition - The directly attributable acquisition costs(legal, accountancy fees, etc.), cannot be included into the cost of acquisition, as it is for a business combination.
• Unlike other non-current assets, goodwill is not depreciated or amortised. Goodwill usually has an indefinite lifespan, but should be tested for impairment yearly.
• Before accounting for a bargain purchase, the acquirer must reassess and record all of the acquiree’s assets, liabilities and contingent liabilities(& considerations) at fair value, and then negative goodwill may be added to the consolidated profit figure for the period.