We previously looked at the 4 steps involved in using the Acquisition Method for Business Combinations. Now, let’s take a look at how to calculate goodwill or bargain purchase in a business combination.
Often a purchaser will pay more to acquire a subsidiary than the fair value of the net assets acquired. The market value of the acquiree is often more than the value of its net assets. Also, an acquirer may see future cost savings by combining the companies, so it’s willing to pay extra.
This difference between the purchase price paid to acquire a subsidiary, and the fair value of the net assets acquired is called purchased goodwill, or just ‘goodwill’. To calculate goodwill, simply subtract the purchase price from the net assets acquired.
Purchased goodwill is an intangible asset, which appears in the consolidated statement of financial position. You might know already that internally generated goodwill cannot appear as an intangible asset in the statement of financial position, so why are we allowed to include purchased goodwill. Well simply, it’s reliably measurable. A purchaser actually paid extra to acquire the assets, which has given us a reliable figure for the goodwill. Internally generated goodwill has no reliable measurement, so it has to be left out.
The initial cost of the goodwill is measured at the date of the acquisition of the subsidiary.
Costs of acquisition
So, purchased goodwill is the difference between the cost of the acquisition of a subsidiary and the fair value of the net assets acquired.
Can we include the directly attributable acquisition costs, like legal and accountants fees when working out the cost of acquisition? No. You can do this for things like plant and equipment measured at cost, but not for business combinations.
You might read in some older textbooks that you can, and it was allowed until 2008 when IFRS 3 was revised. But since IFRS 3 was revised, all costs relating to the acquisition of a subsidiary must be expensed to the P&L in the period of acquisition.
The result of this is that purchased goodwill will exclude these directly attributable costs of acquisition.
Purchased goodwill – impairment
Once the acquisition is complete, the purchased goodwill will sit as an intangible non-current asset in the statement of financial position.
Should we depreciate or amortise purchased goodwill? No. Unlike other non-current assets, goodwill is not depreciated or amortised. There’s no set timeframe where it is used up, goodwill has an indefinite lifespan. Instead it should be tests for impairment annually.
If there’s any evidence of impairment, the value of the goodwill should be written down and expensed in the statement of comprehensive income.
Also remember, that once purchased goodwill is written down, it cannot be reinstated.
Bargain Purchase (aka Negative Goodwill)
If the FV of assets is more than value of business, recognise gain in P&L
Sometimes you might find an acquirer will pay less to acquire an entity that the fair value of its net assets. Why would this happen? Well if the sale of the company is distressed, perhaps the previous owner wants to get rid of it in a hurry and will accept any offer. In these cases the goodwill of the acquired company may be a negative figure, which is what we call a bargain purchase, or negative goodwill.
I once sold a car worth €5,000 for €3,900 because I was moving away. If the car was a business, the purchaser would have a bargain purchase of €1,100, because he just bought a car for less than its market value.
When a bargain purchase takes place, the ‘negative goodwill’ should be recognised in the consolidated profit and loss for the period. It’s recognised straight away, not amortised or spread out. There’ll be no goodwill amount in the consolidated statement of financial position.
Before deciding a bargain purchase has taken place, the acquirer must double check their measurement of the acquirees identifiable assets, liabilities and contingent liabilities. This is because bargain purchases are so rare, they need to be double checked. Once rechecked, the negative goodwill may be added to the consolidated profit figure for the period.
Purchase cost > FV of net assets acquired = Goodwill (asset)
Purchase cost < FV of net assets acquired = Bargain purchase (Recognise immediately in P&L)
Goodwill and mid year acquisition
Most of the time an acquisition will take place at some stage during the financial period, not conveniently at the start or very end of the financial period. This will create some difficulty for the accountants who have to work out the fair value of the assets acquired and liabilities assumed. The subsidiary may have prepared accounts to the year end, so how do we roll this forward to the date of acquisition?
There’s no rigid way of doing this. The way to split it is the “fairest way” which involves your best judgement. Have a look at sales patterns, major acquisitions and disposals of assets by the subsidiary and other events when making your decision