What Is Badwill and How Is It Accounted For?
Learn how a bargain purchase creates badwill, an accounting event where the acquirer recognizes an immediate gain from buying a company below its fair value.
Badwill is an accounting term that arises when a company is acquired for a price below the fair market value of its assets. This situation, formally known as a bargain purchase, is the opposite of a “goodwill” transaction, where the purchase price exceeds the value of the assets. While goodwill represents intangible value like brand reputation, badwill signals that the acquiring company secured a deal at a discount. This unusual occurrence results in a direct financial gain for the buyer.
Identifying a Bargain Purchase
A bargain purchase happens when the selling company is under significant pressure. One of the most common drivers is severe financial distress, where a company must sell to avoid bankruptcy or to satisfy creditors. This urgency can force the seller to accept a price below what the assets are worth. This type of forced transaction is often referred to as a “fire sale.”
A seller might be compelled by a regulatory agency to divest a part of its business, creating a limited timeframe and a smaller pool of potential buyers. A company might be facing a court order that necessitates a quick sale of assets. Significant, unresolved contingencies, such as pending major litigation or environmental liabilities, can also scare off potential buyers and drive down the price.
Calculating Badwill
The calculation of badwill is a direct comparison between the price paid and the value of what was received. The process begins by determining the purchase consideration, which is the total value of cash, stock, and any other assets the acquirer gives to the seller.
Next, the acquirer must determine the fair value of the net identifiable assets acquired. This involves assessing the market value of every individual asset—such as property, equipment, and inventory—and subtracting the fair value of all liabilities assumed, like loans and accounts payable. According to accounting rules, specifically Accounting Standards Codification (ASC) 805, this valuation must be comprehensive and reflect current market conditions.
Badwill exists if the net asset value is greater than the purchase consideration. For example, imagine Company A acquires Company B for $5 million. After a thorough appraisal, Company B’s assets are determined to have a fair value of $10 million, while its liabilities have a fair value of $3 million. The net identifiable assets are therefore $7 million ($10 million – $3 million). The badwill is calculated as $2 million ($7 million in net assets minus the $5 million purchase price).
Accounting Recognition and Reporting
Once a potential bargain purchase is identified, accounting standards require a careful review before any gain can be recorded. The acquiring company must reassess the procedures used to value all the acquired assets and assumed liabilities. This step is to ensure that the bargain is genuine and not the result of measurement errors.
After the reassessment confirms the existence of a bargain purchase, the badwill amount is recognized immediately and in its entirety. Unlike goodwill, which is recorded as an intangible asset on the balance sheet, badwill is reported as a one-time gain on the acquiring company’s income statement. This gain flows directly to the bottom line, increasing the company’s net income for the period in which the acquisition was completed.
The recognition of a gain from a bargain purchase increases reported earnings, which in turn increases metrics like earnings per share (EPS). Investors and analysts watch these figures closely, and such a gain can provide a significant, though non-recurring, boost to the company’s profitability profile for that reporting period.