Negative Goodwill (NGW)

Definition

Negative Goodwill (NGW) occurs when a company purchases an asset or a business for less than its fair market value. It generally arises in a distressed sale, where the seller is compelled to sell for financial reasons. This concept is the opposite of goodwill, where a company pays a premium over the fair market value.

Phonetic

Negative Goodwill – /ˈnɛɡətɪv/ /ɡʊdˈwɪl/ (N.G.W)

Key Takeaways

1. Negative Goodwill (NGW): This occurs when the purchase consideration of a company is less than the fair market value of its identifiable assets. This typically happens in distress sales or bankruptcies where assets are sold below their actual value.
2. Recognition and Treatment: Negative Goodwill is recognized on the buyer’s balance sheet when a business is acquired for less than the fair value of its net assets. However, it needs to be carefully evaluated as it may hint at inaccuracies in asset valuation.
3. Impact and Reassessment: The impact of Negative Goodwill on a company’s finances can be major. It boosts the acquirer’s profits in the period the bargain purchase occurred, but it also warrants re-evaluating the fair values assigned to the acquired identifiable assets and liabilities because it might denote an error in the estimation process.

Importance

Negative Goodwill (NGW) is crucial in business and finance because it represents a situation where the price paid for a company in a merger or an acquisition is less than the fair market value of its net tangible assets. This can occur when a company is under financial distress, leading buyers to purchase it below its actual worth, creating a gain for the acquiring company. Recognizing negative goodwill can have significant impacts on a company’s financial statements. Once aware of the NGW, the acquiring company must immediately record it on its income statement as a gain, which will increase its net income. Thus, NGW plays a key role in understanding the financial health and real value of a company, especially after a merger or acquisition.

Explanation

Negative goodwill (NGW), often encountered in the world of mergers and acquisitions, is an unusual financial scenario that arises when the price paid to purchase a company is less than its fair market value. This discrepancy typically occurs during the acquisition of financially distressed companies or when business conditions force the selling company to accept an offer for less than the net value of their assets. The goal of the buying company is to make a strategic purchase, save the distressed company from bankruptcy, or capitalize on the current market conditions. The purpose of NGW is to help balance out the figures in balance sheet transactions after a company acquisition. When a company acquires another at a price that is lower than its fair market value, the difference is booked as negative goodwill and recognized as a gain in the acquiring firm’s income statement, contributing to their net income. This creates instant profit and increases the profitability ratio of the firm. Furthermore, it also contributes to other key performance indicators like return on assets (ROA) and return on equity (ROE). Therefore, negative goodwill is a beneficial factor for the acquirer in financial reporting and performance measurement.

Examples

Negative Goodwill, also known as a “bargain purchase,” occurs when a company purchases another for less than its fair market value. This difference is then recognized as a gain in the buying company’s financial statements. Here are three real-world examples: 1. Hewlett Packard’s acquisition of Palm: In 2010, Hewlett Packard bought struggling phone maker Palm for around $1.2 billion. Shortly after the acquisition, HP wrote off a significant amount of Palm’s carrying value, essentially writing down a large part of what it had paid. This was due to a reassessment of Palm’s fair value, indicating that HP may have paid less than Palm was truly worth, resulting in a potential case of negative goodwill. 2. Wells Fargo acquisition of Wachovia: During the financial crisis in 2008, Wells Fargo purchased Wachovia. The acquisition was made at a time when Wachovia was on the brink of collapse, causing it to be sold for a value lower than its net asset value. Due to this, Wells Fargo experienced negative goodwill where they gained assets at a bargain. 3. Barclays acquisition of Lehman Brothers: In 2008, during the global financial crisis, Barclays purchased the North American division of Lehman Brothers for a value beneath its fair market value. This purchase could be categorised as negative goodwill, as Barclays ended up with assets of greater worth than they initially paid during the acquisition.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Impairment Loss
• Bargain Purchase
• Fair Market Value
• Balance Sheet
• Merger and Acquisition (M&A)

Sources for More Information

• Investopedia
• Corporate Finance Institute
• WallStreetOasis
• WallStreetMojo