What Is a Bargain Purchase?
A bargain purchase involves assets acquired for less than fair market value. In a bargain purchase business combination, a corporate entity is acquired by another for an amount that is less than the fair market value of its net assets. Current accounting rules for business combinations require the acquirer to record the difference between the fair value of the acquired net assets and the purchase price as a gain on its income statement due to negative goodwill.
- Bargain purchases involve buying assets for less than fair market value.
- An acquirer must record the difference between the purchase price and fair value as a gain on the balance sheet as negative goodwill.
- The difference in the price paid and fair value is recorded as a gain.
How a Bargain Purchase Works
In the aftermath of the 2008 market crash, the enormous number of financial companies that were trading at huge discounts to their book value presented an unprecedented opportunity for bargain purchases. Firms that were able to take advantage of these distressed priced companies and assets were able to add to their asset base at relatively little cost.
Bargain purchases often happen when a liquidity crunch is taking place. That is, businesses and assets are sold for less than the fair market value during a liquidity crunch. Generally, during a liquidity crunch, these things need to be sold quickly, hence they must be offered for a discounted price.
When accounting for a bargain purchase, the assets and liabilities of the potential business being acquired are recorded at fair value. Then all assets and liabilities are analyzed to ensure they have been properly accounted for. The fair value of the asset or item being purchased is recorded. The difference between the fair value and what’s paid is recorded as a gain.
For example, if company ABC has to sell its business to pay taxes, they may agree to a below fair market value price. They agree to sell a 50% interest in the company for $250,000. After calculating the fair value of its assets and liabilities, it’s found that the fair value of its net assets to be $700,000, or $1 million in assets less $300,000 in liabilities. The fair value of half the business is $350,000, well above the $250,000 the company offered. Thus, the acquiring company would record a $100,000 gain ($350,000 fair value less $250,000 price paid).
Examples of a Bargain Purchase
Perhaps the most famous of these bargain purchases during that tumultuous period was Barclay's acquisition of Lehman Brothers (more specifically, its North American investment banking operations) in September 2008, which resulted in delivering approximately GBP 2.26 billion in negative goodwill to Barclays' books.
Another deal that emerged from the financial crisis to illustrate a bargain purchase: The takeover of HBOS plc (the holding company of Bank of Scotland plc) by Lloyds TSB in 2009 for far less than the value of net assets produced negative goodwill in the amount of approximately GBP 11 billion that was added to Lloyd's capital base and its net income that year.