What is Negative Goodwill
Negative goodwill (NGW) arises on an acquirer's financial statements when the price paid for an acquisition is less than the fair value of its net tangible assets. Negative goodwill implies a bargain purchase and the acquirer immediately records an extraordinary gain on its income statement. For the purchased company, negative goodwill often indicates a distressed sale, whereby unfavorable sale conditions lead to a depressed sale price.
BREAKING DOWN Negative Goodwill
Negative goodwill is based on the accounting concept of goodwill, an intangible asset that represents the worth of a company's brand name, patents and other intellectual property, customer base, licenses, and other items that are difficult to put a dollar figure on but help to make a company valuable. Most of the time, a company will be purchased for more than the value of its net tangible assets, and the difference is attributed to goodwill. When the price paid is less than the actual value of the company's net tangible assets, negative goodwill results. This rarely occurs, and it is typically a sign of a distressed sale in an environment of economic upheaval or sudden industry disruption.
According to Financial Accounting Standards Board (FASB) Statement No. 141 (revised 2007) regarding business combinations, this excess of value over net tangible assets is immediately recorded as an extraordinary gain on the income statement, whereas before implementation of the revision of FASB Statement No. 141, NGW was first allocated (offset) against the fair value of the purchased assets, and then recorded as a gain if there was remaining value after allocation.
Impact on Financial Reporting
NGW can bear an analytical impact on financial reports. An acquisition that involves NGW increases reported assets, income, and shareholder equity, with the effect of distorting performance metrics associated with those items. For example, return on assets (ROA) and return on equity (ROE) would appear lower because NGW increases the value of the acquirer's assets and shareholder equity. Sometimes, the accounting treatment of NGW can have a dramatic impact on financial statements and lead to serious implications.
Example of Negative Goodwill
An illustration: 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 to its net income that year. On paper, this made Lloyd's look much stronger than reality at the time.