Badwill

What Is Badwill?

Badwill, also known as negative goodwill, occurs when a company purchases an asset or another company at less than its net fair market value. This usually happens when the outlook for the company being acquired is particularly bleak.

Understanding Badwill

When one company acquires another company at a value that is greater than the market value of the target company's assets and liabilities, it records the excess amount on its balance sheet as "goodwill."

Companies with strong brands, for example, are often acquired at a price above the market value of their assets and liabilities because their value as a company lies partly in their brand name and other intangibles that make them attractive to customers. The value in excess of the fair market value is goodwill, which is an intangible asset.

Companies may also be acquired at a price that is less than their fair market value. Often this occurs when a company is in financial distress. In this case, the acquiring company records on its balance sheet the difference between the fair market value of the company and the price paid as negative goodwill, also known as badwill, which is also an intangible asset.

Badwill can also refer to the negative effect felt by a company when investors discover it has done something that is not in accordance with good business practices. Although typically not expressed in a dollar amount, badwill can result in a loss of revenue, clients, suppliers, and market share and may even prompt legal action.

Accounting for Badwill

The accounting treatment for badwill is regulated under the Financial Accounting Standards Board's Statement No. 141 (SFAS 141) Business Combination. SFAS 141 defines badwill as the difference between the fair market value of an asset and the price paid to acquire it, when the price paid is lower than the fair market value.

On the financial statements of the acquirer, the value of badwill is booked to reduce the cost of noncurrent assets that have been acquired to zero. Once noncurrent assets have been reduced to zero by the badwill amount, any remaining badwill is marked as an extraordinary gain on the income statement.

Outside of the United States, badwill is recognized under International Financial Reporting Standards (IFRS) 3. IFRS 3 treats the accounting for badwill as the same as SFAS 141.

Example of Badwill

Company ABC acquires Company DEF for a purchase price of $700 million. At the time of the purchase, the fair market value of Company DEF is $900 million. Company ABC was able to purchase Company DEF for a bargain purchase as the purchase price was below the fair market value.

The difference in the price paid and the fair market value is the badwill, which is $200 million. Fifty million dollars of the badwill is used to reduce noncurrent assets to zero, and the remaining balance of $150 million is marked as a credit as an extraordinary gain.