Bargain purchase in the financial definition

What is a bargain purchase?

A bargain purchase is an asset that was purchased for less than fair value. In a bargain price business combination, one entity is acquired by another for an amount less than the fair value of its net assets. The current accounting regulations for business combinations require the acquirer to record the difference between the fair value of the net assets acquired and the purchase price due to negative goodwill in the income statement.

This is how a bargain purchase works

After the 2008 stock market crash, the enormous number of financial companies trading at huge discounts to book value provided an unprecedented bargain buying opportunity. Firms that have benefited from these distressed businesses and assets have been able to grow their asset bases at a relatively low cost.

Bargain buying often happens when a liquidity crisis occurs. That is, companies and assets are sold for less than fair market value during a liquidity crisis. In general, these things need to be sold quickly during a liquidity crisis, so they need to be offered at a discounted price.

Special considerations

When accounting for a bargain purchase, the assets and liabilities of the potential company acquisition are recognized at fair value. All assets and liabilities are then analyzed to ensure that they have been properly accounted for. The fair value of the acquired asset or object is recorded. The difference between the fair value and the amount paid is recognized as profit.

For example, if ABC company has to sell its business to pay tax, it may agree to a price below fair market value. They agree to sell a 50 percent stake in the company for $ 250,000. After calculating the fair value of its assets and liabilities, it was determined that the fair value of its net assets was $ 700,000, or $ 1 million in assets less $ 300,000 in liabilities. The fair value of half of the company is $ 350,000, well above the $ 250,000 the company has been offering. Thus, the acquiring company would post a profit of $ 100,000 ($ 350,000 market value less $ 250,000 price paid).

Examples of a bargain purchase

Perhaps the most famous of those bargain purchases during this tumultuous period was Barclays ‘acquisition of Lehman Brothers (more specifically, the North American investment banking operations) in September 2008, which resulted in approximately £ 2.26 billion in negative goodwill on Barclays’ books.

Another deal that emerged from the financial crisis to illustrate a bargain purchase: Lloyds TSB’s 2009 acquisition of HBOS plc (the holding company of Bank of Scotland plc) for far less than the value of net assets resulted in negative goodwill approximately £ 11 billion added to Lloyd’s capital base and net income this year.