Bargain purchase in an acquisition

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What is a Bargain Purchase in an Acquisition?

A bargain purchase has occurred when an acquirer gains control of an acquiree whose fair value is greater than the consideration paid for it. A bargain purchase transaction most commonly arises when a business must be sold due to a liquidity crisis, where the short-term nature of the sale tends to result in a less-than-optimal sale price from the perspective of the owners of the acquiree.

How to Account for a Bargain Purchase

For the acquirer to account for a bargain purchase, follow these steps:

  1. Record all assets and liabilities at their fair values. This may call for the services of an appraisal service, so that you can develop justifiable valuation paperwork.

  2. Reassess whether all assets and liabilities have been recorded. There might be some acquiree assets that were never recorded, such as intangible assets, which you can now recognize as assets.

  3. Determine and record the fair value of any contingent consideration to be paid to the owners of the acquiree. For example, if the acquiree generates certain additional sales subsequent to the purchase date, this may entitle the prior owners to an additional payment.

  4. Record any remaining difference between these fair values and the consideration paid as a gain in earnings. Record this gain as of the acquisition date.

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Example of a Bargain Purchase

The owners of Failsafe Containment have to rush the sale of the business in order to obtain funds for estate taxes, and so agree to a below-market sale to Armadillo Industries for $5,000,000 in cash of a 75% interest in Failsafe. Armadillo hires a valuation firm to analyze the assets and liabilities of Failsafe, and concludes that the fair value of its net assets is $7,000,000 (of which $8,000,000 is assets and $1,000,000 is liabilities), and the fair value of the 25% of Failsafe still retained by its original owners has a fair value of $1,500,000.

Since the fair value of the net assets of Failsafe exceeds the consideration paid and the fair value of the noncontrolling interest in the company, Armadillo must recognize a gain in earnings, which is calculated as follows:

$7,000,000 Net assets - $5,000,000 Consideration - $1,500,000 Noncontrolling interest

= $500,000 Gain on bargain purchase