:quality(80))
In the case of a business acquisition, goodwill is generally recognized on the balance sheet, since a prudent businessperson would not, under normal circumstances, sell their net assets at a value below market value. In this regard, it is hardly surprising that even the internationally oriented accounting framework of the International Financial Reporting Standards (IFRS) lacks specific normative guidelines for cases involving negative differences (“badwill”). The International Accounting Standards Board (IASB), which is responsible for IFRS and is headquartered in London, recognizes favorable business acquisitions practically only in the case of forced sales—such as in distressed M&A deals. If negative differences arise, all initial values used in purchase price allocation must be critically scrutinized to rule out recognition and measurement errors. In technical jargon, this analysis is referred to as a reassessment. Any remaining badwill typically constitutes an economic benefit and must therefore, under IFRS, be recognized in the income statement at the time of acquisition. However, this creates an incentive to overstate net assets and thus engage in improper valuation. This can mislead financial statement users, as this recognition of income may give the appearance of an efficient acquisition decision. Furthermore, there is a risk that the earnings position will be presented in a manner inconsistent with economic reality. This is particularly true in cases where the negative difference is related to future events: If, for example, future losses and adverse developments are expected as a result of a business acquisition, it would be preferable to recognize the negative difference as a liability—which is not permitted under IFRS—and to reverse it upon the occurrence of the expected expenses (analogous to German accounting law). However, it must be noted that the statutory obligation to critically re-examine all valuation methods, combined with the extensive disclosure requirements in the notes to the financial statements, is intended to uncover non-compliant errors and thus prevent them from the outset.
Proactive Safeguards
The causes of negative differences recognized by the IASB are by no means exhaustive. In practice, a wide variety of potential situations involving a favorable business acquisition arise, and not only during times of economic and financial crises. By way of example, one may point to working capital guarantees, which are not uncommon in M&A transactions, in which the purchase price is not subsequently adjusted by the amount by which the working capital determined at the time of acquisition falls below or exceeds a pre-agreed amount. This protects acquirers against any manipulation of cash and debt items by the seller. If the working capital at the time of the transfer of rights and obligations exceeds the previously agreed-upon upper limit, this can, when viewed in isolation, lead to badwill. A thorough analysis of such M&A transactions well in advance is therefore essential.
