Definition
A bargain purchase is a finance term that refers to a transaction where an asset is bought for less than its fair market value. This typically happens when the seller is under pressure to sell quickly or is not aware of the true value of the asset. When reported in financial statements, it can result in a significant one-time gain for the buyer.
Key Takeaways
- A Bargain Purchase occurs in an acquisition when the purchase price of a company is less than its fair market value. This usually happens when the seller is either keen to get rid of the asset or is not aware of its actual worth.
- Bargain Purchase is recognized as a gain in the financial statements of the buyer, increasing their net income, and is typically uncommon due to the efficient market hypothesis which suggests that assets and businesses are appropriately priced most of the time.
- There are strict accounting rules for recognizing a Bargain Purchase. The Financial Accounting Standards Board (FASB) requires careful verification of the fair values calculated, and any gain is recognized only after a thorough review to ensure that all assets acquired and liabilities assumed have been identified and valued.
Importance
In the field of finance, the term “Bargain Purchase” holds significant importance as it refers to a business acquisition that is transacted at a price significantly lower than the fair market value of the acquired assets, minus liabilities.
The transacting parties undergo through such transactions when the seller is desperate to dispose of or quickly liquidate the assets for certain reasons such as bankruptcy, financial distress, etc.
From a buyer’s perspective, this can present a unique, low-risk opportunity to procure valuable assets at a substantially lower cost, providing immediate equity.
On the other hand, from accounting perspective, it can significantly impact Balance Sheets and Profit & Loss statements.
Furthermore, International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) both have specific reporting requirements for these types of transactions.
Explanation
Bargain Purchase is an essential term predominantly used in business acquisitions that primarily reflects the economic benefits gleaned from a purchase transaction. The purpose of a bargain purchase arises when the acquisition of a business or an asset occurs at a cost significantly lower than its fair market value. This usually happens when the market is down, the seller wants to initiate a quick sale, or the assets are undervalued.
In accounting principal, it highlights an exceptional gain for the purchaser instantly at the point of purchase. Bargain purchase plays a crucial role as it can provide a considerable boost to the financial position of the buying entity. With the instant enhancement of assets without a relative increase in liabilities, it positively impacts the company’s balance sheet.
Furthermore, it provides a form of financial cushion for the acquiring entity against potential future losses or write-downs, thereby reducing risk. In some circumstances, it may also result in reduced tax liabilities, thereby providing further financial benefits. Therefore, while bargain purchases may not flow from the normal operations of a business, they can yield significant influential gains and strategic opportunities for the business.
Examples of Bargain Purchase
Acquisition of Bear Stearns by JPMorgan Chase: During the 2008 financial crisis, JPMorgan Chase obtained Bear Stearns at a significantly less price than its market value due to Bear Stearns’ serious involvement in risky securities which resulted in the collapse of the company.
Google’s acquisition of YouTube: In 2006, Google bought YouTube for $
65 billion which was considered high at that time. However, looking at the growth, influence, and profitability of YouTube today, it’s clear that Google made a bargain purchase.
Facebookâs acquisition of Instagram: In 2012, Facebook bought Instagram for $1 billion, a move that was hugely questioned at the time due to Instagram’s lack of profitability. However, Instagram has since grown exponentially in popularity and profitability, making it a clear example of a bargain purchase.
FAQs about Bargain Purchase
What is a Bargain Purchase in Finance?
A bargain purchase happens when a company acquires another for a price significantly below its fair market value. This often occurs when the selling company is under financial distress or in situations when it’s a buyer’s market.
How does a Bargain Purchase affect the acquirer’s financial statements?
When a bargain purchase occurs, the acquirer must recognize the negative goodwill (difference between purchase price and fair value) as gain in their income statement, which increases their earnings for the period.
What are the standards governing a Bargain Purchase?
A bargain purchase is governed by the Financial Accounting Standards Board (FASB) under the business combination accounting rule, ASC 805. This requires the acquirer to disclose a detailed explanation of a bargain purchase transaction.
Can a Bargain Purchase be negative?
No, a bargain purchase cannot be negative. By definition, a bargain purchase refers to acquiring another company at a price under its fair market value.
What are the implications of a Bargain Purchase on tax?
A bargain purchase could impact taxes. The tax situation can be complex and depends on several factors including the jurisdictions involved, the nature of the assets acquired, and others. It is advisable to consult with a tax expert in these cases.
Related Entrepreneurship Terms
- Asset Valuation
- Due Diligence
- Mergers and Acquisitions
- Balance Sheet Analysis
- Goodwill
Sources for More Information
- Investopedia: This source provides definitions of financial terms, including “Bargain Purchase”, along with examples and contextual understanding.
- Corporate Finance Institute: CFI offers a wealth of educational articles and resources on a plethora of finance topics, including Bargain Purchase.
- Accounting Tools: This website has detailed articles on a range of accounting and finance terms. The Bargain Purchase concept is explained comprehensively here.
- The Balance: The Balance provides expertly crafted content on personal finance, investing, and financial terminology. “Bargain Purchase” is among the topics they cover.
