In a business combination, what happens when the acquisition cost is less than the fair value of net assets acquired?

• A. The excess is recorded as goodwill
• B. The acquisition cost creates a gain recorded in financial statements
• C. The cost is typically disregarded and only net assets are recorded
• D. The acquisition is deemed invalid

Answer: (B)

In a business combination, when the acquisition cost is less than the fair value of the net assets acquired, this scenario results in a bargain purchase. Under accounting standards, specifically ASC 805, this excess of fair value over the acquisition cost is recognized as a gain in the financial statements.

This gain represents the economic benefit derived from acquiring the net assets at a price lower than their fair value, and it is classified as a one-time gain and recognized in the income statement in the period of the acquisition. This is consistent with the underlying principle that transactions should reflect economic realities and that any gain or loss should be recognized immediately when it is realizable.

Thus, the correct option illustrates the treatment of that excess—not as goodwill, as goodwill arises when the acquisition cost exceeds the fair value of net assets, nor is it disregarded, as it has to be accounted for in the financial statements. The acquisition is also valid and does not affect the legality of the transaction.