GAAP Accounting Question
Since Assets=Liabilities+Shareholders Equity
What would cause a company to have negative book value(share holders equity)? If a company issues debt, this increases the liabilities side as well as the asset side by the same proportion. So how can negative book value ever be the case?
Could it be that if a company reports negative earnings(net income) for a year this reduces shareholders equity by reducing retained earnings... but shouldn't the balance sheet also drop by the same amount t equalize? Under what scenario can a company have negative book value? I would appreciate any insight. Thank you!!
Asset impairments. You finance the purchase of something, say a whole bunch of subprime mortgage bonds, and their fair value gets marked down. You now have assets worth less than liabilities incurred to obtain them. Book value is now negative. Market equity is a different story.
A leveraged recapitalization would do it too. You borrow a lot of money and pay it out to shareholders as a dividend. You have no more assets than you did, but your liabilities are now larger. Book equity is the plug and thus becomes negative.
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