In module four, we will discuss the assets acquired and liabilities assumed in the business combination. So, in lesson one, let's start with the identifiable assets acquired. In a business combination, identifiable assets acquired and liabilities assumed are recognized at the requisition date fair value. But, what does it mean identifiable? All the tangible assets such as properties, machines, inventories are obviously identifiable assets. But, what about the intangible assets? An intangible assets is identifiable if it meets either the Separability criterion, or the Contractual-legal criteria. An asset is separable if it is capable of being separated or divided from the entity, and sold, transferred, licensed, rented, or exchanged either individually or together with a related contract. An example of an intangible asset that meets this separability criterion is the customer list. Customer lists is an intangible assets that includes different information about customers. It is frequently licensed and thus meets this Separability criteria. An example of an intangible asset that meets the Contractual-legal criterion is the copyright for a book. These assets arise from contractual or legal rights. Please note, a copyright for a book also meets the separability criteria, since it can be sold or licensed separately. However, the separability criterion is not a necessary condition for an asset to meet the Contractual-legal criteria. Let's see the following example. Company S owns and operates a nuclear power plant. The license to operate that power plant was granted five years ago for a period of 25 years. When Company P requires Company S, the license to operate the power plant is recognized as an intangible assets, separately from goodwill, since it meets the Contractual-legal criterion. This is the case even if Company P cannot sell or transfer the license separately from the acquired power plant. The following are the common example of different identifiable intangible assets. Let's start. Marketing-related intangible assets, such as trademarks and trade names. Customer-related intangible assets, such as customer lists and customer contracts. Artistic-related intangible assets, such as copyright for films and books. Contract-based intangible assets, such as construction permits, and franchise agreements. Technology-based intangible assets, such as patented technology and computer software. In module three, we discussed a real life business combination in which Express Scripts Company acquired 100 percentages of Medco Company for $30 billion and $154 million dollars. These transaction happened on April 2, 2012. The following is an example from the 2012 annual wrap-up, the 10-K document of Express Scripts company. We can see the purchase price allocation. The fair value of the assets acquired and liabilities assumed on the acquisition of Medco Company. Obviously, we do not know the carrying amount of the assets and liabilities reported by Medco on the business combination date, Since Medco company did not report the financial statements on April 2, 2012. Thus Medco's 2011 annual wrap-up, the 10-K document, can provide us with the best estimate of the book values of assets and liabilities of Medco Company on the business combination date. We can see that Medco reported net assets, assets minus the liabilities, of approximately four billion dollars. As we can see, based on this example, the major differences between the book values of assets and liabilities reported by the subsidiary–Medco Company– and the amount that which they are are recognized on the acquisition date, the acquisition date fair value are attributable to, first of all, goodwill of approximately $17 billion. Also, intangible assets other than goodwill: Approximately $14 billion, and therefore tax liability of approximately five billion dollars. These are the common differences in many of the business combinations and we will discuss them in depths in this course. Goodwill is an intangible asset that represents the future economic benefits arising from other assets acquired in a business combinations that are not individually identified and separately recognized. We know that based on the goodwill equation, goodwill is basically the difference between the fair value of the consideration transfer, and the fair value of identifiable net assets acquired. So, goodwill represents all the synergies expected from combining the operations of the two businesses. We know that goodwill is an intangible assets with indefinite useful life. Thus, goodwill is not amortized. Instead, goodwill must be tested for impairment at least annually. Let's discuss private companies accounting for goodwill. Private companies may lack an accounting alternative in the respect to accounting for goodwill. Under the accounting alternative, goodwill must be amortized on a straight-line basis over a 10 years period. Or it can even be amortized over a period shorter than 10 years if the private company can demonstrate that another useful life is more appropriate. In addition, under the accounting alternative, the impairment tests for goodwill is simpler than under regular FASB guidance. Goodwill impairment tests will be discussed later in the course. In our example, we can see that on Medco's books a goodwill of approximately seven billion dollar was reported. However, the goodwill recognized on the acquisition date was approximately $24 billion. The question is why? Why do we have such a big difference? The goodwill reported on the subsidiaries books is not an identifiable assets in the current business combination. The goodwill recorded on the subsidiaries books, the old goodwill was recognized in the previous periods by the subsidiary on the acquisition of other businesses. It represents the synergies and other economic benefits that the subsidiary expected when it acquired the other businesses in the prior periods. It is irrelevant to the current business combination. We should assign the fair value of zero to the old goodwill and a new goodwill should be calculated. As was previously discussed in module two, goodwill is calculated using the goodwill equation as follows. Fair value of the consideration transfer plus fair value of any non-controlling interests, plus fair value of any previously held equity interests in the subsidiary, minus the fair value of identifiable net assets acquired. A positive outcome of this equation is a goodwill.
