In Module 2, we discussed how to prepare the consolidated balance sheet on a business combination data. Now, in Module 5, we will discuss how to prepare the consolidated financial statements subsequent to the acquisition date. The lesson number 1 will be about accounting acquisition premium. The difference between the fair value of the consideration transferred within a business combination, and the book value of net assets acquired is called accounting acquisition premium. We will call it in this course just AAP. So, fair value of consideration transferred minus the book value of net assets acquired, the difference is the accounting acquisition premium. What are the reasons for this difference? Can we identify the reasons for the accounting acquisition premium? As was previously discussed in Module 4, on the business combination data, the fair values of assets and liabilities of the subsidiary may differ from their book values on the subsidiaries books. The difference between the fair value of assets and liabilities acquired and their book value is the identifiable portion of AAP. The remaining amount of the AAP that was not identified– the unidentifiable portion of AAP–is the goodwill. So, fair value of the consideration transferred minus the book value of net assets acquired is the total amount of AAP. This total amount of AAP is allocated between the identifiable portion of AAP, and the unidentifiable portion of the AAP which is the goodwill. So, let's see the following example. On January 1, 2018, company P paid $100 thousand for all of the outstanding shares of common stock of Company S. Assume that on the acquisition date, Company S had reported equity was $75 thousand. The book values of all the assets and liabilities of Company S equal their fair values except for the following. So, we have the difference between the fair values and the book values only for the following three items: Equipment fair value of $50 thousand, the book value on the subsidiaries books $55 thousand, land fair value $40 thousand and the book value was $20 thousand, and accounts payable– a liability–with a fair value of $15 thousand and a book value of $11 thousand. First of all, let's calculate the total AAP. The total AAP is calculated as fair value of the consideration transferred of $100 thousand minus the book value of identifiable net assets acquired of $75 thousand. So, the total AAP is $25 thousand. Since assets equal liabilities plus equity, the book value of net assets which is assets minus liability is exactly the equity of the company. After we calculated the total AAP, we can calculate the identifiable portion of the AAP. The identifiable AAP. The identifiable AAP is calculated as the difference between the fair values and the book values of all the identifiable assets acquired and liabilities assumed. So, let's start with equipment. The fair value of the equipment was $50 thousand. The book value was $55 thousand. So, we have a negative AAP for an equivalent of $5 thousand. Then land, the fair value was $40 thousand. The book value was $20 thousand. We have a positive AAP of $20 thousand for the land. Now, accounts payable. Please note, when I calculate identifiable AAP for liabilities, they must be included as negative amount in this calculation. So, the fair value of the liability is negative $15 thousand, the book value is negative $11 thousand, and the difference is a negative difference of $4 thousand. All in all, we got the total identifiable positive AAP of $11 thousand. After we calculate the identifiable portion of the AAP, we can calculate the remaining– the unidentifiable–AAP. Since the total AAP was $25 thousand, and the identifiable portion of the AAP is $11 thousand, the difference is the unidentifiable AAP of $14 thousand which is the goodwill. Also just to be on the safe side, you always can calculate the goodwill using the goodwill equation. So, let's use the goodwill equation to calculate goodwill. Fair value of consideration transferred of $100 thousand minus the fair value of identifiable net assets acquired. In this specific situation, we know that the book value of net assets was $75 thousand. I also know that $11 thousand is the excess of fair value over the book values. Plus $11 thousand excess of fair value of assets over the book value. We will get $86 thousand. So, one more time we calculated the goodwill as $14 thousand.
