Natural Resource Assets
Response to the following problem:
You have been engaged to examine the financial statements of Brahe Corporation for the year ending December 31, 2010. Brahe Corporation was organized in January 2010 by Messrs. Moses and Price, original owners of options to acquire oil leases on 5,000 acres of land for $350,000. They expected that first the oil leases would be acquired by the corporation and subsequently 180,000 shares of the corporation's common stock would be sold to the public at $6 per share. In February 2010, they exchanged their options, $150,000 cash, and $50,000 of other assets for 75,000 shares of common stock of the corporation. The corporation's board of directors appraised the leases at $600,000, basing its appraisal on the price of other acreage recently leased in the same area. The options were therefore recorded at $250,000 ($600,000 $350,000 option price).
The options were exercised by the corporation in March 2010, prior to the sale of common stock to the public in April 2010. Leases on approximately 500 acres of land were abandoned as worthless during the year.
Required
1. Explain why the valuation of assets acquired by a corporation in exchange for its own common stock is sometimes difficult.
2. a. Explain the reasoning Brahe Corporation might use to support valuing the leases at $600,000, the amount of the appraisal by the board of directors.
b. Assuming the board's appraisal was sincere, what steps might Brahe Corporation have taken to strengthen its position to use the $600,000 value and to provide additional information if questions were raised about possible overvaluation of the leases?
3. Discuss the propriety of charging one-tenth of the recorded value of the leases against income at December 31, 2010 because leases on 500 acres of land were abandoned during the year.