Prepare responses to the following requirements. When necessary, assume a risk-adjusted discount rate of 12 percent, and a forecasted effective income tax rate of 35 percent for the combined entity (ignore any deferred tax effects).
1. Estimating fair value estimates is not an exact science, as indicated by the difference in opinions between Longhorn's staff and the analyst. Assume you are hired as an external evaluator and use the information provided in the case to provide an unbiased measure of fair value for each of Noles's assets and liabilities acquired by Longhorn as of July 1, 2014.
For each asset and liability, discuss the key judgments relied on to obtain a market-driven fair value estimate and why certain information was relied upon, and other information not, in determining your estimate. Then, prepare a schedule showing the application of the acquisition method of accounting for Longhorn's acquisition of Noles.
2. Using the estimates you developed in Requirement 1, determine the impact of the acquisition on 2014 forecasted earnings per share. Forecast data for both companies are provided in Exhibit 3.
3. What is meant by the phrase ‘‘bargain purchase gain'' under acquisition method accounting? Include citations to U.S. GAAP in your response.
4. Would Jeremy be more or less likely to achieve his bonus compensation if this acquisition results in the recognition of a BPG? Explain.
5. How would relatively low (high) asset fair value estimates and relatively high (low) liability estimates affect the likelihood that a BPG will result in the current period? How could management biases affect the fair value estimates and the amount of any resultant BPG?
6. What concerns might an investor have if a BPG allows Jeremy to receive a bonus?