You have been hired to examine Brahe Corporation’s financial statements for the year ending December 31, 2016. Brahe was organized in January 2016 by Moses and Price, the 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 2016, they exchanged their options, $ 150,000 cash, and $ 50,000 of other assets for 75,000 shares of common stock of the corporation. Brahe’s board of directors appraised the leases at $ 600,000, basing the appraisal on the price of other acreage recently leased in the same area. The options were therefore recorded at $ 250,000 ($ 600, 0002 $ 350,000 option price).
The options were exercised by the corporation in March 2016, prior to the sale of common stock to the public in April 2016. 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. Explain the reasoning Brahe might use to sup-port valuing the leases at $ 600,000, the amount of the appraisal by the board of directors.
3. Assuming the board’s appraisal was sincere, what steps might Brahe 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?
4. Discuss the propriety of charging 1/ 10 of the recorded value of the leases against income at December 31, 2016, because leases on 500 acres of land were abandoned during the year.