Adapted from SEC 33-9881.pdf. You are not required to use any outside information for this analysis.If you do, you must cite it fully and completely.Miller Energy is an oil and gaz company headquatered in Knoxville, Tennessee. In the fall of 2009, Miller Energy bid on and then purchased oil and gas properties in Alaska that werein the process of being “abandoned” as part of the bankruptcy proceedings of a California- based energy company.Miller Energy exchanged $ 2.25 million in cash- along with the assumption of certain liabilities it valued at approximately $ 2 million.Accounting Standards Codification (“ASC”), Business, 805, Business Combinations, required Miller Energy to record the value of its acquired Alaska assets at ” fair value.”Miller reported a value of $ 480 million for the Alaska acquisition ($380 for oil and gas reserves and $110 for fixed assets).This was based on a reserve report The petroleum engineer firm did not know Miller Energy intended to use the report for fair value purposes and believed that the purpose of the report was for use as supplemental data in the company’s SEC disclosures.There were numerous, readily apparent data points strongly indicating that the assets were worth substantially less than $ 480 million (including inaccurare and understand cost data provided to the engineer, lack of testing of assumptions, inconsistency with insurance report?)Miller Energy”bargain purchase gain,” was $277 million after tax, which boosted net income for the quarter to $272 million-an enormous increase over the $ 556097 loss reported for the same period the year before.The bargain purchase gain was included in oil and gas revenues on the income statement.The newly-booked value of the Alaska acquisition, result in a nearly 5,000% increase in Miller Energy’s total assets and significantly affected Miller Energy’s stock price.You are called to testing for shareholders of Miller Energy that were defrauded.Provide a one -page memo describing in you own words some of the violations Miller has committed with examples.Try to use specific accounting rules, concepts and principles.You (as a student in this class) are not expected to fully understand the intricacies of the fraud.Instead, describing the principles of accounting and how they were misapplied in this case.
Miller Energy failed to account for the acquisition in accordance with generally accepted accounting principles (“GAAP”). Accounting Standards Codification (“ASC”) 805, Business Combinations, required Miller Energy to record the value of its acquired Alaska assets at “fair value.” However, contrary to authoritative accounting guidance, company used as fair value a reserve report that was prepared by a petroleum engineer firm using the rules for supplemental oil and gas disclosures. As set forth in GAAP, the numbers used in these supplemental disclosures do not reflect fair value, and the reserve report used by company expressly disclaimed that the numbers therein represented the engineer firm’s opinion of fair value.
Reserve reports are commonly used in the oil and gas industry to estimate quantities of oil and gas (the reserves) expected to be recovered from existing properties. Generally, these reports list reserves in categories based on a minimum estimated percentage probability of eventual recovery and production, i.e., proved, probable, and possible. Information in reserve reports that are prepared in accordance with Commission regulations is frequently used, for among other purposes, to satisfy supplemental accounting disclosure requirements concerning estimates of future oil and gas production. However, the numbers used in reserve reports for this purpose are expressly not considered “an estimate of fair market value.
ASC 805, Business Combinations – formerly Statement of Financial Accounting Standards (“SFAS”) 141(R) – became effective in December 2008. Among its principal revisions, ASC 805 requires acquisitions that result in a “bargain purchase,” e.g., entities purchased at fire sales prices in non-orderly transactions, to be measured at fair value, with any resulting gain recorded on the income statement.
ASC 820, Fair Value Measurements (formerly SFAS 157), provides the framework for measuring fair value. “Fair value” is defined in ASC 820 as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” A reporting entity must determine an appropriate fair value using one or more of the valuation techniques described in accounting literature.
ASC 820 outlines three broad approaches to measure fair value: the market approach, income approach, and cost approach. Under the market approach, prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities are used to measure fair value. The income approach utilizes valuation techniques to convert future amounts to a single discounted present value amount. Finally, the cost approach is based on the amount that currently would be required to replace the assets in service, i.e., current replacement cost.
ASC 820 emphasizes that fair value is a market-based measurement, not an entity specific measurement, and should be determined based on the assumptions market participants would use in pricing the asset or liability.
ASC 820 emphasizes that when a price for an identical asset or liability is not observable entities should use a “valuation technique that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs” and entities may not ignore assumptions market participants would use.
When computing their estimate of fair value, Miller Energy failed to consider the existence of numerous, readily apparent data points strongly indicating that the assets were worth substantially less than the $480 million value Miller Energy recorded. In failing to do so, Miller Energy, materially overstated the value of the newly acquired Alaska assets.