Reply to two student initial posts, accounting homework help

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ASSIGNMENT:

This case is based on an actual situation.

Stan Sewell paid $50,000 for a franchise that entitled him to market software programs in the countries o the European Union. Sewell intended to sell individual franchises for the major language groups of Western Europe – German, French, English, Spanish, and Italian. Naturally, investors considering buying a franchise from Sewell asked to see the financial statements of his business.

Believing the value of the franchise to be $500,000, Sewell sought to capitalize his own franchise at $500,000. The law firm of St. Charles & LaDue helped Sewell form a corporation chartered to issue 500,000 shares of common stock with par value of $1 per share. Attorneys suggested the following chain of transactions:

  1. Sewell’s cousin, Bob, borrows $500,000 from a bank and purchases the franchise from Sewell.
  2. Sewell pays the corporation $500,000 to acquire all its stock.
  3. The corporation buys the franchise from Cousin Bob.
  4. Cousin Bob repays the $500,000 loan to the bank.

If the final analysis, Cousin Bob is debt-free and out of the picture. Sewell owns all of the corporation’s stock, and the corporation owns the franchise. The corporation’s balance sheet lists a franchise acquired at a cost of $500,000. This balance sheet is Sewell’s most valuable marketing tool.

Requirements

  1. What is unethical about this situation?
  2. Who can be harmed? How can they be harmed? What role does accounting play?

STUDENT 1:

Stan Sewell initially bought the franchise at a cost of $50,000 with the intent to sell individual language franchises to several foreign investors. Sewell knew that before he could make the sells to the investors, they would first want to see his financial statements for the business. Though Sewell bought the franchise at $50,000, he believed its value to be $500,000. So, before doing any real business to raise the value of the franchise on his balance sheet, Sewell opted to do some back-door business transactions with his cousin Bob. Bob, taking a loan from the bank, purchases the total of the company’s stock. The corporation then purchased the franchise back from Bob, effectively raising the true value from $50,000 to $500,000. At this point, Bob is able to repay his loan from the bank.

The ethical issue about this situation is that there were no true monetary transactions that occurred. Sewell falsely raised the value of the franchise in order to make it appear more attractive to investors. His goal to deceive the investors through these false transactions and inflated balance sheet is a violation of the GAAP. Investors can be harmed by buying into this corporation without it having ever truly proving its worth as a successful business.

The issuance of stock should be based on what a company’s market value is. Sewell evaluated his franchise at an inflated value $500,000, rather than the actual market value of $50,000. This is where the role of accounting lies. An independent accounting firm should have evaluated the market value of the business prior to the issuance of stock at any value. This would have ensured that honest and fair exchange of money so as not to deceive future investors.

STUDENT 2:

First off stating the obvious is that they have listed the corporation on the balance sheet at 500000.00 when in fact they purchased this for the price of 50000.00. I say this because they use this and state it as Sewells most valuable marketing tool. If he has his cousin Bob purchase the franchise then they could put it on the balance sheet at 500000.00 because that is the new purchase price. Therefore that would increase the value of the franchise.

When I look at this situation this is totally unethical. No money is really changing hands as it is going from his cousin who “purchased”, then to him having all the stock in it, virtually owning it. Then buying it and his cousin writing a check for the 500000.00 thus increasing the value of the franchise. By doing this they are deceiving investors and creditors based on the no money exchange in a sense. When the creditors and investors think that a company is worth 500000.00 they see it as a “success” and are more likely to invest their money in it. However, in this situation the company is really only worth the 50000.00 and was manipulated to look like it is worth much more. In this sense the investors and creditors are the ones who would be hurt because of false sense of the business value.

With accounting the role that assets and how they are valued played a role in this scenario, show that you should value what you pay for the asset not what you want it to be worth in the long run. Doctoring numbers don’t work either.

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