ACC 206 Week 1- Ethical Issue 12-1
ACC 206 Week 1- Ethical Issue 12-1 fin571
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Date Created: 11/11/15
Ethical Issue 12-1 Note: 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 of 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: a. Sewell's cousin, Bob, borrows $500,000 from a bank and purchases the franchise from Sewell. b. Sewell pays the corporation $500,000 to acquire all its stock. c. The corporation buys the franchise from Cousin Bob. d. Cousin Bob repays the $500,000 loan to the bank. In the final analysis, Cousin Bob is debt-free and out of the picture. Sewell owns all 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? Ethical Issue 121 Req. 1 If the strategy outlined in the problem has, as its objective, to mislead investors and deliberately overstate the value of the franchise, then that would be unethical. The value of the franchise is key to determining how much it is “capitalized” for, i.e. at what value the asset is recorded on the balance sheet of the corporation. The information suggests that it may be worth more than the $50,000 that it was originally purchased for, but whether it is worth $500,000 appears doubtful. Req. 2 If Sewell’s corporation provides fraudulent financial information, then parties who might invest or loan money to the corporation may be harmed by making a poor decision based on fraudulent data. Accounting rules require that assets of this type be recorded at their “fair value” so the accounting rules would require a realistic and accurate appraisal of the value of the franchise. One of the authors experienced this actual situation in his first job after college.
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