Stan Sewell paid $50,000 for a franchise that entitled him to market software pr

Question

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 saught to capitalize his own frnachisemat 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 list a franchise acquired at a cost of $500,000. This balance sheet lists a franchise acquired at a cost of $500,000. This balance sheet is Sewell's most valuable marketing tool.

1. What is unethical about this situation?

2. Who can be harmed? How can they be harmed? What role does accounting play?

Explanation / Answer

1)The franchise is bought at just 50000 by Stewell but is sold at a much higher price of 500000. The franchise was actually acquired at 50000 but the balance sheet reports the franchise acquired at a cost of $500,000 this is unethical,the Balance sheet should report the franchise acquired at a cost of $500,00 and a gain of 500000-50000=450000 which should be taxed as per regulations. Certainly tax authorities can be harmed and the investors as they do not know about corporations true asset value and the true nature of the income.

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