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 sec the financial statements of his business.
Believing the value of the franchise to be greater than $50,000, 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. A third party borrows $500,000 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 the third party, who repays the loan.
In the final analysis, the third party is debt-free and out of the picture. Sewell owns all the corporations 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?
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