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:
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- Sewell’s cousin, Bob, borrows $500,000 from a bank and purchases the franchise from Sewell.
- Sewell pays the corporation $500,000 to acquire all its stock.
- The corporation buys the franchise from Cousin Bob.
- 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.
- What is unethical about this situation?
- Who can be harmed? How can they be harmed? What role does accounting play?