Panelco Company Is a Medium-Sized Company That Produces Wall Paneling

question 61

Essay

Panelco Company is a medium-sized company that produces wall paneling. Panelco is a wholly-owned subsidiary of a holding company called United, Inc. Both Panelco and United are owned by the same individuals as principal shareholders.
Panelco has fallen on hard times due to a downturn in the construction industry in the primary market area the company serves. Sales of the company have declined and net losses have occurred for each of the last three years. The company is in dire need of cash but the owners of the United and Panelco know that additional financing from a bank or other source is unlikely due to the company's weakened financial condition.
The owners of United and Panelco believe that the downturn in construction will eventually reverse and that Panelco will return to profitability when conditions improve. Based on these beliefs, the owners have proposed to the independent auditors a plan whereby the holding company (United) would obtain a loan from a bank and then make an intercompany loan to Panelco. Under this plan, the owners would sell their personal residences to United. Lease agreements between United and the owners would be drafted. These lease agreements would allow the owners to continue to occupy their homes. Title to the homes would pass to United. United would become involved in property management in addition to holding the stock of Panelco. United would have no additional properties other than the personal residences of the owners. The acquisition of additional properties by United is unlikely.
Required:
Assume that you are the partner in the public accounting firm performing the audit of United and Panelco. Prepare your response to the owners of United and Panelco regarding the plan to obtain additional financing. Include references to the Conceptual Framework and underlying assumptions of accounting in your response.