You cant write up assets, said Harry Legge, Internal Audit Director of MNC International Inc., to his boss, Emmit Smith, Vice-President and Chief Financial Officer. Nonsense, said Emmit, I can do this as part of a quasi-reorganization of our company. For the past three years, MNC International, a heavy equipment manufacturing firm, has experienced a downturn in its profits as a result of stiff competition with overseas firms and a slowdown in the North American economy. The company is hoping to turn a profit by modernizing its property, plant and equipment. This will require MNC International to raise a lot of money. Management is very optimistic as to the future of the company and they anticipate the economy will rebound and enters a significant growth period.

Over the past few months, Emmit has tried to raise funds from various financial institutions, but they are unwilling to lend capital. The reason they give is that the companys net book value of fixed assets on the balance sheet, based on historic cost, is not large enough to sustain major funding. Emmit attempted to explain to bankers and investors that these assets are more valuable than their recorded amounts, especially since the company used accelerated amortization methods and tended to underestimate the useful lives of assets. Emmit also believes that the companys land and buildings are substantially undervalued because of rising real estate prices over the past several years.

Emmits proposed solution to raise funds is a simple one: first, declare a large dividend to company shareholders that result in Retained Earnings having a large debit balance. Second, write up the fixed assets of MNC International to an amount that is equal to the deficit in the Retained Earnings account.

Instructions

Assuming you are Harry Legge, acting in the role of the internal auditor, discuss the financial reporting issues. MNC is thinking of going public. Present your discussion in the form of:

1. Overview
2. Analysis
3. Conclusion and recommendation