Question

Harding Financial Services Company holds a large portfolio of debt and stock securities

f debt and stock securities Ethics Case BYP12-7 Harding Financial Services Company holds a large portfolio of debt and stock se as an investment. The total fair value of the portfolio at December 31, 2015, is greater cost. Some securities have increased in value and others have decreased. Ann Bales the vice president, and Kim Reeble, the controller, are in the process of classifying for the first securities in the portfolio. Bales suggests classifying the securities that have increased in value as trading securi order to increase net income for the year. She wants to classify the securities that have decreased in value as long-term available-for-sale securities, so that the decreases in value will not affect 2015 net income. Reeble disagrees. She recommends classifying the securities that have decreased in value as trading securities and those that have increased in value as long-term available-for-sale securities. Reeble argues that the company is having a good earnings year and that recognizing the losses now will help to smooth income for this year. Moreover, for future years, when the company may not be as profitable, the company will have built-in gains. Instructions (a) Will classifying the securities as Bales and Reeble suggest actually affect earnings as each says it will? (b) Is there anything unethical in what Bales and Reeble propose? Who are the stakehold affected by their proposals? (c) Assume that Bales and Reeble properly classify the portfolio. At year-end, Bales proposes to the securities that will increase 2015 net income, and Reeble proposes to sell the secu will decrease 2015 net income. Is this unethical? proposes to sell the securities that

Answer 1

a) Securities are classified in three categories: Held to maturity Trading securities Available for sale Trading securities are valued at market price and difference is carried to income statement while available for sale securities are also valued at market price but difference is carried in consolidated income so this will not impact net income of the period. Accordingly, Bales suggestion will increase the net income as increase will be carried to income statement and decrease will be carried to consolidated income. Accordingly Reeble suggestion will decrease the net income as decrease will be carried to income statement and increase will be carried to consolidated income.

b) Yes, the actions suggested by both employees are unethical. Stakeholders will be affected mainly by the shareholders. Alongwith that other interested parties like banks, government agencies, analysts, employees , suppliers ,creditors , debtors etc will get affected by such a decision.

c) The decision to sell, should be based on the fact whether the decision is leading to maximization of shareholder wealth, if the security which is correctly priced, leads to addition to net income , management may consider to sell it . Also, if management believes that particular security is better off being sold, as they expect further price decline, they must base their decision on such factors.The motivation to show higher /lower net income should not bias the decision to sell securities.