Question

Tara Enterprises has numerous investments in debt and equity securities. The controller, James Cameron is preparing its year-end financial statements and is in the process of classifying for the first time the securities in the portfolio.

The poor economy in the past year has caused the portfolio's overall fair value to substantially decline; however, some securities have increased in value and others have decreased. Cameron earns a bonus each year, which is computed as a percent of net income.

Cameron presents a schedule classifying the securities for the COO's review. In reviewing the schedule the COO notices that the securities that have increased in value have been classified as trading securities while the securities that have decreased in value are classified as long-term available-for-sale securities.

1. Who might be affected by the suggested classification?
2. Will the suggested classification affect Cameron's bonus? Explain.
3. In your opinion, is the suggested classification ethical? Explain.

Answer 1

a.

Trading shares are those assets which are held in a portfolio of a firm with the purpose of short-term profit selling. The fair value of these securities in the balance sheet is registered. Any change of these securities ' fair value is reported as a benefit in the dividend. Cameron has therefore increased the value of shares as export instruments to increase the company's net profits. Securities available for sale are those not listed as redemption or trade security investments. The loss will not be recorded in the revenue statement as a decline in the value of such securities. The notional loss is recorded as a head loss–other full income. Such expenses shall not impact the profits of the company. Cameron has therefore recorded shares for sales that are available to prevent the firm from reducing its net earnings. This is to secure the bonus.

b.

Yes, this would affect Cameron's bonus. The income statement reveals the increase in the value of traceable assets, thus increasing net income. This raises the bonus. Any drop in the value of the shares available for sale does not impact net revenue. The reaction against this tactic is Cameron's benefit from any reduction in stock prices. Had such shares been listed as traded securities, their valuation would have declined in a statement of sales, the net revenue decreased and Cameron's bonus in effect.

c.

Indeed, the definition proposed is not legal at all. The rating was performed to optimize net earnings. This is not the right basis for an accounting standard classification. The securities should have been categorized according to their merit and type (whether it is held for short-term trading or is held until maturity). Cameron's practice is just to make up the books of accounts