Tara Enterprises has numerous investments in debt and equity securities. The con

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 ncome 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

Explanation / Answer

1. The investors, creditors and employees of the company might be affected by the suggested classification. The investors might take incorrect decisions misled by the dressed up financial health of the company.

2. Yes, the suggested classifiaction will lead to an increase in Cameron's bonus. Since the securities which have increased in value have been classified as trading securities, the net income will increase leading to an increase in the bonus as it is a % of net income.

3. The suggested classification is not ethical. It is driven by personal gain and is not in the interest of the company as a whole. The correct way would be to classify securities based on the holding period and the intention with which they were bought.

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