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

Question

Harding Financial Services Company holds a large portfolio of debt and stock securities as an investment. The total fair value of the portfolio at December 31, 2014, is greater than total cost. Some securities have increased in value and others have decreased. Ann Bales, the financial vice president, and Kim Reeble, the controller, are in the process of classifying for the first time the securities in the portfolio.

Bales suggests classifying the securities that have increased in value as trading securities in 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 2014 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.

(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 stakeholders affected by their proposals?

(c) Assume that Bales and Reeble properly classify the portfolio. At year-end, Bales proposes to sell the securities that will increase 2014 net income, and that Reeble proposes to sell the securities that will decrease 2014 net income. Is this unethical?

Explanation / Answer

The method suggested by both the employees is incorrect. valuing securities as held for trade when the prices have gone up to increase the net income for the year will give a wrong picture to the stakeholders . Also if the earnings of the period are smooth, recognizing losses in the current period is also not an ethical decision. The management should ensure that true and fair presentation of books to be given to the shareholders, for them to assess the correct valuation of the company.

B. Yes, the actions suggested by both the employees is unethical. The stakeholders mainly shareholders will get affected. Alongwoth that other interested parties like banks, government agencies, analysts, employees , suppliers ,creditors , debotors etc will get affected by such a decision.

CThe 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 , managment may consider to sell it . Also, id management beleives a particular security is better off being sold,since they are expecting a further price fall, they must base their decision on such factors.The motivation to show higher /lower net income should not bias the decision to sell securities

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