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

Classification of securities betweem trading securities and securities available for sale in long term is going to affect the users of financial statements. They come to know that which securities company is intending to sell in short term to earn profit and which securities is company is planning to hold inlong term. Due to this user of financials statement may got affected by this classification. Investors and lenders of the company are main users of financial statements for the Tata enterprises. If classification will be based on intention of management then it will be fair but if classification will be based on fair value increase/decrese then it is not fair and it may affect the decision of inventors and lenders of the company.

Suggested classification will not affect the cameron's bonus because cameron is getting bonus as % of net income of Tata enterprises. As per accounting principles to be follwed for accounting of trading securities and accounting for available for sale in long term, Securities that have fair value determinable at year end to be valued at fair value only and increase/decrease should be recorded in Income statement. So looking to these circumstances suggested classification is not going to affect Cameron's bonus in any way.

An available for sale security is a debt or equity instrument that is not classified as one of the following:

• Trading securities. This classification is assigned to investments where the intent is to sell them in the short term to earn a profit.

• Held-to-maturity securities. This classification is assigned to investments where the intent is to hold them until the maturity date.

These classifications are mandated by Generally Accepted Accounting Principles for recording investments in the accounting records of a business.

However controller James has made classification not on the basis of intention of managerment to sell them in short tem rather he has made classification on the basis of increas/decrease in fair value of securities. So as per my opinion suggested classification is not ethical.