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.

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

Answer 1

Answer 1

This classification will have an impact on the profit of Tara Enterprises. Also the balance sheet items would be affected as well.

If any dividend etc. is to be distributed, the same shall be more in quantum, since the profits available for distribution are higher.

Answer 2

Since net income will be higher considering the increase in the value of the trading securities, J Cameroon will be entitled for a higher amount of bonus. This also can act as a motivator for doing the classification.

Answer 3

The classification of the short term (trading) and long term (investment purpose) is primarily dependent upon the intention of the investor. There can be no rule w.r.t. the same. But the trend visible here reflects a biased approach of the controller i.e. J. Cameroon. So, classification on the basis of the profit or loss making is not an ethical practice.

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