Question

Qtip Corp. owns stock in Maxey Corp. The investment represents a 10 percent interest, and Qtip is unable to exercise significant influence over Maxey. The Maxey stock was purchased by Qtip on January 1, 2013, for $23,000. The stock consistently pays an annual dividend to Qtip of $2,000. Qtip classifies the stock as available for sale. Its fair value at December 31, 2013, was $21,600. This amount was properly reported as an asset in the balance sheet. Owing to the development of a new Maxey product line, the market value of Qtip’s investment rose to $27,000 at December 31, 2014. The Qtip management team is aware of the provisions of SFAS No. 115. The possibility of changing the classification from available for sale to trading is dis- cussed. This change is justified, the managers say, because they intend to sell the security at some point in 2015 so they can realize the gain.

Discuss the role that managerial intention plays in the accounting treatment of equity securities that have a readily determinable fair value under SFAS No. 115.

What income statement effect, if any, would the change in classification have for Qtip?

Discuss the ethical considerations of this case. d. Opponents of SFAS No. 115 contend that allowing a change in classification masks effects of unrealized losses and results in improper matching of market-value changes with accounting periods. Describe how the accounting treatment and the proposed change in classification would result in this sort of mismatching.

Answer 1

Answer:-

1. Discuss the role that managerial intention plays in the accounting treatment of equity securities that have a readily determinable fair value under SFAS No. 115.

Ans:- Under SFAS No. 115, managerial intent regarding the treatment of equity securities that have a readily determinable fair value may result in different accounting methods for the same security. This is due to the fact that under SFAS No. 115, the accounting treatment for these equity securities is determined based on management’s intent for retaining or disposing of the equity security.

2. What income statement effect, if any, would the change in classification have for Qtip?

Ans:- The impact on the income statement if Qtip’s management team re-classed the equity security from available-for-sale to trading would be the amount equal to the realization of the gain/loss in earnings. The gain/loss would impact net income. “For a transfer from available-for-sale to trading, the unrecognized holdings gain or loss at the date of transfer is reported immediately in earnings.” (Schroeder, Clark, and Cathey, 2014)

3. Discuss the ethical considerations of this case.

Ans:- This would only be unethical in the event that management changed the classification without changing their intent as well. This would be unethical due to the fact that it would impact earnings without the intent changing.

4. Opponents of SFAS No. 115 contend that allowing a change in classification masks effects of unrealized losses and results in improper matching of market-value changes with accounting periods. Describe how the accounting treatment and the proposed change in classification would result in this sort of mismatching.

Ans:- “Unrealized gains and losses for available-for-sale securities are not recognized in earnings until they are reclassified as trading securities and sold. Thus, for these securities, there is no accrual accounting-based matching of market gains and losses in the period when they are incurred. The result is a distortion of reported earnings.” (Schroeder, Clark, and Cathey, 2014)