Question

Chad is the CFO of Boho Chic, Inc. The company currently has an investments portfolio that includes a variety of both debt and equity securities. Chad’s bonus is based on whether Boho meets certain earnings projections. How can Chad take advantage of the classification of investment securities to improve his chances of receiving his bonus? Discuss the ethical and legal implications.

Answer 1

Chad can have the well-performing investments affect income and the ones not doing so well not affect income based on how he classifies them, an act that doesn't reflect fair and accurate financials.

Explanation:
Debt securities can be classified as either held to maturity (any gain/ loss isn't recorded because the intent is to hold the investment until maturity), trading (gain or loss is reflected in income), and available for sale (gain or loss is reflected on other comprehensive income). In addition, equity securities can also be classified as trading or available for sale (if less than 20% ownership) as well as significant influence (own between 20% - 50% which requires use of the equity method where and profits and dividends adjust the cost of the investment on the books) and controlling interest (over 50% which requires the preparation of consolidated financial statements). With this knowledge, Chad has the ability to manipulate income by changing the classification of the investment to determine whether or not it affects income.

However, determining the classification of an investment shouldn't be based on how it will affect income. The financials of a company should reflect a fair and accurate representation of it's financial condition. For example, if a person truly intents to hold a debt security until maturity, it should be classified as such. If the intent is to actively trade securities to make a profit, they should be labeled as trading securities.It ia management decision how to classify an investment instrument , changing its classification needs proper explanation to notes to accounts

Not only is Chad acting unethically (A porfessional should always be unbiased and practice integrity ) by choosing classifications based on how much he'll earn in bonus and not accurately report the investments correctly on the financials, it's also illegal. He can get in trouble for possibly inflating income when it could possibly be lower based on the classifications.(Where the tax authorities/ if it is public authorities then the securities exchange control can levy high penalties and other legal touble for the company)