Addison Manufacturing holds a large portfolio of debt and equity securities as an investment. The fair value of the portfolio is greater than its original cost, even through some securities have decreased in value. Ted Abernathy, the financial vice president, and Donna Nottebart, the controller, are near year-end in the process of classifying for the first time this securities portfolio in accordance with FASB Statement No. 115. Abernathy wants to classify those securities that have increased in value during the period as trading securities in order to increase net income this year. He wants to classify all the securities that have decreased in value as available-for-sale (the equity securities) and as held-to-maturity (debt). She contends that the company is having a good earnings year and that recognizing the losses will help to smooth the income this year. As a result, the company will have built-in gains for future periods when the company may not be as profitable.
Answer the following questions:
(a) Will classifying the portfolio as each proposes actually have the effect on earnings that each says it will?
(b) Is there anything unethical in what each of them proposes? Who are the stakeholders affected by their proposal?
(c) Assume that Abernathy and Nottebart properly classify the entire portfolio into trading available for sale, and held-to-maturity categories. But then each proposes to sell just before year-end the securities with gains or with losses, as the case may be, to accomplish their effect on earnings. Is this unethical?
Please see the attached file.
(a) Classifying the securities as they propose will indeed have the effect on net income that they say it will. Classifying all the gains as trading securities will cause all the gains to flow through the income statement this year and classifying the losses as available-for-sale and held-to-maturity will defer the losses from ...