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Ehical issue(compliance of FASB statement no:115)

Bad Smell Cigar 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 though some securities have decreased in value. I.M. Stinky, the financial vice president, and Irene Totheright 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. I.M. Stinky 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 (the debt securities). Irene Totheright disagrees. She wants to classify those securities that have decreased in value as trading securities and those that have increased in value as available-for-sale (equity) and 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 proposals?

c. Assume that I.M. Stinky and Irene Totheright 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?

Solution Preview

Dear student,

Provisions of FASB statement no: 115
According to FASB statement no: 115, the securities are classified into three categories:
1. Held to maturity category: In case of debt securities which are held by the company as investment with the positive intent and ability to hold till maturity are called held-to-maturity securities and should be shown in the balance sheet at amortized cost.
2. Trading securities: Debt and equity securities that are bought and principally held for the purpose of selling them are called trading securities. Trading securities should be reported at fair value and the unrealized gains and losses should be incorporated in the earnings of the company during the financial year.
3. Available for sale. Debt and equity securities which are not classified ad held to maturity category and trading securities are classified as securities available for sale. These securities are ...

Solution Summary

The answer contains ethical issues involved in the violation of FASB statement no:115