Bartlet Financial Services Company holds a large portfolio of debt and stock sec

Question

Bartlet Financial Services Company holds a large portfolio of debt and stock securities as an investment. The total fair value of the portfolio at December 31, 2014, is greater than total cost. Some securities have increased in value and others have decreased. Deb Faust, the financial vice president, and Jan McCabe, the controller, are in the process of classifying for the first time the securities in the portfolio. Faust suggests classifying the securities that have increased in value as trading securities in order to increase net income for the year. She wants to classify the securities that have decreased in value as long-term non-trading securities, so that the decreases in value will not affect 2014 net income. McCabe disagrees. She recommends classifying the securities that have decreased in value as trading securities and those that have increased in value as long-term non-trading securities. McCabe argues that the company is having a good earnings year and that recognizing the losses now will help to smooth income for this year. Moreover, for future years, when the company may not be as profitable, the company will have built-in gains. Instructions (a) Will classifying the securities as Faust and McCabe suggest actually affect earnings as each says it will? (b) Is there anything unethical in what Faust and McCabe propose? Who are the stakeholders affected by their proposals? (c) Assume that Faust and McCabe properly classify the portfolio. At year-end, Faust proposes to sell the securities that will increase 2014 net income, and McCabe proposes to sell the securities that will decrease 2014 net income. Is this unethical?

Explanation / Answer

(a) The classification of the securities as Faust and McCabe suggested actually going to affect the earnings of the concern because when you divide your portfolio between good and bad, actually you are reducing your playing area. After classification you will be more concentrating on the gems and hardly pay any attention on the losing ones. The effect is that you book out the profits and losses and the net profit is always less than the prior classification profits.

(b) In an mutual fund, a group of members have invested in together and the investment is in the hands of the portfolio manager, who will decide where to invest in risky or safe stock. So, for the company, members and the stockholders, all investments made are of same value and they wouldnot like the same will be classified into good and bads. So, it is quite unethical on the part of Faust and McCabe proposal of classification into Increased Stocks and Decreased Stocks. The company, members and the stockholders would not approve the classification which i) reduces the business area ii) reduces the income iii) reduces the capital.

(c) After classification of the portfolio, either faust or McCabe may propose to cash out the profitable or loss making securities, which will provide the concern to invest in less risky and profitable securities. Here, they are missing the "Available for sale" ethics of the investment of Mutual Funds, where you have to sell out the securities only when they have achieved their targeted goals. Without purpose disturbing the portfolio will not be acceptable by the members because it will distroy their long term goals/profits. In investing manager are also not allowed to "pump and dump" the securities as if they are having unlimited funds and profit making is not their purpose of investing. So, any kind of classification and booking profits and losses without achieving targets are unethical in the investing company or mutual funds.

Related Questions

Navigate

• Browse (All)
• Browse B
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.