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, 2010, 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 available-for-sale securities, so that the decreases in value will not affect 2010 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 available-for-sale 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. Assume, at year-end, that Faust proposes to sell the securities that will increase 2010 net income, and that McCabe proposes to sell the securities that will decrease 2010 net income. Is this unethical?