Kreiter Financial Services Ltd. recently purchased a portfolio of debt and equity securities. Financial vice-president Vicki Lemke and controller Ula Greenwood are in the process of classifying the securities in the portfolio. Lemke suggests accounting for both debt and equity securities expected to increase in value during the year using the fair value through profit and loss model in order to increase profit. She wants to account for all securities that are expected to decline in value using the cost model for equity securities and the amortized cost model for debt securities so that no decline in the value of the investment will ever be shown. Greenwood disagrees. She recommends accounting for all equity securities that are expected to increase in value using the equity method and using the amortized cost model for all debt securities and the cost model for equity securities expected to fall in value to avoid recording the decline. Greenwood argues that the fair value of an equity investment is more volatile and, if the equity method were used instead, there would be a "smoother" buildup in the value of the investment.
Instructions
(a) Prepare arguments against the position taken by Lemke. What flaws are there in her arguments? Are any of her proposals reasonable? Does she understand the implications that each method has for the financial statements?
(b) Prepare arguments against the position taken by Greenwood. What flaws are there in her arguments? Are any of her proposals reasonable? Does she understand the implications that each method has for the financial statements?
(c) Assume that Lemke and Greenwood classify the portfolio properly. If Kreiter sold all of its trading investments that had risen in value just prior to year end and sold all of its trading investments that declined in value immediately after year end, would these decisions allow the company to manipulate profit?