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Chapter 13: Q6CA (page 658)

ETHICS (Fair Value) Addison Manufacturing holds a large portfolio of debt securities as an investment. The fair valueof the portfolio is greater than its original cost, even though some debt securities have decreased in value. Sam Beresford, the financialvice president, and Angie Nielson, the controller, are near year-end in the process of classifying for the first time this securitiesportfolio in accordance with GAAP. Beresford wants to classify those securities that have increased in value during the period astrading securities in order to increase net income this year. He wants to classify all the securities that have decreased in value as

held-to-maturity.

Nielson disagrees. She wants to classify those debt securities that have decreased in value as trading securities and thosethat have increased in value as held-to-maturity. She contends that the company is having a good earnings year and that recognizingthe 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.

Instructions

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 Beresford and Nielson properly classify the entire portfolio into trading, available-for-sale, and held-to maturitycategories. But then each proposes to sell just before year-end the securities with gains or with losses, as thecase may be, to accomplish their effect on earnings. Is this unethical?

Short Answer

Expert verified

The proposal of selling securities at year-end is unethical.

Step by step solution

01

Step 1:Effect on the earnings

Yes, each proposal will affect the earnings of the company. Beresford’s proposal increases the current year’s profits of the company. On the other hand, Nielson’s proposal decreases the current year’s profits.

02

 Effect of the proposals

No, there is nothing unethical in both proposals because both want to benefit the company by their submission. Stakeholders affected by their proposals are owners of the company.

03

Unethical or ethical

Yes, there is unethical in this because due to their proposal of selling securities at year-end, the company will face heavy losses as some deposits are more minor than cost.

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Most popular questions from this chapter

(Fair Value and Equity Methods) Brooks Corp. is a medium-sized corporation specializing in quarrying stonefor building construction. The company has long dominated the market, at one time achieving a 70% market penetration. Duringprosperous years, the company’s profits, coupled with a conservative dividend policy, resulted in funds available for outside

investment. Over the years, Brooks has had a policy of investing idle cash in equity securities. In particular, Brooks has made periodicinvestments in the company’s principal supplier, Norton Industries. Although the firm currently owns 12% of the outstandingcommon stock of Norton Industries, Brooks does not have significant influence over the operations of Norton Industries.

Cheryl Thomas has recently joined Brooks as assistant controller, and her first assignment is to prepare the 2017 year-endadjusting entries for the accounts that are valued by the “fair value” rule for financial reporting purposes. Thomas has gatheredthe following information about Brooks’ pertinent accounts.

1. Brooks has equity securities related to Delaney Motors and Patrick Electric. During 2017, Brooks purchased 100,000 shares of

Delaney Motors for \(1,400,000; these shares currently have a fair value of \)1,600,000. Brooks’ investment in Patrick Electrichas not been profitable; the company acquired 50,000 shares of Patrick in April 2017 at \(20 per share, a purchase that currentlyhas a value of \)720,000.

2. Prior to 2017, Brooks invested \(22,500,000 in Norton Industries and has not changed its holdings this year. This investmentin Norton Industries was valued at \)21,500,000 on December 31, 2016. Brooks’ 12% ownership of Norton Industries has acurrent fair value of \(22,225,000 on December 2017.

Instructions

(a) Prepare the appropriate adjusting entries for Brooks as of December 31, 2017, to reflect the application of the “fairvalue” rule for the securities described above.

(b) For the securities presented above, describe how the results of the valuation adjustments made in (a) would be reflectedin the body of Brooks’ 2017 financial statements.

(c) Prepare the entries for the Norton investment, assuming that Brooks owns 25% of Norton’s shares. Norton reportedincome of \)500,000 in 2017 and paid cash dividends of $100,000.

Question: In accounting for short-term debt expected to be refinanced to long-term debt:

  1. GAAP uses the authorization date to determine classification of short-term debt to be refinanced.
  2. IFRS uses the authorization date to determine classification of short-term debt to be refinanced.
  3. IFRS uses the financial statement date to determine classification of short-term debt to be refinanced.
  4. GAAP uses the date of issue, but only for secured debt, to determine classification of short-term debt to be refinanced.

(Equity Method) On January 1, 2017, Pennington Corporation purchased 30% of the common shares of Edwards

Company for \(180,000. During the year, Edwards earned a net income of \)80,000 and paid dividends of $20,000.

Instructions

Prepare the entries for Pennington to record the purchase and any additional entries related to this investment in Edwards Company

in 2017.

Question:Adriana Co., with annual net sales of $5 million, maintains a markup of 25% based on cost. Adriana’s expenses average 15% of net sales. What is Adriana’s gross profit and net profit in dollars?

BE13-3 (L01) Takemoto Corporation borrowed \(60,000 on November 1, 2017, by signing a \)61,350, 3-month, zero-interest bearing note. Prepare Takemoto’s November 1, 2017, entry; the December 31, 2017, annual adjusting entry; and the February 1, 2018, entry.
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