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, 2012 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 2012 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. Questions (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 or 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 2012 net income, and that McCabe proposes to sell the securities that will decrease 2012 net income. Is this unethical?

Basic accounting standards, regulated by the SOX (Sarbanes-Oxley Act), COSO and the SEC, govern how debt and security investments are reported by corporations. While there are advanced complex considerations--like relevance and reliability, comparability and consistency, and periocity and matching--that affect real-world accounting situations, basic accounting decisions are regulated by law, and violations can result in charges of financial manipulation and fraud as in the 2015 case of the SEC (Securities Exchange Commission) against the Computer Sciences Corporation, who were charged with a $190 million penalty. Further, while real-world debt and security investment accounting present subtleties and complexities, it is professional and personal ethics that provide the foundation for applying regulated basic accounting standards (Kermis & Kermis, "Financial reporting regulations, ethics and accounting").Ethical Accounting: IntentThe underlying standard of accounting for debt and security investments is intent: "accounting for investments in the debt and equity securities ... requires management to categorize the securities based on the intent for holding the investment" (Judy Laux, "Investment in Securities"). Along with following basic accounting standards, in order for either Faust or McCabe to perform investment accounting ethically, they must categorize legitimately according to actual intent for holding any given debt or security investment.Accounting Treatment for Trading versus for Available-for-SaleSecurities held with the intent of trading--meaning that they are held with the aim of selling when the value of the security increases, generating a short-term profit for the corporation--have their present market values reported on the balance sheet, through the step of year-end adjustments, in addition to having gains and losses (of original market value and present market value) reported on the income statement; this is regardless of whether the trading security has been sold or is still held. Thus this accounting entry on the income statement has ramifications for year-end profitability reporting. In contrast, securities held with the intent of available-for-sale are not reported on the income statement at all. Available-for-sale investments are reported only on the balance sheets in the stockholders' equity section (as an asset value for stockholders); compare this to trading investments being reported on the balance sheet as year-end adjustments. Accounting treatment differences for trading and available-for-sale investments do not affect corporate earnings. Faust and McCabe: Ethical or Unethical Faust, the Financial VP, and McCabe, the Financial Controller, want to classify the investments based on increased and decreased values and on their effects on present or future year income. On the face of it, this is an unethical approach that ignores intent for holding an investment, thus violating the accounting standard requiring classification of investments as trading or available-for-sale based upon intent for holding. Additionally, choosing to classify based on income projections for varying years may affect stockholders who may gain or lose asset value based upon the classification decisions. StakeholdersStakeholders are a larger, more comprehensive group than stockholders, including sub-groups or individuals that can either affect or be affected by decisions made by the corporation; some stakeholders are the government, boards of directors, unions, community members and individual securities investors.Year-End Net IncomeOn the face of it, classifying debt and security investments to optimize selectively chosen year-end incomes has the same ethical problems mentioned above: regulated basic accounting standards established by SOX and COSO (Committee on Sponsoring Organizations) and the SEC, require that classification of debt and security investments be made based on intent for holding the investment. Making classifications on other, arbitrarily chosen income advantages violates this fundamental basic accounting standard requirement.
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