Addison Manufacturing holds a large portfolio of debt securitiesas an investment. The fair value of the portfolio is greater thanits original cost, even though some debt securities have decreasedin value. Sam Beresford, the financial vice president, and AngieNielson, the controller, are near year-end in the process ofclassifying for the first time this securities portfolio inaccordance with GAAP. Beresford wants to classify those securitiesthat have increased in value during the period as tradingsecurities in order to increase net income this year. He wants toclassify all the securities that have decreased in value asheld-to-maturity.

Nielson disagrees. She wants to classify those debt securitiesthat have decreased in value as trading securities and those thathave increased in value as held-to-maturity. She contends that thecompany is having a good earnings year and that recognizing thelosses will help to smooth the income this year. As a result, thecompany will have built-in gains for future periods when thecompany may not be as profitable.

(a)  

Will classifying the portfolio as each proposes actually havethe effect on earnings that each says it will?

(b)  

Is there anything unethical in what each of them proposes? Whoare the stakeholders affected by their proposals?

(c)  

Assume that Beresford and Nielson properly classify the entireportfolio into trading, available-for-sale, and held-to-maturitycategories. But then each proposes to sell just before year-end thesecurities with gains or with losses, as the case may be, toaccomplish their effect on earnings. Is this unethical?