what criteria need to be considered before classifying a security as trading or non-trading?
The financial service company holds a large portfolio of debt and stock securities as an investment. The total fair value of the portfolio at the end of the year, is greater than total cost. Some securities have increased in value and others have decreased. The financial vice president, and the controller are in the process of classifying for the first time the securities in the portfolio.
the vice president 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 non-trading securities, so that the decreases in value will not affect 2014 net income.
the controller disagrees. She recommends classifying the securities that have decreased in value as trading securities and those that have increased in value as long term non-trading securities. She 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.
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The classification of Securities is one based on the intent of the business entity (holder of the securities) at the time of acquiring those securities. The classification can not depend on the movements in the market value of the securities. Such treatment that classifies of securities either as trading or non-trading on the basis of increase or decrease of the market values of securities violates accounting standards and the principle of consistency because the market values normally keep fluctuating.
Accounting standards necessitate that companies classify any investments in debt or equity securities when they are purchased. (Investopedia)
So the contentions of both the Financial Vice President and the Controller are not correct. Normally securities which are purchased in the normal course of the business are available for sale with in a period of 12 months and are treated as short-term Trading Securities unless they are acqured with no intention of being sold in the normal course of business.
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