Describe a specific accounting scenario where management intent is likely to impactthe classification of an item on the balance sheet. Also discuss how the use of management intent for balance sheet classification might be abused.

Question

What will be an ideal response?

Answer 1

Management intent plays a part in the classification of many components of the balance sheet. For example, management intent often determines whether an asset or liability is classified as current or long-term (that is, whether management intends on liquidating the
asset or liability within 12 months). Another example is the classification of short-term investments, between trading securities, available for sale securities, and held-to-maturity securities. The holding gains and losses for these three classifications of investments are treated differently. Therefore, using management intent for classification purposes could be abused, for example, if an equity investment is classified as an available-for-sale security instead of a trading security.
(In other words, management could claim that their intent is to not actively trade the security, when in fact they actually do.) If the security has a holding / unrealized loss, then classifying it as an available-for-sale security results in a reduction to other comprehensive income instead of net income, which could artificially inflate net income for the period.