Companies A and B, similar in all respects, recently bought identical securities. However, using the "Management intent" rule, A has classified the securities as
"trading" securities while B has categorized them as "available-for-sale" securities. Which of the following statements is/are true as a result of this difference?
I. A and B will show same assets on their balance sheets.
II. A will have a higher income volatility than B.
III. A will have a higher cash flow volatility than B.
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A. B. C. D.D
Both "trading" and "available-for-sale" securities are reported at their fair market value on the balance sheet. Hence, the reported assets for A and B are not affected by the different classifications. However, changes in the market value of trading securities are considered part of the Income statement while changes in the market value of available-for-sale securities are charged directly to the retained earnings account. This will cause a higher volatility in the income of A. Further, this higher volatility in income leads to a higher volatility in tax payments, thus causing a higher volatility in the cash flows.