Long-term investments represent those assets that a company holds for more than one year including bonds, stocks, and real estate. While the short-term investments are held for selling motive, the company may never dispose of long-term investments. Reclassifying a long-term investment into cash means that the cash account balance increases. If the cash balance increases, the total balance of the company’s current assets also go up. It follows that, if the company’s current assets balance is higher relative to its current liabilities then the current ratio for that particular company will be high. Therefore, the current ratio is higher after reclassifying long-term investments into cash than it was before reclassifying (Subramani, 2013). The current ratio is a very significant ratio as it measures the extent to which the company is able to settle both short-term and long-term debts. The ratio indicates the extent to which the net current assets are able to meet the current obligations of the company.
Reclassifying long-term investments does not in any way make the company’s financial position stronger than before since the balance of the total assets does not change. Accounting standards provides for the reclassification of investments from one category to another so long as they are transferred at a fair value(Pielichaty, 2014). When reclassifying investments from holding to maturity (HTM) to available for sale (AFS), accounting standards requires that the unrealized holding gains or loss be recognized at the transfer date in the other comprehensive incomes. In a nutshell, reclassifying long-term investments into cash does not have effects on the financial position of the company as at the transfer date since the total balance of assets does not change.
It is ethical and appropriate if a company reclassifies long-term investments as current in order to meet debt obligations. So long as the company’s management sells the investments to settle debt obligations, their actions are ethical. Sales subsequent to reclassifying the assets the first time improves the current ratio of the company. However, reclassifying back the investments from current to long-term is unethical as it suggests that the management is playing shell game with the company books of accounts(Pielichaty, 2014). In this case it is not possible to ascertain the intentions of the management and therefore the actions are unethical and inappropriate. Accounting standards allow reclassifying of long-term investments to short-term so long as the management can prove that their action is to improve the financial position of the company.
Reclassifying long term investments into short-term makes financial sense to the company especially if the investments include stocks of a publically trading firm. The company may have intended to hold the stocks for longer but the shares market rose significantly and many investors were willing and ready to buy those stocks. In that case, the company may reclassify the long-term investments to short-term investments in order to dispose of these stocks. This will increase the company’s cash balance and its net assets. The company may use the proceeds from the sale of stocks to settle debt obligations such as paying the suppliers or repaying outstanding loan(Subramani, 2013). This is a wise decision as the shares are sold above par thus generating a lot of money for the company. It an ethical decision and makes a lot of financial sense. This is an excellent example of instances when it makes financial sense to reclassify long-term investments to short-term investments.
Pielichaty, E. (January 01, 2014). Investment properties: Measurement and reclassification in light of accounting law. Revija Za Ekonomske in Poslovne Vede, 1, 2, 30-41.
Subramani, R. V. (2013). Accounting for investments, fixed income securities and interest rate derivatives: A practitioner’s handbook. Hoboken, N.J: Wiley.