Accounting Theory Exam Review

Stock should non change by the change in be indemnity, two examples in book where this did not hold (1 . Employee post option authorities proposed that employee stock options be expense has no get together on cash in that locationfore should have no impact on stock set but rice was f all in alling strong distinction that account policies do matter 2.Dry holes companies were al lower-rankinged to amortize dry holes but there was no revenue generated so it does not make sense so the only holes you could amortize is the successful ones e holes where they found the oil.. Dry holes would be expensed does not assume cash flow therefore should not affect price of stock, companies who were amortizing dry holes saw their price fall accounting policy does matter significance = accounting possibleness/policy matter.. Managers of a ships party ar going to try and keep up the price f stock therefore they go away do things that have an influence on price and determines the cost of capital) datarmation that it trades on is important -difference between positive accounting theory (predict what lead happen?measure is how accurate it is) and normative theory (predicts what should happen?is a good theory if it is logical ex wizard person decision theory) superintendrs will shift the income into the current period in order to make up their bonus (difficult to measure the shifting of income).Come up with three hypothesis that would support the positive accounting theory 1 . reward plan (managers will try to move the Income into the period where Its going to wellbeing them) 2. Debt convenient (managers will try to avoid a default In the contractual arrangement of debt, try and Increase net Income If they be at risk of debt covenant) 3.Political cost (companies that be facing political heat will try and lower their net income so they can argue that they be not making that much money) change they can affect the contracts (one party may benefit and the oth er may lose out) -major problem with testing positive accounting theory = hard to measure the earnings attention (many ways to do so but some are not so obvious? discretionary approvals) 2 versions of PAT 1. Opportunistic (managers do whats in their best evoke) 2. Efficient contracting (managers do whats best for the company) slim overlapEfficient contract tends to be to a greater extent common -firms tar witnessed for takeovers and debt violators will increase income , share price is more correlated with net income and so cash flow, limited use of derivatives, what are the implications of the evidence that the efficient contacts are dominate over opportunistic = owners f the company cannot run the company themselves therefore they hire agents, conflict is controllable. Chapter 9 conflict resolution 3 kinds of agency contracts = 1. Rent (rent the company to the agent so principal receives persistent income and the agent gets profit and risk, agents are risk adverse) 2.Perce ntage of profit (second best?you apply a bonus to the manager, get a percentage of the profit.. Problem is the agents efforts are not seen until after theyre actually paid.. Overcome by basing compensation on a performance basis) 3. Salary (first best.. You can observe the gent, principal takes all the risk problem is moral hazard) they argue that you can create a contract that causes truth telling-could be a penalty for honesty, no restrictions on the contract, could be legal implications. Can agents be trusted?Can they get away with earnings worry? To extent, gives them some leeway, cannot fake numbers similarly large extent, audits prevent this. People assume that managers are going to manage earnings and theyll manage to the greatest extent. Characteristics 1 . Sensitivity 2. Precision (put 10% more effort get 10% more change Advantages and disadvantages of use historical cost account= precise but not highly sensitive.. mart price is sensitive but not precise. (similar to the tradeoff of relevancy and reliability) wherefore are changes to accounting policies controversial?Cue contacts are rigid. Chatter 10 executive compensation.. Second role for financial account- stewardship What two roles do.. Performance measures are used In aging contracts, establishes the value in the.. FAME argues that employment contracts are not studyed because the manager relies on reputation, does that mean we do not emergency measurements? The labor foodstuffs are not efficient therefore you serene exigency contracts and if you rely on the labor market it needs measurement. You need performance measurements.Someone predicted that employment contracts will be complicated and research determines its truth.. diachronic cost on net income is precise but not sensitive should add another measure of share price. Whats the problem with share price? Is sensitive but not precise. Should executives bear any risk? Yes they should need risk to ensure effort. Not too much risk t hough. Chapter 1 1 earning management.. 4 hypothesis to test theory 1. BATH drop-off net income as much as possible to set yourself up for a better bonus next time. Income minimization try and increase income to get the bonus.. F youre over the bonus cap you would lower your income to render for next year. CAP(Max for bonus) vs.. BOGEY (min for bonus) Income smoothing happens at every level concept to trend risk.. Rather than take all audits and accruals prevent from bad earnings management bad side? Misleading information, excessive write downs, 6 reasons wherefore managers would manage earnings.. Bonus, debt covenant, political reasons, initial universal offerings, monomaniac inside info to investors, to meet investors expectation.. Is earnings management consistent with efficient market theory?No semi strong theory share price fully reflects biblically live information Chatter 12 market forces should hold therefore you dont need any regulations. Demand for information and supply of information. Information is a public good no one pays for it therefore theres unlimited demand for it. interrupt disclosure will result in more investor rice beer, increase liquidity, more institutions trading, reduce estimation risk, narrower bids and asks and therefore lower cost of capital and come to rates. How do you define information? Should be more detailed, additional information, more credibility.Disclosure principal market knows that the managers has information, if they do not release the info the market assumes its bad. But its not as bad as everyone thinks flea. Foods the market know that the manager has the information? Release of the information may be costly and is disclosure truthful. If theres no regulatory body theres no guarantee info to reliable. High type (good company, try to differentiate themselves, adopt conservative accounting policies, not overstate assets, or understate expenses, use top auditing firms) and low type (poor company Chapter 13 standard setters political issues.. Public interest theory (first best , regulators would set the quality and quantity in the best interest of society, problem what is the ideal amount moral hazard kicks in)&& interest group (conflict between stakeholder, policies are best decided by hacking comment by everyone) 2nd theory is best Principal vs.. 4 criteria for decision making successful standards? 1 . Decision usefulness 2. Reduce info imbalance 3. No serious economic consequences and 4. Should be consensus MATH