Accounting Theory Exam Review

Topics: Employee stock option, Stock, Revenue Pages: 5 (1276 words) Published: September 12, 2014
Accounting Theory Exam Review
Part I – 25 MC
Part II – 2 marks
Part III – 10 marks
Part IV – 7 marks
Part V – 10 marks
Total – 54 marks

8 – 5 marks
9 – 16 marks
10 – 6 marks
11 – 5 marks
12 – 10 marks
13 – 5 marks
Reading – 7 marks
Total – 54 marks

Chapter 8 – Economic Consequence
If they do not affect cash flow, they do not matter. Stock should not change by the change in accounting policy, two examples in book where this did not hold (1. employee stock option – authorities proposed that employee stock options be expense has no impact on cash therefore should have no impact on stock price but price was falling strong indication that accounting policies do matter 2. Dry holes companies were allowed 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 ie holes where they found the oil.. dry holes would be expensed does not affect 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 theory/policy matter.. managers of a company are going to try and keep up the price of stock therefore they will do things that have an influence on price and determines the cost of capital)information that it trades on is important -difference between positive accounting theory (predict what will happen—measure is how accurate it is) and normative theory (predicts what should happen—is a good theory if it is logical – ex single person decision theory) managers will shift the income into the current period in order to increase their bonus (difficult to measure the shifting of income). Come up with three hypothesis that would support the positive accounting theory 1. Bonus plan (managers will try to move the income into the period where its going to benefit them) 2. Debt convenient (managers will try to avoid a default in the contractual arrangement of debt, try and increase net income if they are at risk of debt covenant) 3. Political cost (companies that are facing political heat will try and lower their net income so they can argue that they are not making that much money) -significance of rigid contracts = cannot change the terms. If accounting policies change they can affect the contracts (one party may benefit and the other may lose out) -major problem with testing positive accounting theory = hard to measure the earnings management (many ways to do so but some are not so obvious—discretionary approvals) 2 versions of PAT 1. Opportunistic (managers do what’s in their best interest) 2. Efficient contracting (managers do what’s best for the company) – slight overlap… Efficient contract tends to be more common -firms targeted for takeovers and debt violators will increase income , share price is more correlated with net income then cash flow, limited use of derivatives, what are the implications of the evidence that the efficient contacts are dominate over opportunistic = owners of 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 fixed income and the agent gets profit and risk, agents are risk adverse) 2. Percentage of profit (second best—you pay 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 agent, 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 management? To extent, gives them some leeway, cannot fake numbers to a...
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