Accounting Theory Mid-Term: Points to focus on

Question 1

Describe Earning Response Coefficients

Answer 1

ERC’s measure the amount of abnormal market return in relation to good news or bad news

It is an attempt to explain why the market responds more strongly for some companies than for others

Question 2

How is earnings quality measured? (2 things)

Answer 2

Earnings Persistance

Accruals quality

Question 3

What does the result of an ERC calculation show?

Answer 3

The abnormal share return per dollar of unexpected earnings

Question 4

Does higher earnings quality result in higher ERC?

Answer 4

Yes

Question 5

Is a high ERC good or bad?

Answer 5

Good

Question 6

What are the 7 elements of ERC’s? (Important)

Answer 6

Beta

Capital Structure

Earnings quality

Persistence

Growth Opportunities

Similarity of Investor Expectations

Informativeness of price

Question 7

Describe the role of Beta in ERC’s

Answer 7

Low beta=higher ERC&raquo_space;>Good

High Beta=low ERC»>Bad

Question 8

Describe the role of Capital structure in ERC’s

Answer 8

If a company carries a lot of debt, earning go to the creditors, not the shareholders. Therefor good news goes to the debt holders

Question 9

Describe the role of Earnings Quality in ERC’s

Answer 9

High probabilities= high ERC

Better able to predict future earnings

Question 10

Describe the role of persistence in ERC’s

Answer 10

High earning persistancy=high ERC

Question 11

Describe the role of growth opportunities in ERC’s

Answer 11

High opportunities for growth=high ERC

Question 12

Describe the role of Similarity of Investor Expectations in ERC’s

Answer 12

The more that investors are on the same page, the higher the ERC

Question 13

Describe the roll of informativeness of price in ERC’s

Answer 13

How significant is new information?

If it is not very informative, low ERC (BAD)

Question 14

What are the 5 objectives of the MD&A?

Answer 14

Understandable

Relevant

Comparable

Verifiable

Timely

Question 15

What are some of the thins the MD& A must discuss? (19 total, list at least 5)

Answer 15

Core Business

Long term business objectives, strategy, goals, targets

Attitude to and tolerance for risk

Company strategy

Material risks (and response to)

Financial performance

Year over year changes

Significant accounting policies

Off balance sheet arrangements

Impact of FV Measurements

Analysis of actual results

Managements responsibility for effective systems

Transactions between related parties

Cash needs and ability to meet them

Acquisitions and dispositions

Financial instruments

Outstanding share data

Question 16

What are the two main benefits of superior MD&A disclosure?

Answer 16

Investors can make better decisions

Improves the ability of securities markets to direct investments to the most productive uses

Question 17

What is a financial instrument?

Answer 17

Any asset that can be traded. Generally cash based.

Question 18

What are some examples of a financial instruments?

Answer 18

Cash

AR

AP

Operating Loan

LT debt

Question 19

What goes on a balance sheet?

Answer 19

Assets

Liabilities

Shareholder Equity