Acct Theory- Mod 2 Flashcards
What is the main concept of Module 2?
The decision usefulness approach to Financial Reporting
Generally speaking, what are the two main purposes of financial reporting?
Assist investors in making good investment decisions
Measure the performance of management (and promote responsible behavior)
What is decision usefulness?
To make historical-cost based financial statements more useful to the people using them
What is stewardship?
Watching over something and reporting on managements performance
What are constituencies? What are some examples?
The different groups and users of financial statements. (Relate it to political constituencies)
Debt investors Managers Unions Standard setters Government
What is Bayes Theorem?
A mathmatical formula that we use to weigh our decisions and determine what outcome would be the most useful
With regards to Bayes Theorem, what is payoff?
The amounts to be received from an investment decision
With regards to Bayes Theorem, what is Utility?
The satisfaction the is derived from a payoff.
How is utility calculated?
It is different everytime, the method of calculation will be provided to us.
Common examples include:
Square root of payoff
Really, it could be any calulation
What is noise or low earnings quality?
Error in the probabilities used in Bayes Theorem
What are financial statements that are highly informative called?
Transparent or high quality
What is an information system?
A table that outlines the probabilities of each possible state of nature
What does a higher set of diagonal probability in an information system mean?
More informative
More useful
Less estimation risk
What is estimation risk?
The gap between the true value of shares and what someone is willing to pay for them
If an information system has low probability, what would this mean for the estimation risk?
Lower probability=Higher estimation risk
How is an information system table created?
Past statements are reviewed for errors of estimation, analyst revisions and general quality. From this, probabilities are determined
What are posterior states?
After review of financial statement evidence
What is the principle behind portfolio diversification?
Carrying different assets and different types of assets carries a lower risk than a more concentrated portfolio
What are the two main things that can affect probabilities?
Market wide factors/Economy wide factors
Firm specific factors
Explain the concept of portfolio diversification in terms firm specific risks and market-wide risks
Firm specific risks get cancelled out over a broad base of investments, leaving only market-wide risks
What is Beta?
A measure of the relationship between a stock and the wider market
Essentially, it is a measure of how volatile a stock is compared to the market in general.
What is a good Beta?
The closer to 1 the more stable and reliable the stock is. Less than 1 is even better.
Which statement is favoured the most by the decision usefulness approach?
Balance sheet (statement of financial position)
