Acct Theory- Mod 2

Question 1

What is the main concept of Module 2?

Answer 1

The decision usefulness approach to Financial Reporting

Question 2

Generally speaking, what are the two main purposes of financial reporting?

Answer 2

Assist investors in making good investment decisions

Measure the performance of management (and promote responsible behavior)

Question 3

What is decision usefulness?

Answer 3

To make historical-cost based financial statements more useful to the people using them

Question 4

What is stewardship?

Answer 4

Watching over something and reporting on managements performance

Question 5

What are constituencies? What are some examples?

Answer 5

The different groups and users of financial statements. (Relate it to political constituencies)

Debt investors
Managers
Unions
Standard setters
Government

Question 6

What is Bayes Theorem?

Answer 6

A mathmatical formula that we use to weigh our decisions and determine what outcome would be the most useful

Question 7

With regards to Bayes Theorem, what is payoff?

Answer 7

The amounts to be received from an investment decision

Question 8

With regards to Bayes Theorem, what is Utility?

Answer 8

The satisfaction the is derived from a payoff.

Question 9

How is utility calculated?

Answer 9

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

Question 10

What is noise or low earnings quality?

Answer 10

Error in the probabilities used in Bayes Theorem

Question 11

What are financial statements that are highly informative called?

Answer 11

Transparent or high quality

Question 12

What is an information system?

Answer 12

A table that outlines the probabilities of each possible state of nature

Question 13

What does a higher set of diagonal probability in an information system mean?

Answer 13

More informative
More useful
Less estimation risk

Question 14

What is estimation risk?

Answer 14

The gap between the true value of shares and what someone is willing to pay for them

Question 15

If an information system has low probability, what would this mean for the estimation risk?

Answer 15

Lower probability=Higher estimation risk

Question 16

How is an information system table created?

Answer 16

Past statements are reviewed for errors of estimation, analyst revisions and general quality. From this, probabilities are determined

Question 17

What are posterior states?

Answer 17

After review of financial statement evidence

Question 18

What is the principle behind portfolio diversification?

Answer 18

Carrying different assets and different types of assets carries a lower risk than a more concentrated portfolio

Question 19

What are the two main things that can affect probabilities?

Answer 19

Market wide factors/Economy wide factors

Firm specific factors

Question 20

Explain the concept of portfolio diversification in terms firm specific risks and market-wide risks

Answer 20

Firm specific risks get cancelled out over a broad base of investments, leaving only market-wide risks

Question 21

What is Beta?

Answer 21

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.

Question 22

What is a good Beta?

Answer 22

The closer to 1 the more stable and reliable the stock is. Less than 1 is even better.

Question 23

Which statement is favoured the most by the decision usefulness approach?

Answer 23

Balance sheet (statement of financial position)