Acct Theory- Mod 5

Question 1

What is the main concept of Mod 5?

Answer 1

Measurement Approach to Decision Usefulness

Question 2

What is the general concept of the measurement approach?

Answer 2

Measuring items at fair value as opposed to using historical cost information

Question 3

What is the difference between the INFORMATION approach and the Measurement approach?

Answer 3

INFORMATION: Accountants provide useful information that is then interpreted by investors. Relies on historical costing.

MEASUREMENT: Accountants provide representational faithful information at fair value. Relies on as much as possible be calculated at fair value

Question 4

What is the current trend in decision usefulness?

Answer 4

Away from the information approach and towards the measurement approach

Question 5

Why is their a trend in decision usefulness towards the measurement approach?

Answer 5

Measurement approach increases the relevance of the information (Therefore increasing the decision usefulness)

Reduces an auditors legal liability

There is lots of competition for accountants in reporting financial information, so the information needs to be as relevant as possible and as useful to decisions as possible

Question 6

What is the concept of “Behaviour Finance”?

Answer 6

The study of investor physcology and beahviour

Question 7

What are the six reasons that prove our markets are semi-strong?

Answer 7

Limited Attention

Overconfidence

Representativeness

Self-Attribution Bias

Conservatism

Motivated Reasoning

Question 8

Define: Limited Attention

Answer 8

People don’t have time to analyze every aspect of annual reports. So instead they focus on net income

Question 9

Define: Overconfidence

Answer 9

Overestimating the accuracy of ones own interpretations and at the same time discarding the interpretations of others

Question 10

Define: Representativeness

Answer 10

Assigning too much weight to evidence that supports what you already beleive

Question 11

Define: Self-Attribution Bias

Answer 11

Good outcomes are as a result of your own brilliance

Bad outcomes are from things out of your control, like stupid people

Question 12

Define: Conservatism

Answer 12

Not fully beleiving the bayes theorem probabilities and therefore not making appropriate adjustments

Question 13

Define: Motivated Reasoning

Answer 13

Accepting information that you agree with and ignoring information that you don’t agree with

Question 14

What are 3 additional theories/concepts that prove that our markets are only semi strong?

Answer 14

Prospect Theory

Beta

Bubbles

Question 15

What is Prospect Theory?

Answer 15

Evaluating an investments (Prospect) potential gains and losses separately as opposed to together.

Investors are risk adverse (meaning they want to avoid even the smallest loss). This means that they will hold on to a “loser” investment in the hopes that it will recover, all to avoid selling at a loss.

An example would be hanging on to Bre-X stock because you don’t want to sell it at a loss

Question 16

What is the Disposition Effect?

Answer 16

cut winners short (sell)

Let losers run (hold)

Question 17

What are book to market price ratios?

Answer 17

The difference between the book value of shares and the market value of shares

Book value= Shareholder Equity/#of Shares outstanding

Market Value= Book Value/# of shares outstanding

Question 18

What is a bubble?

Answer 18

Surges in stock prices that exceed anything predicted by rational decision making. Often driven by a “herd” mentality.

Question 19

What is Post-Announcement Drift? Why does it happen?

Answer 19

When actual earnings are higher or lower than expectations and the stock trades at a higher volume that lasts for several weeks.

It takes time for the stock price to adjust to news. Investors take time to digest the news.

Question 20

Why might an auditor be liable?

Answer 20

Historical information that they sign off on may turn out to be very different from the fair value.

They also carry liability insurance so people know that they will likely get money if they sue them

Question 21

What is the clean surplus theory?

Answer 21

Assumption that there are no unusual items in the income statement and as such the income statement would show all gains and losses of the company

It combines data from the income statement and the balance sheet to value the company

Question 22

What is the difference between “Value in use” and “Fair value”

Answer 22

Value in use: Valued at discounted present value of future receipts

Fair Value: The price that would be received to sell an asset

Sometimes market price isn’t possible to ascertain, so value in use would be used.

Question 23

What are some examples of the measurement approach in action?

Answer 23

AR & AP is measured at the amount of cash to be exchanged, not PV

PPE Impairment tests

Question 24

What is sensitivity analysis?

Answer 24

Creating individual probabilities based on each risk a financial instrument faces

Question 25

What is value at risk?

Answer 25

The joint probability based on all risk factors