Acct Theory- Mod 5 Flashcards
What is the main concept of Mod 5?
Measurement Approach to Decision Usefulness
What is the general concept of the measurement approach?
Measuring items at fair value as opposed to using historical cost information
What is the difference between the INFORMATION approach and the Measurement approach?
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
What is the current trend in decision usefulness?
Away from the information approach and towards the measurement approach
Why is their a trend in decision usefulness towards the measurement approach?
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
What is the concept of “Behaviour Finance”?
The study of investor physcology and beahviour
What are the six reasons that prove our markets are semi-strong?
Limited Attention
Overconfidence
Representativeness
Self-Attribution Bias
Conservatism
Motivated Reasoning
Define: Limited Attention
People don’t have time to analyze every aspect of annual reports. So instead they focus on net income
Define: Overconfidence
Overestimating the accuracy of ones own interpretations and at the same time discarding the interpretations of others
Define: Representativeness
Assigning too much weight to evidence that supports what you already beleive
Define: Self-Attribution Bias
Good outcomes are as a result of your own brilliance
Bad outcomes are from things out of your control, like stupid people
Define: Conservatism
Not fully beleiving the bayes theorem probabilities and therefore not making appropriate adjustments
Define: Motivated Reasoning
Accepting information that you agree with and ignoring information that you don’t agree with
What are 3 additional theories/concepts that prove that our markets are only semi strong?
Prospect Theory
Beta
Bubbles
What is Prospect Theory?
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
What is the Disposition Effect?
cut winners short (sell)
Let losers run (hold)
What are book to market price ratios?
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
What is a bubble?
Surges in stock prices that exceed anything predicted by rational decision making. Often driven by a “herd” mentality.
What is Post-Announcement Drift? Why does it happen?
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.
Why might an auditor be liable?
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
What is the clean surplus theory?
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
What is the difference between “Value in use” and “Fair value”
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.
What are some examples of the measurement approach in action?
AR & AP is measured at the amount of cash to be exchanged, not PV
PPE Impairment tests
What is sensitivity analysis?
Creating individual probabilities based on each risk a financial instrument faces
What is value at risk?
The joint probability based on all risk factors
