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E-Business > Acct Theory- Mod 6 > Flashcards

Acct Theory- Mod 6 Flashcards

1
Q

What is the objective of effecient contracting theory?

A

Understand and predict managerial accounting policy choices

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2
Q

Why do we seek to measure the performance of management and promote responsible behaviour?

A
  • To monitor management
  • Because we pay them alot
  • Because we can’t see what they are doing on a day to day basis
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3
Q

How does financial accounting relate to and contribute to contract efficiency?

A
  • Contracts typically depend on reported earnings

- Debt contracts usually contain accounting based covenants

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4
Q

What is one of the main risks under effecient contracting theory?

A

Managers my bias or manage reported earnings and working capital if it is to their benefit (for bonuses etc.)

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5
Q

What is the role of company management within the conceptual framework of accounting?

A

They are involved in the process of determination and implementation of new accounting policies

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6
Q

What is the general concept behind contrats that makes contracting work?

A

Two opposing parties with opposite goals.

Example: Banks wants the highest interest rate, you want the lowest interest rate.

Essentially, you want to pay the lowest amount possible and still get what you want.

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7
Q

What is an implicit contract?

A

Agreements that arise from continuing relationships.

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8
Q

Who are the two main constituents under effecient contracting theory?

A

Lenders

Shareholders

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9
Q

What are some risks faced by lenders under effecient contracting theory?

A
  • Management my not share information

- Management my choose policies that hide performance

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10
Q

When it comes to lenders, what is Payoff Asymmetry?

A

Gains are limited and therefore lenders are most concerned about protecting themselves from the downside/

Ex: If you have big gains, the bank still just gets the loan amount. If you have big losses they might get nothing back

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11
Q

What are the three main concepts promoted by effecient contracting Theory?

A
  • Reliability
  • Stweardship
  • Conservatism
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12
Q

What is the basic concept of Economic Consequences?

A

Despite what we have learned earlier, management’s choice of accounting policy will affect share prices.

It occurs when management changes accounting policies to:

  • Respond to changes in accounting standards
  • To avoid costs of technical default on debt covenants
  • Postpone investor awareness of financial distress
  • Preserve reputation
  • Preserve compensation
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13
Q

Will a company’s choice of accounting policies affect the decisions made by investors?

A

Yes. Different accounting policies have different effects on net income, which is a criteria for measuring management performance.

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14
Q

What are the two situations that allow a company to change accounting policies?

A
  • Required by IFRS

- If it results in the financial statements providing more relevant and reliable information

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15
Q

Can accounting policies be changed under ASPE?

A

Yes, but only under certain circumstances

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16
Q

What are some situations that allow accounting policies to be changed under ASPE? (7 Total)

A
  • To consolidate subsidiaries
  • To account for investments with significant influence
  • To account for interest in jointly controlled ventures
  • To capitalize or expense expenditures on internally generated intangible assets
  • To measure a defined benefit obligation
  • To account for income taxes under the taxes payable method or the future income taxes method
  • To initially measure the equity component of a financial instrument
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17
Q

What is an Employee Stock Option (ESO)?

A

A right to purchase shares in the company for a specified period of time at a set price. (Market price at the time of issue)

18
Q

Why are ESO’s popular with companies?

A

No upfront costs for the company

19
Q

What does it mean when an ESO is “In the Money”?

A

When the option price is less than the market price of the shares when the options vest and can be exercised

20
Q

How does an employee “Profit” from an ESO?

A

Buying the shares at a lower price than they could on the open market.

21
Q

In most situations, who gets employee stock options?

A
  • Senior Executives
  • Key Personnel
  • Sometimes, all employees
22
Q

What are the two key reasons that companies grant stock options?

A

-Motivation:
Hard work–Greater Net Income–Rise in Stock Price–Bigger Gain on Options

-Cash flow:
Requires no cash out of the company

23
Q

What is Grant Date?

A

The date when the employee is give the option

24
Q

What is exercise price?

A

The price at which the employee can buy the shares

25
Q

What is intrinsic value?

A

The difference between the exercise price and the market price on the grant date.

26
Q

What is vesting date?

A

The date on which an ESO can be exercised

27
Q

What is expiry date?

A

After this date, the option is worthless

28
Q

Are ESO’s free to companies?

A

No, there is an opportunity cost which is the amount of money forfeited by giving employees a lower price than the company could get by selling the shares on the open market.

29
Q

Do ESO’s need to be recorded by the company?

A

Yes, it is recorded as the value of the share at grant date (Fair value Determination). Recorded under compensation expense.

30
Q

How are ESO’s valued for expensing?

A

Black/Scholes option pricing formula

Calculates the theoretical price of specific types of options

31
Q

What are some criticisms of the Black/Scholes model?

A
  • Options can be freely traded, but ESO’s cannot
  • Options are forfeited if the employee leaves before vesting
  • European options cannot be exercised prior to expirary, unlike ESO’s which are an American option.
32
Q

What are the 3 main reasons management may be opposed to expensing ESO’s?

A
  • Additional expense may drop net income
  • Belief that Black Scholes my overstate expense
  • Limited revaluation of the options allowed
33
Q

What is positive accounting theory?

A

States that you can predict managers choice of accounting policy and how they will react to new accounting standards

34
Q

What are the key assumptions of the positive accounting theory?

A
  • Security markets are effecient
  • Managers are rational
  • Managers act in their own best interest (which may or may not be in the best interests of the company
35
Q

With regards to the positive accounting theory, what is The Problem of Alignment?

A

If compensation is tied to goals that benefit a manager AND those of the company, then the manager behaves accordingly (because his goals are the same as the company goals)

If there is a lack of alignment, then managers will be motivated by self interest (at the expense of the company)

36
Q

What are the 3 hypotheses under the Positive Accounting Theory?

A
  • Bonus Plan Hypothesis
  • Debt Covenant Hypothesis
  • Political Cost Hypothesis
37
Q

Describe the Bonus Plan Hypothesis

A

All things being equal, managers are more likely to choose accounting policies that will result in greater compensation for the managers

38
Q

Describe the Debt Covenant Hypothesis

A

All things being equal, the closer a company is to violating debt covenants, the more likely managers will choose an accounting policy that does not violate the debt covenants

39
Q

Describe the Political Cost Hypothesis

A

All things being equal, the greater the political “Cost”, the more likely managers will choose an accounting policy that defers reported income

40
Q

What are the two possible views under positive accounting theory?

A

Opportunistic form

  • Managers are opportunistic
  • Managers are motivated by their own utility

Efficient Contracting Form

  • Manager are motivated to control contracting costs by:
  • –Compensation contracts
  • –Corporate Governance
  • –Internal controls
41
Q

Do accruals influence accounting policies?

A

Yes, they can be manipulated upward and downward

E-Business (12 decks)

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