Chapter 1; Flashcards
The three stages in necessary in almost any discipline from sailing to accounting
Theory, instrument, application
Accounting is the production of what?
Information
Different types of accounting information
Financial, managerial, tax, etc.
What ties all the branches of accounting together?
Some people have information that others need
Broad principles and conventions of general application as well as rules and procedures that determine accepted accounting practices
Generally Accepted Accounting Principles (GAAP)
Evidence that can potentially affect and individuals decision
Information
What creates the demand for financial reporting?
Decision-making needs
A condition in which some people have more information than others
Information Asymmetry
For information to be useful it must be what?
Verifiable
Communication of information that is otherwise unverifiable, by means of an action that is costly to the seller
Costly Signal
Communication of information that is otherwise unverifiable by means that are virtually costless
Cheap Talk
A type of information asymmetry whereby one party to a contract has an information advantage over another party. Hidden information from past and present
Adverse Selection
A type of information asymmetry whereby one party to a contract cannot observe some actions relating to the fulfillment of the contractural terms by the other party. Essentially hidden future actions
Moral Hazard
A separation of ownership and management such that the owners are not able to monitor management personnel to ensure that management makes decisions in the best interests of the owners
Agency Problem
Adverse selection leads the company to provide as much credible information as possible so that the company obtains the highest price for its what?
Shares
In the case of moral hazard investors need to ensure management is properly using the company’s assets and therefore need more what information?
Current
Two reasons for flexibility in financial reporting
Variety of businesses and estimates for the future
A theory for understanding managers’ motivations, accounting choices, and reactions to accounting standards
Positive Accounting Theory
Managers’ efforts to bias reported accounting information in one way or another
Earnings Management
- influence investors to make higher estimates and charge more for shares
- give the appearance of lower risk and get lower interest rates
- to meet regulatory standards for banks
- provide a stronger bargaining position in mergers and against competitors
- to obtain higher profit based bonuses
Reasons for Earnings Management
- reduce likelihood of taxes of highly profitable
- get more gov aid
- level the curve and show all years as doing equally well
- improve bargaining power against unions
Reasons for Negative Earnings Management
A general term used to refer to markets for securities (Ex. Toronto Stock Exchange)
Security Market
Securities markets take accounting information as inputs in the formation of what?
Prices
Firms with equity, debt, or other securities traded in public markets
Public Companies
One in which the prices of securities traded in the market at all times properly reflect all information that is publicly known about those securities
Efficient Securities Market (Semi-Strong Form)
- Securities prices react quickly to accounting information
- Accounting info competes with other sources of info
- It is important to distinguish new info from what was already reflected in the prices (try not to double react)
- Using only publicly known info, it is hard to earn abnormal profits
- It is possible to earn abnormal profits using info that is NOT publicly available
- Accounting reports and standards can assume that users have a reasonable level of sophistication
- Efficient market theory influences legal doctrine
Implications of Efficient Market Theory on Accounting
