Class 1 Slides Flashcards
Why is financial reporting important?
The economy needs CAPITAL RESOURCES to operate. These capital resources are allocated through CAPITAL MARKETS. The allocation process consists of a large number of DECISIONS by capital providers and consumers. These decisions are based on financial and other types of INFORMATION about the available alternatives. Some of the information is provided by FINANCIAL STATEMENTS.
What is accounting theory?
Accounting theory consists of conceptual frameworks, accounting standards, valuation models, hypotheses & theories, normative theory (prescriptive), and positive theory (descriptive)
Why is accounting policy making political?
Financial reporting regulation is essentially a political activity. The final outcome is often negotiated. Standards may impose more costs of some parties over others. For most accounting standards, there are winners are losers.
Can accounting standards cause economic consequences?
Yes, accounting standards have enormous economic consequences. Examples: SFAS No. 2 (expensing of R&D costs); use of fair value accounting and the global financial crisis.
What is the FASB ASC?
The FASB Accounting Standards Codification is a collection of all the accounting standards issues by various regulators over the past fifty years.
What are the benefits of the FASB ASC?
Simplicity; Accuruate representation of GAAP; Up-to-date research; research time is reduced; noncompliance risk is mitigated; updates are provided in real-time
What is argument for supporting unregulated financial reporting?
Those supporting this argument have a laissez faire approach (no or little gov’t intervention). Other arguments include agency theory (which explains why incentives exist for voluntary reporting to owners); signaling theory (which explains wider voluntary reporting to capital markets); and private contracting (investors can buy the information from a 3rd party for free)
What is agency theory?
Modern day firms are characterized by a separation of ownership and control. As a result, there is a conflict of interest between the shareholders (principals) and managers (agents), where the managers’ goals are not aligned with shareholders’ goals. As such companies incur agency costs to keep managers in check. Examples: hiring security guards to prevent theft; hiring supervisors to monitor employees.
What incentives do managers have to lower agency costs?
Agency costs reduce managers’ compensation. Other costs (monitoring, contracting, etc.) also reduce the income available to the managers.. Good reporting will enhance the reputation of a manager and should result in higher compensation as agency costs are minimized if owners perceive that accounting reports are reliable.
What is signaling theory?
Information is an important part of a capital market. Firms compete with one another for scarce capital. The ability of a firm to raise capital will be enhanced if the firm has a good reputation for financial reporting. Voluntary disclosure is necessary in order to compete successfully in the market for capital. Good reporting would lower a firm’s cost of capital. Conversely, firms that do not voluntarily disclose information imply some sort of bad news.
Why do managers voluntarily disclose bad news?
Managers voluntarily disclose bad news related to earnings for 2 reasons:
- To lower litigation risk against managers.
- Managers have reputational incentives. Firms whose managers acquire a reputation for failing to disclose bad news are less likely to be followed by analysts and money managers, thus reducing the price and/or liquidity of their firms’ stocks.
What is meant by “private contracting for information”?
If information were truly desired beyond that which is publicly available and free of charge, private individuals can buy the desired information. This information is then sold to those who desire it in the form of investor newsletters.
