Fundamentals Of Accounting Theory Flashcards
What does GAAP mean?
-Generally accepted accounting principles.
-Put in place because management is biased to prepare statement that show companies positively
For public companies, what are the 3 GAAP that must be used to prepare their financial statements?
-IFRS
-international accounting standards (IAS)
-Interpretations (IFRIS OR SIC)
Why is there supply and demand for accounting information?
Because there is information asymmetry in this system
Describe information asymmetry in accounting context
It refers to the fact that those within the enterprise have more information than the external parties that are required to make decisions about the enterprise.
Describe adverse selection
Adverse selection is defined as a type of information asymmetry whereby one party to a contract has an information advantage over another party.
Describe moral hazard
Moral hazard is defined as a type of information asymmetry whereby one party to a contract cannot observe some actions relating to the fulfillment of the contractual terms by the other party
What is an agency problem?
It is the separation of the owners and management whereby the owners cannot observe the actions of management to ensure they are acting in their best interest
Why does agency problem exist?
An agency problem arise when managers who are agents for stockholders are tempted to act in their own interests rather than maximizing value. This can sometimes lead to unethical behavior which never leads to maximizing value
What are the desirable characteristics of accounting information and trade offs
-information that is relevant because it will help make predictions about the future performance
-information that is reliable and accurate
-given that users have conflicting needs and the fact that not everyone would be satisfied with the same accounting information some trade off must be made
What are the reasons why management is tempted to manage a company’s earnings upwards
-convince investors company is worth more and to pay more for shares
-convince creditors company is lower risk so they will provide more funds at a better rate
-to meet debt convenants or other regulatory requirements
-to obtain higher compensation
Why management may be tempted to manage a company’s earnings downward
-to reduce taxes or other regulations
-increases likelihood of government subsidies
-to take a big bath in a bad year that future years will be more likely to show rising profitability
-improve bargaining position with employee unions
What does the efficient market theory assumes
-security react quickly to accounting information
-accounting information competes with other sources information
-it is important to distinguish new information from what has already been reflected in the price
-using only publicly available information it is difficult to earn abnormal profits
-accounting reports and standard assume users have a reasonable level of sophistication
