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Accounting Theory and Practice > Week 6 Positive Accounting Theory > Flashcards

Week 6 Positive Accounting Theory Flashcards

1
Q

What is positive accounting theory concerned with?

A

Concerned with explaining and predicting which firms will and which firms will not use a particular method but it says nothing as to which method a firm should use.

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2
Q

What does agency theory explain?

A

Explains why the selection of particular accounting methods might matter?

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3
Q

What is the agency relationship?

A

A contract under which one or more (principals) engage another person (the agent) to perform some service on their behalf which involves delegating some decision-making authority to the agent.

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4
Q

What assumptions does agency relationship make?

A

Assumptions of self-interest and wealth maximisation.

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5
Q

How are incentive problems controlled?

A

Through contracts

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6
Q

What is the primary factor that limits the ability of contracts to solve incentive conflicts?

A

Costly information

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7
Q

Why is information likely to be asymmetrical?

A

The manager knows more than the owners about the profit potential of the firm and his perquisite taking.

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8
Q

What is price protection?

A

In the absence of contracts to restrict agents’ potentially opportunistic behaviour the principal will pay the agent a lower salary to compensates principals for adverse actions of the agent.

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9
Q

Well designed contracts ALIGN the interests of managers with what?

A

LONG-TERM firm value

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10
Q

What is the agency problem?

A

The agency problem relates to issues associated with motivating one party (the agent) to work in the best interests of another party (the principal).

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11
Q

Agency problems arise because of what?

A

Inefficiencies and information asymmetries

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12
Q

The agency problem leads to what?

A

Agency costs

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13
Q

What are the three types of agency costs?

A

Monitoring costs
Bonding costs
Residual costs

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14
Q

What are monitoring costs?

A

Costs of monitoring agents’ behaviour.

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15
Q

What are bonding costs?

A

Costs involved in agents bonding their behaviour to expectations of principals.

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16
Q

What is residual costs?

A

The loss from not being able to remove all opportunistic behaviour due to that being too costly.

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17
Q

What are three key hypotheses frequently used in PAT literature to explain and predict support or opposition to an accounting method?

A

Bonus plan hypothesis
Debt hypothesis
Political cost hypothesis

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18
Q

What is earnings management ?

A

Earnings management uses accounting methods that ensure that the profit and loss statement presents the preparer’s desired level of reported profit/loss.

19
Q

What are the three techniques that firms may use to manage their reported earnings.

A

Manipulate accruals
Timing of transactions
Change accounting policies

20
Q

How is manipulating accruals used to manage a firm’s reported earnings?

A

Shifting revenues and expense between periods.

21
Q

How is the timing of transaction used to manage a firm’s reported earnings?

A

By delaying or accelerating asset sales.

22
Q

How is changing accounting policies used to manage a firm’s reported earnings?

A

By being an early adopter of a new standard that increases income.

23
Q

What is the bonus plan hypothesis / management compensation hypothesis?

A

Managers of firms with bonus plans are more likely to use accounting methods that increase current period reported income.

24
Q

What is the debt (debt/equity hypothesis) hypothesis.

A

The higher the firm’s debt/equity (or debt/assets) ratio, the more likely managers use accounting methods that increase income (or assets).

25
Q

The higher the debt/equity ratio (or debt/assets), the closer the firm is to what?

A

Constraints in debt covenants.

26
Q

What is a debt covenant violation?

A

A breach of contract.

27
Q

What are political costs?

A

Political costs are costs resulting from political attention from government, lobby groups etc.

28
Q

Political costs may result in what?

A

Increased taxes, increased wage claims, product boycotts etc.

29
Q

What are the two perspectives adopted by PAT research?

A

Efficiency perspective

Opportunistic perspective

30
Q

What is the efficiency perspective concerned with?

A

Concerned with the efficiency of contracts based on estimates.

31
Q

Under the efficiency perspective, managers/preparers will select accounting methods based on what?

A

Economic performance

32
Q

What is the opportunistic perspective concerned with?

A

Recognises contracts are never complete so concerned with managerial avoidance beforehand.

33
Q

Under the opportunistic perspective, managers/preparers will select accounting methods based on what?

A

What suits their own purposes and manage earnings.

34
Q

Assuming self-interest, owners expect managers (agent) to undertake activities not always in the interest of who?

A

Owners (principal)

35
Q

Managers have access to information not always available to who?

A

Principals

36
Q

Costs of divergent behaviour are what type of cost?

A

Agency costs

37
Q

In the absence of controls to reduce opportunistic behaviour, agents (managers) expected to undertake activities disadvantageous to who?

A

The value of the firm

38
Q

When managers contract themselves not to consume perks so will receive higher salary, this is known as what?

A

Bonding

39
Q

What is the fixed basis of rewarding managers?

A

Salary independent of performance.

40
Q

Under the fixed basis of rewarding managers, why might manager not take great risks?

A

Because they do not share in potential gains.

41
Q

What is the salary plus remuneration basis of rewarding managers?

A

Base salary with bonuses tied to performance.

42
Q

What is an example of market-based bonus schemes?

A

Shares (incentive to help the company)

43
Q

In the absence of safeguards to protect debtholders (creditors), managers are predicted to adopt strategies to do what?

A

Disadvantage the debtholders

44
Q

Conservative accounting methods lead to what?

A

Relatively lower revenue recognition
Faster expense recognition
Higher liability recognition
Lower asset recognition

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