Accounting theory

Question 1

What is positive accounting theory designed to do?

Answer 1

To explain and predict which firms will and will not use particular accounting practices.

But not which they should do

Question 2

What are the assumptions of positive accounting theory? 3

Answer 2

• individuals are driven by own self interest
• only act on opportunities which would maximise their own wealth
• don’t have morality/loyalty

Question 3

What is agency theory?

Answer 3

Tries to explain why you should select a certain accounting method and why it matters
Focuses on relationship between principle and agent

Question 4

How do principles restrict the behaviour of agents?

Answer 4

They lower their salary so agents have an incentive to join contracts that would limit actions which would be detrimental to principle

Question 5

What are the 3 different types of agency costs?

Answer 5

• Monitoring costs:cost of monitoring agent’s behaviour (auditing FS)
• bonding costs:cost of agents trying to bond their behaviour with expectations of principle (preparing FS)
• residual loss:it is too costly to get rid of all opportunistic behaviour

Question 6

What are the two perspectives adopted by positive accounting theory researchers?

Answer 6

• Efficiency perspective:researchers try to explain how contracts can minimise agency costs (ex-ante-before the event)
• opportunistic perspective:researchers try to explain managers’ actions once contracts are already in place (ex-post) it’s not possible to write complete contracts so managers act opportunistically

Question 7

What are the 3 key hypotheses in positive accounting theory?

Answer 7

• bonus plan hypothesis:managers who have bonus plans are more likely to use accounting methods that increase reported income
• debt hypothesis:managers are more likely to use accounting methods that increase income when firm has a high debt/equity ratio
• political cost hypothesis:it is more likely for large firms to use accounting methods that reduce reported profits because they want to show that they don’t exploit smaller firms

Question 8

What are the criticisms of PAT?

Answer 8

• doesn’t provide prescription
• assumes actions are driven by self interest (too negative and simplistic)
• assumes market efficiency
• not a lot of development (same hypothesis in different settings)
• ignores organisational specific relationships

Question 9

What are the main points in capital market research? 5

Answer 9

• explores role of accounting and other financial info in equity markets
• explores how groups of individuals react to accounting disclosures
• examines statistical relationships of financial info and share prices
• favourable reactions evidenced by share price increase
• no share price change means no reaction

Question 10

What is the main point of capital market research?

Answer 10

to asses the aggregate effect of financial reporting on investors by looking at market reactions (only investors)

Assumes market efficiency

Question 11

What is information content of earnings used for?

Answer 11

Used to separate firm specific share price movements from market wide movements

Assumes that investors are risk averse and have the same expectations

Question 12

How is total actual return separated in the information content of earnings?

Answer 12

Normal (expected) returns-market wide
Abnormal (unexpected returns)-firm specific

Abnormal returns are used to indicate the info content of announcements

Question 13

What will happen if markets are efficient?

Answer 13

Share prices will instantaneously adjust to all publicly available info

But there are market anomalies

Question 14

List 3 results of CMR research

Answer 14

Beaver-share prices and returns were related to accounting earnings (price anticipated future earnings)
Collins-share prices were a better indicator of future earnings in larger firms
Dechow-earnings are more strongly associated with returns over short intervals than with realised cash flow

Question 15

What are the criticisms of CMR? 4

Answer 15

• statistical research:can’t tell you reasons how and why accounting info seems useful or how earnings Can be anticipated
• treats groups as homogenous
• indirect:taking results and inferring from them
• sometimes conducted by researchers who don’t know enough about accounting to know which info may matter

Question 16

What is behavioural financial accounting research?

Answer 16

Analyses individual responses to financial reporting and examines decision making by many groups

Using methodologies from behavioural sciences to examine the interface between acc info, processes and human behaviour

Question 17

What type of research is behavioural financial accounting research ?

Answer 17

Positive research because it tries to explain/predict what people do

Question 18

What are the 3 main research themes in behavioural financial accounting?

Answer 18

• use and presentation of items:if a cue is not used, is it not material or do they not know how to use it?
• information overload:increasing cues can improve decision making, but only to a certain point
• weighing cues and consistency:the realtime importance of cues and consistency of decision over time

Question 19

What are the 3 types of heuristics?

Answer 19

• representativeness-how similar is this to a typical case?
• anchoring and adjustment:may stick to a certain view due to past experiences and won’t adapt much to new info
• availability:remembering past similar cases and their outcomes

Question 20

What are the limitations of behavioural financial accounting research? 5

Answer 20

• Conflicting results:can’t control variables or ask clear questions
• incomplete theories:don’t explore range of judgements and why they occur
• laboratory setting:unrealistic cues,artificial students,no experienced
• differences in culture/gender
• verbal protocol analysis:explanations incomplete, hard to process

Question 21

What is CSR?

Answer 21

Reporting on info of how a firm interacts with its physical/social environment (non financial)

Because of reputation,ethical reasons,it isn’t regulated

Question 22

What is legitimacy theory?

Answer 22

Trying to ensure that outside parties perceive the entity as legitimate. Meaning of legitimacy changes over time

Question 23

How do firms make themselves legitimate? 3

Answer 23

• they change output/goals/methods of operating to conform to the meaning of legitimate
• they try to change the meaning of legitimacy so it matches the firms current practices
• tries to become associated with symbols or values which imply legitimacy through communication

Question 24

What are the two parts of the stakeholder theory?

Answer 24

• Ethical branch:all stakeholder have the right to be treated equally by the firm. Management should manage the firm for the benefit of stakeholders.stakeholders should be provided info even if it’s not used
• managerial branch:tries to explain when management will try to achieve expectations of certain powerful stakeholders. Considers the different stakeholder groups in society.expectations of stakeholders should impact on firms policies

Question 25

What is institutional theory?

Answer 25

Prices a complimentary perspective in voluntary reporting to both stakeholder and legitimacy theory

Explain how legitimacy mechanisms become universal

Question 26

What is isomorphism?

Answer 26

The adaption of an institutional practice by a firm. By doing this organisations will become more homogenous and will confirm to expectations of the wider environment

Question 27

What are the 3 types of isomorphism?

Answer 27

• coercive isomorphism:responsive to stakeholder pressure
• mimetic isomorphism:copying other organisations
• normative isomorphism:responsive to groups norms and values

Question 28

What is decoupling?

Answer 28

The detachment between actual organisational practices and publicly announced practices

Evidenced by differences between disclosure and performance

Question 29

What is a limitations of traditional accounting?

Answer 29

-Externalities caused by the firm can’t be reliably measured so they are not recognised

Question 30

What are the arguments for CSR being regulated?

Answer 30

• improved comparability and consistency
• bad news can be included
• without regulation info only like benefits the company
• improved monitoring

Question 31

What are the arguments against regulating CSR?

Answer 31

• would discourage innovation and experimentation
• would only provide a basic minimum
• what info do stakeholders want
• extra costs

Question 32

What are the common features of the critical perspectives? 3

Answer 32

• accounting isn’t a neutral/objective report of events
• accounting practices support the powerful elite:inequality
• two way relationship:turn theory into practice, and practice into theory

Question 33

What are the critical perspectives on the government? 4

Answer 33

• supports those with capital
• actions not in public interest:try to enhance legitimacy of existing social systems
• use mandatory disclosure to keep people quiet
• restricts flow of info or types of available info

Question 34

What are the critical perspectives on accounting? 3

Answer 34

• conceptual framework is a means of legitimising acc profession
• financial reports are a means of legitimising company activities
• accountants seem like dull/boring people but is a facade. Mask how much power we have

Question 35

What are the Critical perspectives on regulation? 3

Answer 35

• Deregulation calls also get gov funding
• increased regulation is to support companies in regaining the trust of investors
• regulation is just testing symptoms, not cause

Question 36

What are the critical perspectives on positive accounting theory?

Answer 36

• it doesn’t look at relationships between less powerful groups
• CMR is too narrow and ignores non investors
• they are critical of anti regulation stances adopted by PAT

Question 37

What are the critical perspectives on CSR?

Answer 37

• used so regulators can suit their own objectives
• CSR is greenwash to camouflage corporate agendas
• disclosure legitimises, doesn’t challenge powerful companies

But at least CSR are using a workable solution. Overthrowing the capital system is unlikely

Question 38

What is positive accounting theory?

Answer 38

Tries to explain accounting practices