Exam Prep

Question 1

Define Inductive Reasoning

Answer 1

be based on numerous observations

Question 2

Define Deductive Reasoning

Answer 2

developed on the basis of logic

Question 3

What is theory?

Answer 3

A scheme or system of ideas or statements held as an explanation or account of a group of facts or phenomena
Based on logical (systematic or coherent) reasoning

Question 4

Power of accountants

Answer 4

Output of the accounting process impacts many decisions about wealth transfers so the judgement of accountants affect various parties’ wealth
Accountants can give legitimacy to organisations which may not otherwise be deemed legitimate (e.g. emphasising profits)

Question 5

Describe accounting theories development. Give types of theories, approaches and features of each.

Answer 5

INDUCTIVE (1920-1960)
developed through observation. What majority does is the norm.

NORMATIVE (1960-1970)
Deductive approach. Prescribes practices. Based on norms, values and believes of the researcher
eg. CoCoA Continuosly Contemporary Accounting

POSITIVE (1970)
aim at explaining and predicting accounting practices.
starts with assumptions and through logical deduction lead to prediction. eg. PAT.

Question 6

Parsimonious?

Answer 6

A parsimonious theory is one that provides the most ‘logically economic’ explanation for a particular phenomenon or event

Question 7

Define Financial Reporting

Answer 7

A process involving the collection and processing of information of a financial nature for the purpose of assisting various decisions to be made by parties external to the organisation

Question 8

Describe GPFRs

Answer 8

GENERAL PURPOSE FINANCIAL REPORTS

OBJECTIVE
to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.

Question 9

Define Regulation

Answer 9

Oxford:
prescribed rule or authoritative direction

Macquarie:
a rule of order, as for conduct, prescribed by authority; a governing direction or law’

Control or govern

Question 10

what are the perspectives of choosing accounting methods?

Answer 10

efficiency perspective - methods chosen that best show
company’s performance.

Opportunistic perspective - methods chosen driven by
self interest.

Question 11

Free market Perspective

Answer 11

1. Adam Smith’s Invisible hand perspective
2. Private economic-based incentives
3. ‘Market for managers’
4. ‘Market for corporate takeovers’
5. ‘Market for lemons’
6. Other reasons for not regulating

Question 12

Adam Smith’s Invisible hand perspective

Answer 12

without regulation, (like with invisible hand) productive resources will find their way to most productive uses.

Question 13

Criticism of Free market perspective

Answer 13

Ignores market failures
uneven distribution of power
information assymetry

Question 14

Private economic based incentives.

Answer 14

one of free market perspectives.
shareholders expect managers to be self interested and opportunistic.

With no safeguards, shareholders will have lower share price, banks will charge more to borrow money.

accounting based bonuses and debt ratios implemented.

if no financial reports prepared = higher costs.

Question 15

Market for managers argument

Answer 15

assumed managers will be encouraged to adopt strategies to maximise value of the firm (provides favourable view of own performance)

What if manager close to retirement?
efficient market assumption
previous performance known assumption

Question 16

Market for Corporate takeover argument

Answer 16

one of free market perspectives

underperforming companies will be taken over and managers sacked. Managers want to maximise company’s performance.

Question 17

Market for ‘lemons’

Answer 17

one of free market perspectives
no information means ‘bad news’.
company will try to report on good and bad news.
managers don’t want to withhold bad information. Reputation at stake.

Question 18

Pro-regulation perspective

Answer 18

Assumptions:

• market not efficient (sub optimal info produced)
• investors need protection from fraud
• regulation leads to consistent methods used (comparable)

Question 19

Theories of Regulation

Answer 19

1. Public interest theory
2. capture theory
3. economic interest group theory

Question 20

Public interest theory

Answer 20

Pro-regulation

• government represents best interests of society
• regulation benefits society
• balancing act between perceived social benefit vs
  social cost

Question 21

Capture theory

Answer 21

regulated party captures the regulator.
once captured tries to influence the regulator to its own advantage.
difficult for regulator to remain independent

Question 22

Economic interest group theory

Answer 22

groups which will protect economic interests.

groups often in conflict with each other and lobby to benefit themselves.

Question 23

Harmonisation

Answer 23

a process of increasing the compatibility of accounting practices by setting bounds to their degree of variation.
More flexible than standardisation

Question 24

Standardisation

Answer 24

a process that imposes a given set of rules or requirements on a particular item, process of practice (i.e. every country adopts the same accounting standards.)

Question 25

IFRS

Answer 25

International Financial Reporting Standards. | 1/1/2005 all Australian AASB reporting entities compliant with IFRS & IAS

Question 26

Your opinion on whether the adoption of IFRS in many parts of the world has been a success. What are the benefits of accounting standardisation?

Answer 26

* review and endorsement process by National standards boards results in difference in practice amonst nations. * IASB no ability to enforce its accounting standard in countries that adopted IFRS. * countries can modify IFRS before they're adopted. * inconsistencies in implemenation, monitoring and enforcement. * subjective judgement may differ based on cultural/political differences * how auditors and regulators deal with those differences? * different determination of fair values for similar assets.

Question 27

What is a conceptual framework?

Answer 27

A coherent system of interrelated objectives and fundamentals that is expected to lead to consistent standards and that prescribes the nature, function and limits of financial accounting and financial statements. provides a 'theory' of financial accounting.

Question 28

What are fundamental qualitative characteristics of Conceptual Framework?

Answer 28

``` Relevance Truthful Representation (completeness, neutrality and free of error) ```

Question 29

What are the fundamental quantitative characteristics of Conceptual Framework?

Answer 29

comparability verifiability timeliness understandability

Question 30

What is measurement?

Answer 30

process of determining the monetary amounts at which the elements of the financial statements are to be recognised and carried in the balance sheet and income statement.

Question 31

How do numbers in financial reports affect agreements or contracts?

Answer 31

* debt/asset ratio * performance linked management bonuses * governement funding

Question 32

What are the alternative bases of measurements?

Answer 32

* historical costing * current costs (entry price) * realisable value (exit price) * Present value (future cashflows discounted by correct rate) * Deprival value ($ value of loss by depriving the company from the use of the asset)

Question 33

What are the advantages and disadvantages of using many forms of measurement?

Answer 33

ADV: * Flexibility (companies differ) DISADV: * difficult to compare * difficult to add up * managerial opportunisim

Question 34

Three fundamental principles of measurement?

Answer 34

1. Represent faithfully most relevant information. 2. how does it affect Comprehensive Income & Cash Flow statements? 3. cost of measurement justified by benefits of that information.

Question 35

What is stewardship?

Answer 35

process whereby a manager demonstrates how he or she has used the resources that have been entrusted to them by others who generally are not directly involved in the management of the entity

Question 36

Describe Historical Cost?

Answer 36

ASSETS: FV at the time of aquisition LIABILITIES: amount of proceeds received in exchange for the obligation

Question 37

What are the limits of historical costs?

Answer 37

* assets bought at different times may hold different value * problem to additivity * can overstate profits in times of rising prices * holding gains recognised when disposed of an asset rather than when the gains occurred.

Question 38

Describe Inflation Accounting?

Answer 38

range of accounting systems designed to correct problems arising from historical cost accounting in the presence of inflation. NOT FAIR VALUE ACCOUNTING

Question 39

Describe how historical costing can convert old prices to new prices?

Answer 39

1. HC x CPI - inflation 2. CCA - cost to buy now 3. CoCoA - Cost to sell

Question 40

Describe the realisation principle of historical costing?

Answer 40

* P&L NOT recognised when held * P&L recognised when sold * gains not recognised while holding an asset

Question 41

Describe how historical costing tries to maintain financial capital?

Answer 41

Payment to owners: - return of capital (SHRINKS COMPANY) - dividends from profit (some left for next year)

Question 42

What is additivity in historical costing?

Answer 42

old money is not the same as new money. Can't add them up together.

Question 43

Describe Current Purchasing power accounting (CPPA)

Answer 43

restate items in Fin Statements in terms of units of equal purchasing power. During rising prices prevents the entity to distribute unadjusted profits based on HC (distributing part of its capital) ADV: * relies on data already available under HC * CPI data available * no additional costs DIS: * CPI may not reflect industries * confusing info for users

Question 44

Describe Current Cost Accounting (CCA)

Answer 44

* based on actual valuations * differentiates between profits from trading and holding gains * Holding gains can be realised or unrealised ADV: * better comparability DIS: * replacement costs not the same. * replacement assets may be better replaced by different assets. * difficult to determine replacement costs.

Question 45

Describe CoCoA

Answer 45

Continuously Contemoprary Accounting. capacity to adapt * based on valuing assets at exit prices at reporting dates * No distinction between realised and unrealised gains—all gains are treated as part of profit * Profit is the amount that can be distributed, while maintaining the entity’s adaptive ability (adaptive capital)

Question 46

Describe Fair Value

Answer 46

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction in the principal (or most advantageous) market at the measurement date under current market conditions (i.e. an exit price) CAN BE VOLATILE. PROCYCLICALITY.

Question 47

Describe PAT

Answer 47

Positive Accounting Theory: * seeks to explain and predict particular phenomena. * focuses on relationships * all individual's actions driven by self interest It is concerned with explaining accounting practice. It is designed to explain and predict which firms will and which firms will not use a particular method … but it says nothing as to which method a firm should use.’ (Watts and Zimmerman 1986, p. 7).

Question 48

What are the origins of PAT?

Answer 48

* efficient market hypothesis | * agency theory

Question 49

Describe Agency Theory

Answer 49

* Relationship between principals and agents * information assymetry can create uncertainty * assumptions of self - interest and wealth maximisation. * leads to agency costs

Question 50

Describe Agency Costs

Answer 50

* Monitoring costs (eg. audits) * bonding costs (preparing financial statements) * residual costs (can't remove all opportunistic behaviour)