ACCOUNTING THEORY 1 - STUDY CHECKLIST
Lesson 1
Ideal conditions; certainty and uncertainty (including differences & similarities)
RRA - SFAS69; weaknesses of RRA (relevant but not as reliable)
Historical Accounting problems (relatively reliable but lacks relevance) -> several ways to
account for same thing (ex. Capital Assets; Full Costs & Successful Efforts)
Relevance VS Reliability = tradeoffs
Lesson 2
PV Model (doesn’t work well in practice)
Single Person Decision theory (concept of utility, investor maximizing his/her return; prior &
posterior probabilities; Bayes Theorem)
Information System (conditional probabilities; main & off main diagonals; progression of
GN/BN -> future expected earnings -> future expected returns; positive relationship b/w F/S &
payoffs)
Rational Risk Averse Investor (risk averse, chooses highest expected utility)
Principle of Portfolio Diversification (firm specific & market wide factors)
Optimal Investment decisions (including / ignoring transaction costs, beta)
Portfolio Risk (covariance calc, portfolio expected value & variance)
Decision Usefulness approach & standard setting bodies (SFAC1 & 2; HB section 1000;
HB 1100; HB 1400)
Lesson 3
Efficient Securities Market (semi strong form, relative concept, fair game, random walk)
Market Prices reflecting all available situation (Beaver study -consensus forecast)
Beaver’s arguments - Implications for financial reporting (4 points)
Informativeness of Price (noise traders)
Capital Asset Pricing model (cost of capital, calculate abnormal return)
Information asymmetry (adverse selection; timeliness of reporting; estimation risk)
Social significance of properly working securities markets (penalties & incentives)
Examples of full disclosure -> MD&A; FOFI
Lesson 4
Information Perspective (Beaver study - dramatic increase in share price volume)
Factors which complicate finding the market response (3 points)
Ball & Brown study (market responding to GN & BN in earnings)
Earnings Response Co-Efficients (ERC)
Beta
Capital Structure
Persistence ( look at components of F/S notes to identify which items are persistent
and which are non persistent)
Earnings Quality
Growth Opportunities
Similarity of Investors’ Expectations
Informativeness of price
Implications of ERC research
Measuring investors’ earnings expectations (time series; analysts’ forecasts)
Extraordinary Items (HB 3480 EI’s; HB 1520 unusual non-recurring items which are not EI)
Best accounting policy? (public good VS private good, elimination of current cost
accounting)
Information content of RRA - reasons for weak results for explanatory power of RRA
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ACCOUNTING THEORY 1 - STUDY CHECKLIST
Lesson 5
Measurement Perspective
Are Security Markets Efficient? (overconfidence; self attribution bias; share price
momentum)
Prospect Theory (Kahneman and Tversky)
Is Beta dead? (Fama & French)
Excess Stock Market Volatility
Stock Market Bubbles
Efficient Security Market Anomalies
post announcement drift (Bernard & Thomas)
market efficiency with respect to financial ratios (Ou & Penman)
market response to accruals (Sloan)
implications of securities market inefficiencies for financial reporting
Value relevance of financial statement info (Lev’s study on earnings quality)
Auditor’s Legal Liability (supports use of valuations)
Ohlson’s Clean Surplus Theory
Measurement Oriented Standards in GAAP
Financial Instruments
valuation of debt & equity securities (gains trading) SFAS 115 , Exposure draft HB 3855;
SFAS 130
derivative instruments HB 3860, SFAS 107, SFAS 133
Hedging - purpose of hedging and why a company would not hedge; criteria for hedges of
existing assets/liabs and anticipated transactions; types of price risk
Accounting for intangibles
accounting for purchased goodwill
self developed goodwill (Lev & Zarowin - R&D)
clean surplus model revisited
Beta Risk
Stock Market Reaction to other risks (MD&A; risk related disclosures HB 3860, SFAS 107,
SFAS 133)
Measurement Perspective on Risk Reporting (SEC requirement – quantitative price risk
disclosures)
Lesson 6
Economic Consequences -changes in accounting policies & constituency reaction; reasons
why; standard setters’ actions as a result
Employee Stock Options (APB25, SFAS 123, HB 3870, Black/Scholes model)
Market Reaction to accounting policy with no cash flow implications
PIP controversy
SFAS19
Positive Accounting Theories
Bonus Plan Hypothesis
Debt/Equity Hypothesis
Political Cost Hypothesis
Efficient and Opportunistic versions of PAT
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ACCOUNTING THEORY 1 - STUDY CHECKLIST
Lesson 7
Non co-operative games of mgr-investor conflict (Nash equilibriums, Danielson –> straight
forward maximization, constrained maximization)
Co-operative Game Theory Models (binding agreements, moral hazard, reservation utility,
disutility of effort)
Owner-Mgr employment contracts (first best; second best; rental; fixed & moving support)
Bondholder-Mgr Lending contracts
Holmström Agency Model
Use of Net Income as a basis for contracting, auditing to add credibility
Rigidity of Contracts (incomplete)
Lesson 8
Are Incentive contracts necessary? (Fama, Arya, Fellingham & Glover, Wolfson)
Managerial incentive plans
Manager Compensation – Share price VS Net Income (pros & cons)
Role of Risk in Manager Compensation (methods to reduce risk)
Empirical Compensation Research
Politics of Executive Compensation (Jensen & Murphy)
Earnings Management (Healy’s study)
(1) Control various accruals (discretionary VS non discretionary -look at components of
F/S notes to identify which items are discretionary and which are non discretionary)
(2) Change accounting policies
Beneficial & adverse effects of earnings management
Other Motivations for Earnings Management
Contractual; Political; Taxation; Change of CEO: IPO’s, Communicate information to
shareholders
Patterns of Earnings Management
Taking a bath
Income Minimization
Income maximization
Income smoothing
Good Earnings Management (efficient contracting mgr behavior, blocked communication)
Bad Earnings Management (opportunistic mgr behavior)
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ACCOUNTING THEORY 1 - STUDY CHECKLIST
Lesson 9
How to characterize information production
Finer information
Additional information
Credibility
CONTRACTUAL INCENTIVES (for regulation of info production)
Manager incentive contract; Debt Covenants -> concept of internalization
MARKET BASED ( non contractual) INCENTIVES (for regulation of info production)
Managerial Labour Market
Takeover Market
Efficient Securities Market (Capital Market)
Other INFORMATION PRODUCTION INCENTIVES
* Disclosure Principle
* Signalling
* Private Information Search
Externalities and Free Riding
MARKET FAILURES
* Moral Hazard
* Adverse Selection
* Unanimity (lack of)
(Note: ensure you know what estimation risk is)
Cost & benefits of regulation
Lesson 10
Public Interest Theory; Interest Group Theory
Standard Setting Process
Standard Setting Relationship to Theories of Regulation
Conflict and Compromise – IAS 39, which applies to investments in debt and equity
securities, SFAS 130 Other Comprehensive Income (compromises!)
Criteria for Standard Setting - decision usefulness; reduction of info asymmetry; economic
consequences; political aspects (“reasonable compromise”)
ERH – Ethical Perspective on Standard Setting – internal & external motivation,
transparency
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