Chapter 8: Problem 10 (Crude Oil Prices)
Pricing and Accounting Policy Choices Predicted by the Bonus Plan and Debt Covenant Hypotheses of Positive Accounting Theory in Response to Increasing Crude Oil Prices
Bonus plan hypothesis. The bonus plan theory asserts that managers will make financial accounting decisions in a way that best benefits them (Scott, 2012). When managers are faced with the decisions that affect their own bonuses, they will take into consideration current and future periods. Depending on the structure of the bonus plan, this can result in manipulating earnings to either increase or decrease them (Healy, 1985).
Although increasing the price of the goods will help increase earnings, the method most used to do this is with accruals. If the bonus plan entails a minimum threshold of earnings in order to receive a bonus and, even with accruals, the threshold cannot be met, managers often accrue income into the next period so it can be utilized for calculating a future bonus. Alternately, if the minimum threshold has been met, or there is not one in place, the manager may accrue earnings into the current period as to maximize the amount of bonus. Also, if there is a maximum bonus threshold at which earnings are not subject to a bonus, managers will choose accruals that move earnings to a future …show more content…
The debt covenant theory asserts that managers will make financial accounting decisions based on any accounting-based debt covenants in a way as to not violate them. When managers are faced with a possible violation of the terms of a debt covenant, they may choose accruals to move earnings into the current period (Scott, 2012). Because this would most likely result in earnings volatility, managers may also choose to raise the price of the oil to increase earnings without manipulation. By reviewing a company’s debt covenants, investors can predict if any of the accounting policies that can increase earnings will be
Pricing and Accounting Policy Choices Predicted by the Bonus Plan and Debt Covenant Hypotheses of Positive Accounting Theory in Response to Increasing Crude Oil Prices
Bonus plan hypothesis. The bonus plan theory asserts that managers will make financial accounting decisions in a way that best benefits them (Scott, 2012). When managers are faced with the decisions that affect their own bonuses, they will take into consideration current and future periods. Depending on the structure of the bonus plan, this can result in manipulating earnings to either increase or decrease them (Healy, 1985).
Although increasing the price of the goods will help increase earnings, the method most used to do this is with accruals. If the bonus plan entails a minimum threshold of earnings in order to receive a bonus and, even with accruals, the threshold cannot be met, managers often accrue income into the next period so it can be utilized for calculating a future bonus. Alternately, if the minimum threshold has been met, or there is not one in place, the manager may accrue earnings into the current period as to maximize the amount of bonus. Also, if there is a maximum bonus threshold at which earnings are not subject to a bonus, managers will choose accruals that move earnings to a future …show more content…
The debt covenant theory asserts that managers will make financial accounting decisions based on any accounting-based debt covenants in a way as to not violate them. When managers are faced with a possible violation of the terms of a debt covenant, they may choose accruals to move earnings into the current period (Scott, 2012). Because this would most likely result in earnings volatility, managers may also choose to raise the price of the oil to increase earnings without manipulation. By reviewing a company’s debt covenants, investors can predict if any of the accounting policies that can increase earnings will be