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26 Cards in this Set

  • Front
  • Back

What is accounting policy?

The coherent set of hypothetical, conceptual and pragmatic principles forming a general framework of reference for a field of enquiry.

What does accounting policy address? (4)

1. Definition

2. Recognition

3. Measurement

4. Disclosure

What are the types of accounting theory and describe them (2)

1. Normative

- prescribes what should happen

- e.g. Conceptual Framework

- est a principle: who should look at your financial statements etc.

- Designed to explain and predict which firms will and which firms will not use a particular method

2. Positive

- Explain or predict activities

- Why did you choose policy

Development of theories


Definitions/Actions > Principles > Assumptions > Objectives

(Start with what you know and find info to support it)


Objectives > Assumptions > Principles > Definitions/Actions


What is positive accounting theory derived from (2)

1. Contracting theory

2. Agency theory

What is agency theory

Principal delegates decision-making authority to an agent.

Agent has legal and fiduciary duty to act in the best interests of the principal

Assumption that the agent is a utility maximiser (3)

1. Monitoring costs - incur to monitor behaviour of agent

2. Bonding costs - ensure agents aft in best interest of principal reports

3. Residual loss - loss as a result of separation of control

What is Owner-Manager Agency

Managers are likely to act in their own interests

What are the 3 major problems in owner-manager agency relationships

1. Horizon problem - differing time horizons are important to each party

2. Risk aversion - managers generally prefer less risk

3. Dividend retention - managers preference to hold onto funds

What is the risk when a lender agrees to provide funds to an entity (Manager-Lender Agency Relationships)? (2)

Borrower may not honour its obligation to repay all of the borrowed funds with interest

1. Credit risk

2. Debt covenants

What problems increase the lenders risk (4)?

Excessive dividend payments to owners

Asset substitution

Claim dilution


What entities have political relationships? (3)


Trade Unions


What are the implications of agency theory for accounting policy choice (3)

Bonus plan hypothesis

Debt hypothesis

Political cost hypothesis

Bonus plan hypothesis

Managers with bonus plans prefer accounting policies that increase profit

Debt hypothesis

Managers of entities with high leverage prefer accounting policies that increase profit and equity

Political cost hypothesis

Managers of larger entities are more likely to prefer accounting policies that reduce profit (e.g. decrease taxable income)

Hypothesis involved in role of accounting in capital markets (2)

1. Mechanistic hypothesis

2. Efficient markets hypothesis

Mechanistic hypothesis (3)

Predicts that market reacts mechanistically to changes in accounting nos

Investors assumed to ignore diffs in acctg policies

Implication that investors could be fooled by cosmetic changes in policies

Efficient Markets Hypothesis (3)

Markets are efficient

Prices in mkt rapidly adjust to new info so that price fully reflects available info

Three forms: Weak, Semi Strong, Strong

Positive accounting research - types of market based data (3)

Event studies

Do share prices respond to specific events

Association studies

Is share price or returns associated with level or changes in earnings

Value relevance

Are asset values associated with share price / returns

What does accounting theory tell us about accounting policies (3)?

Capital markets theories attempt to explain the effects of accounting policy coice on share prices

Mechanistic hypothesis predicts that investors ignore diffs in accounting policy choice and fixate on reported nos.

The efficient market hypothesis predicts that share price will rapidly impound all publicly avail info incl the choice of acctg policy on profit

Legitimacy theory (3)

Organisational legitimacy

The values and norm evident in the social contract have changed over time

In the past legitimacy was considered only in terms of economic performance

Now businesses are expected to consider a range of issues including the env and social consequences of their activities

4 ways organisation can obtain or maintain legitimacy

Seek to educate and inform society about actual changes in the orgs performances and activities

Seek to change perceptions of society, but not actually change behaviour

Seek to manipulate perception by deflecting attention from the issue of concern to other related issues

Seek to change expectations of its performance

How can disclosure of info abt an org's effect on, or relationship with society be used in each of the strategies

provide info to offset negative news which may be publicly avail

draw attention to strengths

Stakeholder Theory - Normative (3)

Orgs should treat all stakeholders fairly

Org should be anaged for benefit of all its stakeholders

Stakeholders are identified, and should be considered in org decisions because of their interest in the activities of the org

Stakeholder Theory - Managerial (2)

Seeks to explain how stakeholders influence org actions

Extent to which an org will consider its stakeholders is related to the power / influence of those stakeholders

- stakeholders' power is related to the degree of control that have over resources required by org