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Summary accounting & governance
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Solution Manual for Financial Accounting Theory 8th Edition by William Scott, Patricia O'Brien
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Solution Manual for Financial Accounting Theory 8th Edition by William Scott, Patricia O'Brien ||Complete A+ Guide
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Financial Accounting Theory 8th ed. / William R. Scott / 100 questions and answers, new 2024
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A&G SummaryACCOUTING & GOVERNANCE SUMMARY
Chapter 1: Introduction (video lecture 1) ............................................................................................... 2
Chapter 2: Accounting under ideal conditions (video lecture 2) ............................................................ 5
Chapter 3: The decision usefulness approach (video lecture 2, 3, 4) ..................................................... 7
Chapter 4: Efficient securities markets (video lecture 3 & 4) ............................................................... 10
Williams & Ravenscroft ......................................................................................................................... 14
P1 Gassen & Schwedler ......................................................................................................................... 16
P2 Dhaliwal et al. ................................................................................................................................... 17
P3 Amel-Zadeh & Serafeim ................................................................................................................... 19
Chapter 5: The value relevance of accounting information (video lecture 5) ...................................... 21
Chapter 6: The measurement approach of decision usefulness (video lecture 5) ............................... 24
P4 Fiechter & Novotny-Farkas ............................................................................................................... 28
P5 Siekkinen .......................................................................................................................................... 29
Chapter 11: Earnings management (video lecture 6) ........................................................................... 30
P6 Healy and Wahlen ............................................................................................................................ 37
P7 La Porta............................................................................................................................................. 39
Video lecture 7: Quality of non-financial reporting information .......................................................... 41
P8 Hummel & Schlik .............................................................................................................................. 44
P9 Michelon et al. .................................................................................................................................. 45
P10 Reimsbach et al. ............................................................................................................................. 46
P11 Barth et al. ...................................................................................................................................... 47
Video lecture 8: Corporate governance mechanisms ........................................................................... 48
Chapter 12 Standard setting: economic issues ..................................................................................... 54
Gillan...................................................................................................................................................... 55
P12 Imhoff ............................................................................................................................................. 57
P13 Shleifer & Vishney .......................................................................................................................... 58
Video lecture 9: Enron ........................................................................................................................... 60
Chapter 13: Standard setting: political issues ....................................................................................... 62
P14 Holthausen ..................................................................................................................................... 64
P15 Braam et al ..................................................................................................................................... 66
1
, A&G Summary
CHAPTER 1: INTRODUCTION (VIDEO LECTURE 1)
Accounting: The process of identifying, measuring and communicating economic information to
permit informed judgments and decisions by users of the information.
Separation of ownership and control leads to:
- Information asymmetry (moral hazard)
- Agency problem
Information asymmetry: When some parties know more than other parties.
- Adverse selection: people inside the firm (manager) have more information than the ones
outside the firm (outside investors)
- Moral hazard: if one party does not act in the best interest for the company (engage in risky
behavior or fails to act in good faith because it knows the other party bears the economic
consequences of their behavior) → happens if there is separation of ownership and control.
Agency problem: agents VS principals → principals face risk that agents do not behave appropriately.
Agency problem / Agency theory
1. Assumptions
o Opportunistic, self-interest behavior
o Bounded rationality
o Risk attitudes/ preferences
o Goal conflicts among participants
o Information asymmetry
2. 2 types of behavioural risks
o Adverse selection (one party has not all relevant information)
o Moral hazard (not support best interest of company)
3. To reduce these behavioural risks → 3 types of tools
o Incentives (bonus)
o Monitoring
o Bonding (using contracts)
The agency problem differs between financial accounting & management accounting.
Financial accounting Management accounting
Principal Capital providers Management
(& other stakeholders)
Agent External auditors, Employees
Financial intermediaries,
Government organizations
(management)
Focus on External reporting Internal reporting
Time orientation Focus on past Focus on future
Accounting standards? Yes No
Accounting standards can be of 2 types:
- Principle based: much room for interpretation (Dutch GAAP) (IASB)
- Rule-based: strict rules for every situation (US-GAAP)
➔ World is moving towards more principle-based standards
2
, A&G Summary
Most widely used accounting standard is IFRS (international financial reporting standards)
What is the objective of financial reporting?
- IASB: Conceptual framework for financial reporting: The objective of general purpose
financial reporting is 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 (capital providers)
- Scott: The objective of financial statements is to communicate information that is useful to
[…] users in making their resource allocation decisions and/or assessing management
stewardship.
- Accounting: the process of identifying, measuring and communicating economic information
to permit informed judgments and decisions by users of the information (American
Accounting Association, 1966).
Overall, the objective of financial reporting:
- Communicate information that is useful to users in making decisions about:
o Resource allocation: providing resources to an entity
▪ Buying, selling (or holding) shares and other equity instruments
▪ Providing or settling loans and other forms of credit
o Accountability: assessing management stewardship
▪ Monitor managers’ activities
▪ Managers have to account for choices made
▪ Discharge management from responsibility
o Protection of capital providers
→ It’s about all kind of information: financial and non-financial
Note: information is not the same as data: “Information is evidence that has the potential to affect
an individual’s decision” → information is thus relevant data (it must be important for decision
making)
IASB (2018) Conceptual framework for financial reporting:
- Fundamental qualitative characteristics
o relevance −> materiality
o faithful representation (reliability)
- Enhancing qualitative characteristics
o comparability
o verifiability
o timeliness
o understandability
- Cost constraint
o expected benefits > costs
There are several ways of ‘creative accounting’:
- Earnings management
- New financial instruments
- Mark-to-market accounting
- Special Purpose Entities (SPEs)
- Buy- and sale back
- Guarantee constructions
- Form over substance or substance over form?
3
, A&G Summary
Corporate governance can be described as:
- The ways in which suppliers of finance to corporations assure themselves of getting a return
on their investment (Shleifer & Vishy, 1997).
- A set of mechanisms that influence the decisions made by managers when there is a
separation of ownership and control (Larker et al., 2007).
Fundamental problem in financial accounting theory: how to design and implement concepts and
standards that best combine the investor-informing and manager performance-evaluating roles for
accounting information.
➔ it is unknown whether the benefits of regulation outweigh the costs of it
Well-working capital markets: markets on which the market values of assets and liabilities equal, or
reasonability approximate, their real underlying fundamental values.
Possibility Theorem of Arrow: no set of concepts will be fully satisfactory to both parties. For
example: investors will prefer different accounting concepts than will managers.
Stewardship: an ethic that embodies the responsible planning and management of resources.
4
, A&G Summary
CHAPTER 2: ACCOUNTING UNDER IDEAL CONDITIONS (VIDEO LECTURE 2)
Aim of Financial accounting theory: To advance your understanding practices by better explaining
and better predicting accounting practices using accounting theory.
Distinction in theories:
- Normative: prescriptive → ideal conditions
- Positive: describe and explanatory → real world
Efficiency market can be strong or weak:
- Strong efficiency market if you have all information
- Weak efficiency market if you only have information about the past
Ideal conditions: An economy where firms’ future CF and their probabilities are known
➔ However, in real world there is more risk/ uncertainty & complexity = non-ideal conditions
Measurement bases:
1. Historical cost (purchase price / manufacturing price)
2. Current value (replacement costs / fair value / value in use (PV))
Trade-offs between relevance and reliability
Ideal conditions: relevant → value in use
Non-ideal conditions: reliable → historical costs
Historical cost accounting VS Current value accounting
Historical costs Current value
Relevance Low relevance High relevance
Reliable Reliable (not subject to errors) Low reliability (due to non-
ideal conditions)
Revenue recognition When inventory is sold When changes in value occur
Recognition lag Great recognition lag Little recognition lag
Matching costs and revenues Matching Little matching
5
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