BUS421
Chapter 1 – Introduction
•
Disclosure reduce monopoly power and enables potential entrants
•
Moved from historical cost accounting to current cost alternatives
i.
Value-in-use (discounted PV of future cash flows)
ii.
Fair value (exit value or opportunity cost)
Flow of the Contents
1.
Ideal Conditions
∼
∼
2.
Economy where firm’s future cash flows and probabilities are known
Asset and liability valuation is based on expected PV of future cash flows
Adverse Selection
∼
Problem of communication from firm to outside investors
∼
Assume investors are rational: decisions made to maximize expected utility
∼
Decision usefulness approach:
i. Information approach – form of disclosure does not matter ii. Measurement approach – increase responsibility for incorporating measurements of current asset and liability values properly into the F/S.
3.
Moral Hazards
∼
∼
Precise and sensitivity of information
∼
4.
Unobservability of manager’s effort running the firm (shirking issue)
Manager’s motivation for performance
Standard Setting
∼
Conflicting preferences of investors and managers
Chapter 2-7: Investor decision based and efficient market-oriented theories
Chapter 8-13: Management’s interests in financial reporting
Normative theory – tell individuals or constituencies what they should do (i.e. Chapter 3, singleperson decision theory and theory of investment)
Positive theory – it is judged by its logical consistency with underlying assumptions of how rational individuals should behave (i.e. Chapter 8, positive accounting theory)
Chapter 2 – Accounting Under Ideal Conditions
Conditions under which relevant financial statements will also be reliable and reliable information are presented without bias.
Ideal conditions – Future cash flows of the firm and the interest rate in the economy are publicly known with certainty
•
Assume investors are risk neutral – indifferent between exact
•
Disclosure reduce monopoly power and enables potential entrants
•
Moved from historical cost accounting to current cost alternatives
i.
Value-in-use (discounted PV of future cash flows)
ii.
Fair value (exit value or opportunity cost)
Flow of the Contents
1.
Ideal Conditions
∼
∼
2.
Economy where firm’s future cash flows and probabilities are known
Asset and liability valuation is based on expected PV of future cash flows
Adverse Selection
∼
Problem of communication from firm to outside investors
∼
Assume investors are rational: decisions made to maximize expected utility
∼
Decision usefulness approach:
i. Information approach – form of disclosure does not matter ii. Measurement approach – increase responsibility for incorporating measurements of current asset and liability values properly into the F/S.
3.
Moral Hazards
∼
∼
Precise and sensitivity of information
∼
4.
Unobservability of manager’s effort running the firm (shirking issue)
Manager’s motivation for performance
Standard Setting
∼
Conflicting preferences of investors and managers
Chapter 2-7: Investor decision based and efficient market-oriented theories
Chapter 8-13: Management’s interests in financial reporting
Normative theory – tell individuals or constituencies what they should do (i.e. Chapter 3, singleperson decision theory and theory of investment)
Positive theory – it is judged by its logical consistency with underlying assumptions of how rational individuals should behave (i.e. Chapter 8, positive accounting theory)
Chapter 2 – Accounting Under Ideal Conditions
Conditions under which relevant financial statements will also be reliable and reliable information are presented without bias.
Ideal conditions – Future cash flows of the firm and the interest rate in the economy are publicly known with certainty
•
Assume investors are risk neutral – indifferent between exact