Deck 3: Theories of Accounting

Question 1

Creative accounting describes the actions of report preparers who select accounting methods that best reflect the performance of the firm.

Answer 1

False

Question 2

AASB 101 requires the summary of accounting policies adopted by reporting entities to be presented in any section of the notes to the financial report.

Answer 2

False

Question 3

PAT assumes that managers will adopt accounting methods that benefit themselves ahead of the entity.

Answer 3

True

Question 4

Fair value accounting is an example of positive accounting theory.

Question 5

Income-decreasing accounting methods may be adopted if a firm believes it might be subject to political costs.

Question 6

PAT outlines the best (or most positive)way of preparing accounting reports.

Question 7

Corporate social responsibility reporting is consistent with stakeholder theory.

Question 8

Positive Accounting Theory seeks to:

A) prescribe which accounting methods should be used in particular circumstances.
B) explain and predict which accounting methods management is likely to select from available choices.
C) describe how social relationships are implicated in lobbying by interest groups in accounting standard setting.
D) formulate an understanding of how accountability to a broader set of stakeholders should be achieved.

Question 9

According to Chambers' CoCoA model,if assets cannot be sold separately they should be deemed to have no value.

Question 10

Normative theories are referred to as prescriptive theories.

Question 11

Creative accounting violates IFRS standards and generally accepted accounting principles.

Question 12

The ethical perspective of stakeholder theory is consistent with the efficiency view in Positive Accounting Theory.

Question 13

The Conceptual Framework can be described as a positive theory of accounting.

Question 14

PAT suggests that agents agree to bonding and monitoring mechanisms to avoid price protection by principals.

Question 15

In the decade leading up to the 1970s the notable theories being developed were predominantly normative in nature.

Question 16

Theorists' own values or ideological predispositions may be among the factors that determine which side of the argument they will adopt in respect to disputable connections in a theory with evidence.

Question 17

Regulation is deemed to be an instrument for creating confidence in the capital markets.

Question 18

Information asymmetry is the situation in which the agent has access to information not available to the principal.

Question 19

An empirically based theory could be described as being:

A) developed and supported on the basis of observations.
B) based on a set of accepted scales and measures.
C) based on a political approach developed in the early nation states.
D) related to a specific time period and not able to be generalised.

Question 20

An example of a theory that adopts a systems-oriented perspective is Legacy Theory.

Question 21

The rational economic person assumption as it is used in PAT is that:

A) All action by all individuals is driven by multiple interests in achieving a wide range of goals.
B) All individual action is driven by self-interest and individuals will act in an opportunistic manner.
C) Individuals are governed by a desire to cooperate in organisations to achieve the rational allocation of economic resources.
D) The rational person is concerned only with economic factors and so does not assess the importance of non-economic impacts on their organisation.

Question 22

In the situation where a contractual arrangement has been negotiated that provides managers with a bonus based on the profits generated by the entity:

A) The efficiency perspective identifies this as a way of minimising agency costs by aligning the interests of the principal and the agent.
B) The opportunistic perspective predicts that managers will seek to adopt accounting methods that best reflect the performance of the organisation.
C) The underlying premise of PAT is that agents (managers) aim to act in the best interests of the organisation, so the bonus is recognition of those efforts.
D) The efficiency perspective identifies this as a way of minimising agency costs by aligning the interests of the principal and the agent and the opportunistic perspective predicts that managers will seek to adopt accounting methods that best reflect the performance of the organisation.

Question 23

A combination of well-designed management compensation contracts,the market for corporate takeovers and a well-informed labour market should:

A) not be necessary as any one of these methods will control a manager's actions.
B) ensure that managers only act in their own self-interest.
C) mean that, on average, managers work in the best interests of owners.
D) remove any monitoring and bonding costs required under PAT.

Question 24

Under the efficiency perspective of PAT,where regulation bans an accounting method being used by a particular organisation:

A) This will lead to lower monitoring costs because management does not have as wide a range of methods to choose from.
B) This will lead to more useful reporting of performance because principals will be able to compare reports between different organisations.
C) This will lead to inefficiencies, as the financial statements will no longer provide the best reflection of the performance of the organisation.
D) This decreases the chance that agents will undertake opportunistic behaviour to provide principals with creative accounts.

Question 25

The agency relationship:

A) can lead to a loss of efficiency.
B) can only work if principals are paid a bonus.
C) involves delegating authority.
D) can lead to a loss of efficiency and involves delegating authority.

Question 26

An example of political costs under the PAT perspective is:

A) contributions to political parties.
B) costs associated with increased wage claims by trade unions.
C) the cost of remaining largely unnoticed by government regulatory agencies.
D) wage and salary deductions paid to unions.

Question 27

Examples of behaviours that create agency costs of debt include situations where the borrowing entity:

A) goes through a broker to raise debt funds.
B) pays minimal dividends.
C) invests in high-risk projects.
D) puts the borrowed money in the bank.

Question 28

Within the principal/agent perspective of PAT,the price-protection approach is:

A) The principal pays the agent a lower salary on the basis that the agent is expected to undertake opportunistic behaviour.
B) The contract between the principal and agent includes a clause that stipulates the basis for pricing of goods so that the agent does not price the product too highly in an effort to increase the agent's short-term rewards.
C) The contract between the principal and the agent specifies a period within which the price paid for the services of the agent cannot be changed.
D) The contract between the principal and the agent includes an agreement whereby the agent guarantees the price of the shares in the company will be protected by the agent's actions.

Question 29

The efficiency perspective in PAT research considers:

A) the cost of risk capital ex ante-before the provision of additional accounting information to reduce risk through monitoring.
B) what mechanisms are put in place 'up-front' with the objective of minimising future agency costs
C) the interaction of many investors in the market for corporate shares to generate efficient prices.
D) the lowest cost method of establishing which accounting methods are best for particular enterprises.

Question 30

Market-based bonus schemes may be considered more appropriate from a PAT perspective in industries in which:

A) successful strategies will not be reflected in accounting profits for a number of periods.
B) the price/earnings ratio is commonly greater than 12.
C) profits may be the subject of manipulation by managers.
D) capital investment is not an important strategic decision.

Question 31

Problems associated with rewarding managers based on share-price movements include:

A) Share prices do not often reflect the value of the business.
B) Share prices are a 'noisy' measure of management performance.
C) Share prices track closely the profit measures so it is more efficient to just use profit.
D) Share prices do not often reflect the value of the business and share prices are a 'noisy' measure of management performance.

Question 32

In a market where individuals are perfectly informed:

A) It could be assumed managers would ultimately bear costs associated with bonding and monitoring.
B) There are no monitoring costs as managers will not risk acting in their own self-interests.
C) Managers will receive a higher salary as principals will assume that managers will act opportunistically.
D) Principals will bear the costs of bonding and monitoring so that they can remain informed.

Question 33

Debt contracts will:

A) stipulate in advance all accounting methods to be used by managers.
B) ensure management has some discretionary ability to loosen restrictions negotiated by debt-holders.
C) encourage the practice of claim dilution to ensure debts are repaid.
D) occasionally restrict accounting techniques used by a firm.

Question 34

The central assumptions of economics that form a basis for Positive Accounting Theory are that:

A) all individual action is driven by self-interest and individuals will act in an opportunistic manner.
B) all individuals are entrepreneurial and will act in an opportunistic manner.
C) individuals cooperate in groups to form markets for the benefit of everyone.
D) there is a moral code that guides the behaviour of individuals to operate efficient markets.

Question 35

Using the PAT perspective of managers' behaviour,the effect of paying managers a fixed income salary is that:

A) They will feel secure enough to accept risky projects for the organisation.
B) They will prefer not to have the organisation take on debt.
C) They will be free to consider the optimal investment options for the organisation from the perspective of the principals.
D) They will feel secure enough to accept risky projects for the organisation and they will be free to consider the optimal investment options for the organisation from the perspective of the principals.

Question 36

Managers may be motivated to revalue assets where there are common forms of debt covenants in place because:

A) It loosens the covenant and allows the business to borrow more.
B) Revaluing assets provides more relevant information for debt-holders to use when making decisions.
C) Revaluing assets provides greater cash flows out of which to repay debt.
D) Revaluing assets provides more relevant information for debt-holders to use when making decisions and provides greater cash flows out of which to repay debt.

Question 37

Various researchers have indicated that when managers receive bonuses based on accounting performance they will:

A) make every effort to maximise profits in any given period.
B) adopt projects with low initial returns to ensure long-term success.
C) ensure income is minimised in a year they will not reach their performance target so that any profits can be recognised in later periods.
D) undertake long-term research and development projects if they are near to retirement.

Question 38

From an efficiency perspective of PAT,what approach should be adopted when managers are approaching retirement?

A) Increase the percentage of their remuneration that is paid out as bonuses based on accounting profit in order to keep them motivated to work hard.
B) Use a market-based bonus scheme.
C) Make them redundant as early as possible.
D) Link an additional element of the manager's superannuation package to profits.

Question 39

Positive Accounting Theory (PAT)assumes that principals are aware that agents will act opportunistically,so principals stipulate in any bonus contract the accounting methods to be applied.This means that:

A) A carefully worded contract is assumed by PAT to remove the potential for the agent to overstate profits.
B) Agents will not be permitted to negotiate elements of the bonus contract relating to the stipulation of accounting methods.
C) While the range of accounting treatments may be reduced, the cost of stipulating all the methods for all circumstances is too high, so there will always be scope for agents to opportunistically select accounting methods.
D) It is more efficient in terms of the assumptions of PAT not to use bonus plans for agents.

Question 40

Firms are subject to political costs when:

A) They are quite small and have little political influence.
B) They choose accounting policies that best reflect the performance of the firm.
C) They record high profits and share those profits in the form of increased wages.
D) They are highly visible, in the media or other arenas, often as a result of high profits.

Question 41

How would the deprival value of an asset be determined?

A) It is the net selling price except where the value to the business (present value) is less or the current replacement cost greater.
B) It is the present value of the future cash flows to be generated by the asset except where the current replacement cost or net selling price is less than that value.
C) It is the value to the business of the asset (present value) within the bounds that this value is not less than the net selling price or greater than its current replacement cost.
D) It is the current replacement cost where the present value is less than the current replacement cost and greater than the net selling price.

Question 42

The predictions of PAT formulated by Watts and Zimmerman (1990)are largely concentrated on the following predictions:

A) Managers of companies with bonus plans are likely to choose income increasing accounting policies.
B) Managers of companies that are close to violating accounting-based debt covenants are likely to choose income increasing accounting policies.
C) Managers of companies that are subject to greater political costs are likely to choose income decreasing accounting policies.
D) All of the given answers are correct.

Question 43

An asset that has a deprival value of zero is likely to be:

A) goodwill.
B) intangible assets.
C) land.
D) goodwill and intangible assets.

Question 44

A company has a debt contract in place which requires that the company's working capital (ratio of current asset to current liabilities)must never fall below 2.As balance date approaches,the company estimates that the working capital ratio will be 1.9 and the company may default on its debt contract unless remedial action is taken.Which of the following action(s)will increase the company's working capital at balance day?

A) revalue plant and equipment by 10%
B) increase allowance for doubtful debts by 10%
C) increase provision for warranty claims by 10%
D) accelerate recognition of credit sales by 10%

Question 45

The general aim of the current-cost accounting theory is:

A) to provide calculation of income which, after adjusting for changing prices, could be withdrawn from the entity and yet still leave the physical capital of the entity intact.
B) to provide a statement of financial position valuation method that presents a reflection of the capacity of the entity to adapt to changing conditions.
C) to provide calculation of income which, after adjusting for changing prices, could be withdrawn from the entity and yet still leave the financial capital of the entity intact.
D) to provide a statement of financial position valuation method that allows a more reliable basis for decision making by providing current costs.

Question 46

A new accounting standard requires ABC Ltd to recognise as expense all share-based payments,specifically the issue of options to its employees.Prior to this standard,the company need not do anything until the options are exercised.The manager of ABC Ltd is worried about this new standard as the company is close to a technical violation of its borrowing agreements that the debt-to-equity ratio be less than 40%.Most of the options on issue are cash-settled and will require an increase in liabilities.Which of the following accounting policies if adopted by the company could reduce the likelihood of a debt covenant violation?

A) switching from accelerated depreciation to straight-line depreciation method
B) decreasing provision for warranty expenses
C) revaluing assets upwards
D) All of the given answers are correct.

Question 47

Which of the following accounting policies is consistent with 'creative accounting'?

A) A firm with management compensation contract changes its depreciation policy from straight-line to accelerated rate method.
B) A start-up firm adopts a policy to expense research and development expenses as incurred.
C) A profit making tobacco producing firm changes its depreciation policy from straight-line to accelerated rate method.
D) A firm with debt contracts shifts inventory accounting policy from FIFO to LIFO method.

Question 48

Economic interest group theory of regulation adopts the notion that _____________ are considered to dominate the legislative process.

A) public interests
B) private interests
C) shareholders
D) debtholders

Question 49

A company has a debt covenant in place that limits the amount it can borrow to 50% of its tangible assets.If the company's actual value for that ratio is approaching violation of this debt covenant,consistent with PAT,management would try to relax the constraint by:

A) switching from straight-line depreciation to reducing balance method.
B) increasing allowance for doubtful debts from 5% to 10%.
C) increasing provision for warranty expenses.
D) revaluing assets upwards.

Question 50

Legitimacy Theory and Stakeholder Theory may both generate similar hypotheses to Positive Accounting Theory.The difference between PAT and the other two theories is that:

A) different research methods are applied.
B) PAT does not explicitly consider the organisation in its broader social context.
C) PAT is the only theory that takes a 'positive' research perspective.
D) PAT considers owners and managers who cannot be considered legitimate stakeholders.

Question 51

As part of the company's compensation plan,a chief executive officer (CEO)is paid 1% of net profit if net profit exceeds $20 00 000 but no more than $40 000 in a given year.It is estimated that net profit for the year will exceed $45 00 000.Under PAT the CEO will likely adopt which accounting policy

A) decrease reported profit as much as he can
B) decrease reported profit to $20 00 000
C) increase reported profit as much as he can
D) increase reported profit up to $40 00 000

Question 52

Which of the following are examples of categories of the main normative accounting theories that were developed in the 1950s and 1960s?

A) current-cost accounting and conservatism
B) critical theory and opportunity-cost accounting
C) ABC costing and historical-cost accounting
D) deprival-value accounting and exit-price accounting

Question 53

To comply with AASB 101,in which section of the financial report should a summary of accounting policies adopted by reporting entities be positioned?

A) anywhere in the notes to the accounts as long as this is disclosed
B) anywhere in the financial report
C) initial section of the notes to the accounts
D) middle section of the notes to the accounts

Question 54

Capture Theory may be described as taking the perspective that:

A) the regulated interest controls the regulation and the regulating body.
B) the principal has control over the agent through contracting and monitoring.
C) stakeholders compete to influence the entity in which they have a stake and management attempts to capture that influence through voluntary disclosures.
D) the regulated interest is controlled by the regulation agency that generates the regulations.

Question 55

A machine with a carrying amount of $9000 has a net selling price of $8000.The replacement cost of this asset is $10 000 and the present value of future cash flows is $9500.What is the deprival value of the machine?

A) $0
B) $8000
C) $9000
D) $9500

Question 56

The development of exit-price accounting (or CoCoa)was based on which of the following key assumptions?

A) Firms exist to increase the wealth of their owners.
B) Firms' successful operations are based on the ability of the firm to adapt to changing circumstances.
C) Firms' capacity to adapt will be best reflected by the monetary value of the organisation's net assets at statement of financial position date.
D) All of the given answers are correct.

Question 57

Creative accounting:

A) is a term used by the media to describe the process of selecting accounting methods when creating reports that provide results desired by preparers.
B) occurs, according to PAT, because managers will work for their own interests.
C) occurs when account preparers choose not to follow accounting standards to best reflect the performance of the firm.
D) is a term used by the media to describe the process of selecting accounting methods when creating reports that provide results desired by preparers and occurs, according to PAT, because managers will work for their own interests.

Question 58

Stakeholders are:

A) anyone with a direct financial interest in the firm.
B) special interest groups concerned with the environmental actions of the firm.
C) employees.
D) All of the people included in the given answers.

Question 59

Criticisms of PAT include:

A) It does not provide a means of improving accounting practice.
B) It is not value-free as it is claimed.
C) It is scientifically flawed since its hypotheses are frequently not supported by research.
D) all of the given answers.

Question 60

The pharmaceutical industry has been criticised in the financial press for recognising excessive profits and investing less in research and development so that the government is threatening the removal of tax concessions to the industry.Under these conditions,PAT predicts that pharmaceutical companies are subject to ___________ costs and are likely to adopt _________________ accounting policies

A) agency; income increasing
B) agency; income decreasing
C) political; income increasing
D) political; income decreasing

Question 61

Under PAT,a firm is aware that managers are likely to behave rationally.Which of the following mechanisms will be the appropriate course of action for shareholders to price protect against self-interested managers?

A) Compensate managers at a fixed rate.
B) Compensate managers at a fixed rate plus bonus on the basis of performance.
C) Compensate managers at a fixed rate with extra perquisites.
D) Include debt covenants in the management compensation contract.

Question 62

According to CoCoA current cash equivalents are represented by:

A) the total of the current assets.
B) the working capital.
C) the amount expected to be generated by selling an asset.
D) the total of the monetary assets.

Question 63

PAT has been described as:

A) a vibrant philosophical movement.
B) providing valuable evidence.
C) being empty and commonplace.
D) forward thinking research.

Question 64

Legitimacy Theory relies on the notion that there is a ________ _________ between an organisation and the society in which it operates.

A) formal agreement
B) social contract
C) working relationship
D) government regulation

Question 65

A firm is close to violating the current ratio debt covenant in one of its loan agreements.Which accounting action would you recommend to reduce the likelihood of a technical violation?

A) The firm should pay it accounts receivable.
B) The firm should obtain more debts from its suppliers.
C) The firm should call to convert a note payable to equity.
D) The firm should sell non-performing assets.

Question 66

Failure of an organisation to comply with negotiated debt covenants can lead to:

A) the operations of the organisation being suspended.
B) the organisation being placed in the hands of a party nominated by the lender.
C) the lender taking control of the organisation.
D) all of the given answers.

Question 67

There is significant scope for managers to exercise their judgment in the selection of accounting policies.PAT suggests that accounting policy choices of managers may be influenced by the existence of debt contracts,compensation plans or political costs.How are users made aware of the accounting policies adopted by the reporting entity?

Question 68

Discuss the criticism of PAT is that it is not value-free.

Question 69

What is Institutional Theory and why is relevant to financial reporting research?

Question 70

'A company can be creative in preparing its accounts and yet still be within bounds of acceptable accounting policies.' Explain.

Question 71

Discuss some of the incentives that may encourage managers to manipulate accounting numbers.

Question 72

Identify accounting policies that are in agreement with the efficiency view of positive accounting theory.

Question 73

A new accounting standard requires the provision of liabilities for share-based payments that has implications in the firm's debt-to-equity ratio.Which of the following accounting policy choices will reduce the probability of the firm violating debt covenants in a debt agreement?

A) Expense all research and development costs.
B) Shift from FIFO to weighted average inventory method.
C) Shift from straight-line to accelerated method of depreciation.
D) Shift from cost to revaluation method in accounting for land and buildings.

Question 74

The adoption of IFRS standards requires the use of fair value in recognition and measurement of numerous items in the financial report,stimulating a debate that IFRS standards increases volatility in earnings.Using the opportunistic view,discuss the concerns of reporting entities with the IFRS standards.

Question 75

With most economies moving toward a carbon constrained economy using Institutional Theory discuss how corporate social responsibility reporting could gain legitimacy.

Question 76

Distinguish between opportunistic and efficient contracting versions of positive accounting theory.