Question 1

Which of the following problems arises within owner-manager agency relationships:

A) I and III.
B) I and IV.
C) II and III.
D) II and IV.

Accepted Answer

Problem I (conflict of interest) and IV (risk aversion) arise within owner-manager agency relationships. Problem II (asymmetric information) and III (adverse selection) are more commonly associated with principal-agent relationships between a company's shareholders and its managers.

Question 2

The majority of monitoring and bonding costs will be borne by:
A) principals.
B) agents.
C) shareholders.
D) creditors.

Accepted Answer

Monitoring and bonding costs are associated with ensuring that agents act in the best interest of principals. Therefore, the majority of these costs will typically be borne by the agents themselves. Shareholders and creditors may also incur some monitoring and bonding costs, but these would be a relatively small portion compared to those incurred by agents.

Question 3

An example of bonding costs is:
A) auditor's fees.
B) cost of implementing a management remuneration plan.
C) cost of preparing quarterly financial reports.
D) cost of setting up company's code of conducts.

Accepted Answer

C

Question 4

The way that lenders charge a higher interest rate for loans assessed to be of higher risk is known as:
A) risk aversion.
B) wealth maximisation.
C) claim dilution.
D) price protection.

Accepted Answer

The answer of The way that lenders charge a higher...

Question 5

In which of the following contexts would accountants be required to exercise professional judgement:
A) Determining depreciation method used for non-current assets.
B) Estimating net realisable value of inventories.
C) Deciding which model to use to measure value of property, plant and equipment after initial recognition.
D) All of the options are correct.

Accepted Answer

All of the options mentioned require accountants to exercise professional judgement. Depreciation method for non-current assets, net realisable value of inventories, and measurement model for property, plant and equipment all require consideration of multiple factors and possible alternative methods. Accountants need to use their professional judgement to make the best decision based on the specific circumstances of each case.

Question 6

Considering whether to use historical cost or fair value relates to which of the following components in accounting policy decisions:
A) Definition.
B) Recognition.
C) Measurement.
D) Disclosure.

Accepted Answer

The choice between historical cost and fair value relates to the measurement component of accounting policy decisions, as it determines how an asset or liability is valued on the balance sheet. The other components are as follows: definition refers to determining what items should be recognized in the financial statements; recognition refers to deciding when those items should be recorded; and disclosure refers to determining how the information should be presented in the financial statements.

Question 7

Which of the following processes describe how positive theories are developed:
A) Principles $\rightarrow$ Assumptions $\rightarrow$ Objectives $\rightarrow$ Definitions/Actions.
B) Objectives $\rightarrow$ Definitions/Actions $\rightarrow$ Assumptions $\rightarrow$ Principles.
C) Definitions/Actions $\rightarrow$ Principles $\rightarrow$ Assumptions $\rightarrow$ Objectives.
D) Objectives $\rightarrow$ Assumptions $\rightarrow$ Principles $\rightarrow$ Definitions/Actions.

Accepted Answer

The answer of Which of the following processes describe how...

Question 8

Which of the following is a limitation of the use of inductive reasoning in the development of theory:
A) it does not attempt to improve current practices.
B) it is based on the subjective selection of objectives by the theorist.
C) it is not based on observed actions.
D) it is only useful for developing prescriptive theories.

Accepted Answer

The answer of Which of the following is a limitation...

Question 9

Which of the following statements is not consistent with agency theory:
A) Entities employ managers to conduct business on their behalf and to negotiate contracts with other parties.
B) Managers are more likely to favour the interests of debtholders than those of shareholders in managing debt contracts.
C) Managers will not always act in the best interest of shareholders.
D) There are costs incurred in order to control agent's behaviour.

Accepted Answer

This statement is not consistent with agency theory because it suggests that managers would favour debtholders over shareholders, while agency theory suggests that managers may prioritize their own interests over those of shareholders.

Question 10

The risk aversion problem in shareholder-manager agency relationships arises because:
A) managers are more risk-averse than shareholders.
B) shareholders prefer less risk than do managers.
C) managers have less capital invested in the entity than shareholders.
D) shareholders are not able to diversify their risk.

Accepted Answer

Shareholders generally are willing to take on more risk than managers because they have a more diversified portfolio of investments. Managers, on the other hand, have a greater proportion of their personal wealth tied up in the company they manage, and therefore are more risk-averse. This creates a conflict of interest in the shareholder-manager agency relationship.

Question 11

Which of the following contractual relationships is not the focus of positive accounting theory:
A) Shareholder - manager relationships.
B) Manager - lender relationships.
C) Shareholder - lender relationships.
D) Political relationships.

Accepted Answer

The answer of Which of the following contractual relationships is...

Question 12

An economic assumption which assumes that all individuals act in their own self-interest and are wealth maximisers is called:
A) rational economic person assumption.
B) reasonable economic person assumption.
C) responsible economic person assumption.
D) logical economic person assumption.

Accepted Answer

The assumption that people act in their own self-interest and strive to maximize their wealth is called the rational economic person assumption. This assumption is a fundamental concept in economics and is used to explain human behavior in various economic situations.

Question 13

Which of the following statements about asset substitution is incorrect:
A) Managers have incentives to use debt finance to invest in higher-risk assets.
B) When managers invest in higher-risk projects, lenders would share higher returns earned from the projects.
C) The problem of asset substitution can be reduced by having a debt covenant that restricts investment opportunities of the entity.
D) Asset substitution increased the risk borne by lenders.

Accepted Answer

This statement is incorrect because when managers invest in higher-risk projects, the lenders do not necessarily share the higher returns earned from the projects. The lenders receive a fixed interest rate, and they do not benefit from any increase in the project's profitability. Instead, the managers benefit from any extra returns earned beyond the interest rate, leading to a potential conflict of interest known as asset substitution.

Question 14

The problem of 'underinvestment' occurs when the entity faces financial difficulty and managers are reluctant to undertaken projects with positive net present value because:
A) managers prefer less risk than do lenders.
B) the projects lead to increased funds available to lenders rather than shareholders.
C) the projects would adversely affect managers' bonus payments.
D) managers prefer to maintain a greater level of funds within the entity.

Accepted Answer

Underinvestment occurs when managers avoid projects that would benefit the company because the returns would primarily benefit lenders, not shareholders, reducing the incentive for managers to pursue them.

Question 15

Normative theories:
A) prescribe what should be the case based on a specific objective.
B) are based on what is happening in the world.
C) explain why people behave in certain ways.
D) predicts unobserved phenomena.

Accepted Answer

Normative theories prescribe what should be the case based on a specific objective.

Question 16

Political contracts refer to the relationship between an entity and the following parties, except:
A) government.
B) lobby groups.
C) trade unions.
D) creditors.

Accepted Answer

Political contracts refer to the relationship between an entity and the government, lobby groups, and trade unions. Creditors are not typically involved in political contracts.

Question 17

Which of the following statements is correct:
A) Accounting is only concerned with recording transactions and does not involve human behaviours.
B) Positive theories provide recommendations about what should happen.
C) Inductive reasoning starts with objective setting.
D) The conceptual framework is developed through a deductive approach.

Accepted Answer

The conceptual framework is developed through a deductive approach, which means that it starts with the development of theoretical concepts and then moves to specific observations or applications. Option A is not correct as accounting also involves analyzing and interpreting financial information. Option B is incorrect since positive theories focus on explaining behaviors rather than providing recommendations. Option C is incorrect because inductive reasoning starts with observations and then moves towards developing generalizations or theories.

Question 18

Debt covenants:
A) contain restrictions to control lenders' activities.
B) are designed to protect the interest of managers.
C) reduce the risk to lenders.
D) result in higher interest rates being imposed on the borrowers.

Accepted Answer

Debt covenants are designed to reduce the risk to lenders by specifying conditions, restrictions, and commitments made by borrowers. These conditions help to ensure that the borrower will meet their financial obligations and reduce the likelihood of default. If the borrower breaches the covenant, the lenders may take control of the borrower's assets or demand immediate repayment. This reduces the risk to lenders, which may lower the interest rates being imposed on the borrowers.

Question 19

Sally observes that the cash account is an asset account and has a debit balance. She also notices that inventories account is an asset account and has a debit balance. Therefore, Sally comes into conclusion that all asset accounts have a debit balance. Which approach does Sally use in developing her theory about all asset accounts having a debit balance?
A) Deductive reasoning.
B) Inductive reasoning.
C) Conceptual reasoning.
D) Conclusive reasoning.

Accepted Answer

Sally is making a generalization based on specific observations. This is the process of inductive reasoning, where specific facts lead to a general conclusion. Deductive reasoning involves starting with a general principle and drawing specific conclusions from it. Conceptual reasoning involves using abstract or theoretical ideas to make conclusions, and conclusive reasoning involves drawing firm conclusions without the need for further evidence.

Question 20

The most correct reason of why residual loss is incurred is:
A) principals do not take any actions to control agents' behaviours.
B) agents do not always act in the best interest of principals.
C) it is too costly for principals to completely monitor agents' behaviours.
D) agents are rational wealth maximisers.

Accepted Answer

The answer of The most correct reason of why residual...

Quiz 2: Application of Accounting Theory

Which of the following problems arises within owner-manager agency relationships:

The majority of monitoring and bonding costs will be borne by:

An example of bonding costs is:

The way that lenders charge a higher interest rate for loans assessed to be of higher risk is known as:

In which of the following contexts would accountants be required to exercise professional judgement:

Considering whether to use historical cost or fair value relates to which of the following components in accounting policy decisions:

Which of the following processes describe how positive theories are developed:

Which of the following is a limitation of the use of inductive reasoning in the development of theory:

Which of the following statements is not consistent with agency theory:

The risk aversion problem in shareholder-manager agency relationships arises because:

Which of the following contractual relationships is not the focus of positive accounting theory:

An economic assumption which assumes that all individuals act in their own self-interest and are wealth maximisers is called:

Which of the following statements about asset substitution is incorrect:

The problem of 'underinvestment' occurs when the entity faces financial difficulty and managers are reluctant to undertaken projects with positive net present value because:

Normative theories:

Political contracts refer to the relationship between an entity and the following parties, except:

Which of the following statements is correct:

Debt covenants:

The most correct reason of why residual loss is incurred is: