Question 1

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

Accepted Answer

The assumption that individuals act in their own self-interest and try to maximise their wealth is often referred to as the rational economic person assumption. This assumption is a fundamental principle of neoclassical economics, which assumes that most people behave in a predictably rational way when making economic decisions.

Question 2

Which of the following statements about asset substitution is incorrect?

Accepted Answer

When managers invest in higher-risk projects, lenders may not necessarily share higher returns earned from the projects. Lenders may expect a fixed return on their investment, regardless of the performance of the underlying assets. Therefore, the statement that lenders would share higher returns earned from the projects is incorrect.

Question 3

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

Accepted Answer

Lenders use price protection to adjust interest rates based on the perceived risk of a loan, charging higher rates for higher-risk loans to compensate for potential losses.

Question 4

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

Accepted Answer

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

Question 5

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

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 6

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

Accepted Answer

It is too costly for principals to completely monitor agents' behaviours.

Question 7

Sally observes that 'Cash' account is an asset account and has a debit balance. She also notices that 'Inventory' 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?

Accepted Answer

Sally is using inductive reasoning by observing specific examples (Cash and Inventory accounts) and generalizing to a broader conclusion (all asset accounts have a debit balance).

Question 8

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

Accepted Answer

The decision of whether to use historical cost or fair value relates to the measurement component of accounting policy decisions, as it pertains to determining how items are valued in financial statements.

Question 9

Normative theories:

Accepted Answer

Normative theories prescribe what should be the case based on a specific objective. They focus on how things ought to be, rather than how things actually are.

Question 10

An example of bonding costs is:

Accepted Answer

The answer of An example of bonding costs is:
...

Question 11

The problem of 'underinvestment' arises when managers are reluctant to undertaken projects with positive net present value because:

Accepted Answer

The answer of The problem of 'underinvestment' arises when managers...

Question 12

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

Accepted Answer

Monitoring and bonding costs are costs associated with ensuring that agents (individuals who act on behalf of principals) act in the best interest of the principals. Since these costs are incurred by the principals to ensure that the agents act in their best interest, it is fair to say that the majority of monitoring and bonding costs will be borne by the agents.

Question 13

Which of the following statements is not derived from the agency theory?

Accepted Answer

This statement is not derived from agency theory as it is a general observation of contractual relationships, rather than a specific concept within agency theory. The other three statements are all key concepts of agency theory, which examines the relationship between principals (entities) and their agents (managers) and the potential for conflicts of interest between them.

Question 14

The followings are the limitations of inductive reasoning, except:

Accepted Answer

Inductive reasoning may result in arguments that are not logically valid, as it involves making generalizations based on specific observations, which can lead to conclusions that are not necessarily true.

Question 15

Which of the following problems arises within owner-manager agency relationships?
$$\begin{array} { l l l } 
\text { I. }  \text { Risk aversion } & \text { III. Clan delution } \
\text { II. Asset substitution } & \text { IV. } \text { Dividend retention }
\end{array}$$

Accepted Answer

In owner-manager agency relationships, managers may be risk-averse (I) to protect their jobs, and they might retain dividends (IV) to reinvest in the company rather than distribute them to shareholders.

Question 16

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

Accepted Answer

Political contracts typically refer to the relationship between an entity (such as a business or individual) and the government, lobby groups, and trade unions. Creditors are not typically seen as a party involved in political contracts.

Question 17

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

Accepted Answer

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

Question 18

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

Accepted Answer

Accountants are expected to exercise professional judgement in all of the given contexts. These decisions require careful consideration of relevant accounting standards and guidelines, as well as the specific circumstances of the company and its assets. Professional judgement is essential to ensure that financial statements are accurate, reliable and fairly presented to stakeholders.

Question 19

Which of the following statements is correct?

Accepted Answer

The conceptual framework is developed through a deductive approach, meaning it starts with established theories and principles and works toward specific applications or conclusions.

Question 20

Debt covenants:

Accepted Answer

Debt covenants are designed to reduce the risk to lenders by imposing restrictions on borrowers to ensure that they will be able to repay the debt. These restrictions may include limits on spending, debt ratios, and other financial measures that are designed to give lenders some assurance that they will be repaid. By reducing the risk to lenders, debt covenants may result in lower interest rates being charged on the debt. They are not designed to control lenders' activities or protect the interests of managers, but rather to mitigate the risk of default and ensure that the borrower can meet its financial obligations.

Quiz 2: Application of Accounting Theory