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ADMS 4510 ACCOUNTING THEORY. Prof. Kate Bewley [email protected] Office: ATK 258C Secretary: Vita Sabatini 416 736 5210 Acknowledgement: These slides are based on a presentation originally created by Paul Dunn, PhD. ADMS 4510 web links. Powerpoint slides for the sessions- - PowerPoint PPT Presentation
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ADMS 4510ADMS 4510 ACCOUNTING THEORY ACCOUNTING THEORY
Prof. Kate BewleyProf. Kate Bewley
[email protected]@yorku.ca
Office: ATK 258COffice: ATK 258C
Secretary: Vita Sabatini 416 736 Secretary: Vita Sabatini 416 736
52105210
Acknowledgement: These slides are based on a presentation originally created by Paul Dunn, PhD.
ADMS 4510ADMS 4510
web linksweb links
Powerpoint slides for the sessions-Powerpoint slides for the sessions-
www.atkinson.yorku.ca/pevanswww.atkinson.yorku.ca/pevans
To print Powerpoint slides -To print Powerpoint slides -
Select “Print” from “File” menuSelect “Print” from “File” menu
In the “Print” dialog box under “Print what?” In the “Print” dialog box under “Print what?”
select:select:
-> Handouts (3 per page is recommended)-> Handouts (3 per page is recommended)
-> Pure black and white-> Pure black and white
ADMS 4510 - SESSION 1 ACCOUNTING THEORY- OVERVIEW
Objective of course-Objective of course- to explore ‘theory’ that has been to explore ‘theory’ that has been
developed to explaindeveloped to explain• why accounting existswhy accounting exists
• the way accounting isthe way accounting is
• how it got that way how it got that way
• how it should be, given differing how it should be, given differing circumstancescircumstances
OVERVIEW
N.B. accounting has been N.B. accounting has been developed by humans, to fill developed by humans, to fill human and social needs largely human and social needs largely driven by trading and other driven by trading and other forms of contractingforms of contracting
thus the ‘theories’ of accounting thus the ‘theories’ of accounting are not like the theories are not like the theories explaining natural explaining natural physical/scientific phenomenaphysical/scientific phenomena
OVERVIEW
accounting is best seen as a accounting is best seen as a social science that is at the social science that is at the intersection of economics, intersection of economics, psychology, and sociologypsychology, and sociology
accounting uses techniques and accounting uses techniques and methods drawn from these fields methods drawn from these fields such as statistics, probabilities, such as statistics, probabilities, ‘income’, ‘welfare’, optimization, ‘income’, ‘welfare’, optimization, etc.etc.
OVERVIEW
Two important views of accounting Two important views of accounting that have been developed in that have been developed in recent years’ research are recent years’ research are
1. decision usefulness1. decision usefulness
2. information 2. information
economicseconomics
ACCOUNTING AS INFORMATION - information economics Accounting is an information systemAccounting is an information system
Financial info is a commodity, a Financial info is a commodity, a
productproduct
There is a demand for this productThere is a demand for this product
There is also a supply of financial There is also a supply of financial
infoinfo
DEMAND FOR DEMAND FOR INFORMATIONINFORMATION
Financial information users include:Financial information users include:• investors & creditorsinvestors & creditors• managementmanagement• labourlabour• suppliers suppliers • governmentgovernment• societysociety
Conflicts may exist among these Conflicts may exist among these parties due to parties due to information information asymmetryasymmetry [ adverse selection & moral hazard][ adverse selection & moral hazard]
SUPPLY OF INFORMATION
Sources of financial information :Sources of financial information :• firm disclosures, other firms, analysts, firm disclosures, other firms, analysts,
government, etc.government, etc. Financial disclosure costs :Financial disclosure costs :
• collection & processing costscollection & processing costs• litigation costslitigation costs• political costspolitical costs• competitive disadvantagecompetitive disadvantage• constraints on managerial behaviourconstraints on managerial behaviour
INFORMATION ASYMMETRY
When one party has more When one party has more
information than anotherinformation than another
2 types: 2 types:
• adverse selection adverse selection
• moral hazardmoral hazard
INFORMATION ASYMMETRY
Adverse selection Adverse selection (‘hidden (‘hidden
information’)information’)
– – one party has information one party has information
advantage over the otheradvantage over the other
Moral hazard Moral hazard (‘hidden action’)(‘hidden action’)
– one party cannot fully observe – one party cannot fully observe
the other's actionsthe other's actions
ADVERSE SELECTION
Assumptions :Assumptions : Investors are rational & want reasonable Investors are rational & want reasonable
returnreturn Large numbers of rational investorsLarge numbers of rational investors
trade in a properly working, efficient markettrade in a properly working, efficient market Full disclosure => investors have sufficient Full disclosure => investors have sufficient
information to make rational predictions information to make rational predictions about firm performanceabout firm performance
=> Accounting information is useful to => Accounting information is useful to investorsinvestors
Decision usefulness perspective Decision usefulness perspective (CICA s.1000, FASB)(CICA s.1000, FASB)
MORAL HAZARD
Assumptions : Assumptions : Firm is a nexus of contractsFirm is a nexus of contracts Contracts facilitate agency relationshipsContracts facilitate agency relationships Contracts use accounting numbers, e.g. Contracts use accounting numbers, e.g.
bonus contracts, debt covenantsbonus contracts, debt covenants
=> Accounting policies matter because => Accounting policies matter because they influence management’s they influence management’s compensation and debt restrictionscompensation and debt restrictions
Economic consequences perspectiveEconomic consequences perspective( Positive accounting theory ) ( Positive accounting theory )
FUNDAMENTAL PROBLEM FUNDAMENTAL PROBLEM OF FINANCIAL OF FINANCIAL ACCOUNTING THEORYACCOUNTING THEORY ‘‘Best’ measure of net income to Best’ measure of net income to
inform investors and control adverse inform investors and control adverse selection will be reliable AND selection will be reliable AND relevant about future economic relevant about future economic prospectsprospects
‘‘Best’ measure of net income to Best’ measure of net income to control moral hazard will be highly control moral hazard will be highly correlated with manager’s past correlated with manager’s past efforts, and within manager’s controlefforts, and within manager’s control
Can one ‘bottom line’ do both ?Can one ‘bottom line’ do both ?
Value-based accounting
(Ideal)
Unobservablemanager
effort
Contracts-compensation
-debt covenants
‘Hard’Net Income
Insideinformation
Investmentdecision
Fulldisclosure
Regulation- Accounting
standardsetting
Framework of accounting theory - Figure 1-1Framework of accounting theory - Figure 1-1
Standard-setting: Standard-setting: Accounting concepts Accounting concepts
BACKGROUNDBACKGROUNDFASBFASB 1978 Statement of Financial Actg
Concepts #1 - for businesses 1980 SFAC #4 - for non-business, not-
for-profits & governmentCICACICA 1988 Handbook Section 1000
– financial statement concepts 1991 Section 1000 extended to non-
profits
CICA Section 1000CICA Section 1000Financial statement conceptsFinancial statement concepts
Objectives of financial statementsObjectives of financial statements
Section 1000.15 --> joint perspectiveSection 1000.15 --> joint perspective
Communicate information that is useful Communicate information that is useful
for : for : • making investment & resource decisions making investment & resource decisions
and/orand/or• assessing management stewardshipassessing management stewardship
Unlike U.S., both are equally importantUnlike U.S., both are equally important
CICA - Section 1000CICA - Section 1000Financial statement conceptsFinancial statement concepts
Objectives of financial statementsCost- benefit constraint, materiality
Qualitative characteristics :Qualitative characteristics :• relevance & reliabilityrelevance & reliability• understandability & comparabilityunderstandability & comparability• trade-offstrade-offs
Elements, recognition, measurementGAAP (basis on which f/s are normally prepared)
RELEVANCE AND RELEVANCE AND RELIABILITYRELIABILITY
RelevanceRelevance• the information can make a difference the information can make a difference
in the user’s decisionin the user’s decision• predictive & feedback value, timelinesspredictive & feedback value, timeliness
ReliabilityReliability• the information faithfully represents the information faithfully represents
underlying economic substanceunderlying economic substance• verifiable, unbiased, conservativeverifiable, unbiased, conservative
THE CASE FOR THE CASE FOR HISTORICAL COSTHISTORICAL COST
Historical cost accounting reflects a Historical cost accounting reflects a particular trade-off between particular trade-off between RELEVANCERELEVANCE && RELIABILITYRELIABILITY. Which one does it . Which one does it favour ? ? ? ?favour ? ? ? ?
RELIABILITYRELIABILITY• by waiting until changes in value are by waiting until changes in value are
REALIZED income is more certainREALIZED income is more certain
• by smoothing out cash flows income reflects by smoothing out cash flows income reflects the longer-run earnings power of the businessthe longer-run earnings power of the business
REMAINDER OF SEMESTER
Decision usefulness approachDecision usefulness approach – – Investor's point of viewInvestor's point of view Economic consequences modelEconomic consequences model
– Management's point of view– Management's point of view 7 weeks of specific accounting issues 7 weeks of specific accounting issues Earnings managementEarnings management Economics and politics of standard Economics and politics of standard
settingsetting
GOOD
GOOD
NIGHTNIGHT