Term
| Do accounting policies impact business decisions? |
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Definition
| yes, even if no effect on cash flow |
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Term
| OPEB; consequences of FASB's proposal? |
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Definition
- pay as you go expenditure model
- no accrual or measurement of costs
- FASB proposed a standard requiring accrual which brought significant attention.
- Actual economic consequences of switching to accrual:
1. companies reduced benefits
2. changed to defined contribution plans
3. ceased providing these benefits
4. try to control costs |
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Term
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Definition
| congressional involvement in setting standards to eliminate pooling and amortize goodwill over twenty years. |
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Term
| Potential economic consequences of pooling |
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Definition
eliminating pooling hurts firms
combos that make sense would not be done
US firms @ a disadvantage
growth in high tech industry would be hampered |
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Term
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Definition
-said employee stock options are a form of compensation-an opportunity cost
- instrinsic value was expensed until 2004/5 when options were typically valued @ the money |
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Term
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Definition
| that fair value of stock options can be greater than 0 even if intrinsic value equals 0(at the money) bc it can become valuable in the future, measurement is questionable, and Black-Scholes overstates value because options may be exercising early |
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Term
| How do managers abuse expensing intrinsic value? |
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Definition
-they overuse options bc they generally have no income affect
- earnings management manipulates share price prior to grants to a lower exercise price
- pump & dump practice to inflate price prior to selling
- selective timing of grant dates |
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Term
| Potential economic consequences when the attempt of expensing employee stock options at fair value in the early 1990s? How did the pressure affect this attempt? |
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Definition
- low reliability of FV option
- Lower reported income
- inhibit capital formation
- high tech at disadvantage in world markets
- inhibit use of options, need to pay cash compensation
pressure against it existed in spite of no effect on cash flows, fair values were already disclosed (mkt inefficiency should not matter)
FASB passed it |
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Term
| Positive accounting theory |
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Definition
-emphasizes the impact of contracting costs on firm and manager behavior
- ACG should be chosen to minimize contracting costs
-focuses on contracting costs associated with bonuses, debt covenants, and politics. |
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Term
| Assumptions of positive accounting theory |
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Definition
| managers and investors are rational, security markets are efficient. |
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Term
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Definition
| developed three hypothesis for PAT: bonus plan, political cost, and debt covenant hypothesis |
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Term
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Definition
| management will manage earnings in order to get their bonus because bonuses are often based on accounting numbers: net income in excess of a threshold |
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Term
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Definition
- derives from debt contracts
- some debt covenants are tied to acg numbers like leverage ratios, times interest coverage, or current ratio |
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Term
| Political Cost Hypothesis |
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Definition
| involves social contracts- high profits create political scrutiny (oil & gas companies) |
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Term
| Opportunistic contracting |
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Definition
| choose accounting policies to maximize expected utility (USING FOR MNGMT BENEFIT), constant with PAT |
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Term
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Definition
maximizes the firm value and uses accruals to give decision useful info; should be in the best interests of the firm
Dechow: says that management would signal private information to the market to improve the ability of earnings to measure performance. |
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Term
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Definition
wanted to better understand the use of accruals
thought opportunistic contracting would not measure performance as well and efficient would improve the ability of earnings to measure performance |
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Term
According to Dechow, how well do accruals measure firm performance as reflected in stock returns?
Does it depend on the circumstances? |
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Definition
Accruals mitigate timing and matching problems with cash flows. They make predictions concerning problems with realized cash flows and how earnings (accrual accounting) overcomes these problems.
Yes it does depend on the circumstances. Compare regression results on stk price performance on earnings, stk price performance on realized cash flows |
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Term
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Definition
| both earnings and realized cash flows provide incremental information |
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Term
| According to Dechow,when are earnings more useful? |
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Definition
-firms operating in volatile enviroments
- large changes in working capital, investment and financing activities
- industries with longer operating cycles (suffer more severely from timing/matching problems) |
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Term
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Definition
Healy(1985)- bonus plan hypoth.
Dichev & Skinner (2002)- debt covenant hypothesis
Jones (1991) political cost hypoth. |
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Term
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Definition
| that managers will determine the magnitude of accruals in order to maximize their bonuses |
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Term
| Dichev & Skinner(2002) RQ |
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Definition
RQ: do managers make choices to reduce the probability of violating an accounting debt covenant?
- violating a debt covenant is costly so you want to avoid.
manager- more difficult and it will be costly to obtain future financing if so.
lender- lower value, need to reserve |
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Term
| Divchev & Skinner research design and findings? |
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Definition
they largely sampled private lending agreements and analyzed covenant slack (the difference between actual and covenant threshold) by looking at the current ratio and net worth.
Findings: discontinuity at zero. consistent with managers adjusting accounting when covenant just misses threshold so that it meets it. |
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Term
| Jones (1991) Do firms that would benefit from import relief attempt to decrease earnings through earnings management during import relief investigations by the ITC? - what was his hypothesis? |
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Definition
| Managers of domestic producers that would benefit from import protection make accounting choices that reduce reporting earnings during ITC investigation periods as compared to non-investigation periods |
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Term
| What was Jones's research design and findings? |
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Definition
he introduced the concept of discretionary accruals; abnormal income- decreasing accruals are opportunistic in this situation
Findings:
managers decrease earnings during import relief investigations |
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Term
| Discretionary Accruals vs. Non-discretionary Accruals |
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Definition
net income=operating cash flows +/- net accruals
a non-obligatory expense that is yet to be realized but recorded in the account books
-- non= an OBLIGATORY expense* everything else the same |
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Term
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Definition
total accruals consist of nondiscretionary and discretionary
- nondiscretionary are a function of size, change in revenue, and gross pPE
- remainder is discretionary |
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Term
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Definition
accounting can impact business decision in predictable ways even if there are no direct cash flow implications
how things are measured can lead to different economic consequences |
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Term
| 1. What is the relationship between market efficiency and economic consequences? |
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Definition
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Term
| 4. What is an example of the use of discretion for efficient contracting purposes? |
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Definition
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Term
| 5. What is the logic behind determining discretionary accruals as a measure of earnings management? |
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Definition
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Term
| 6. What is the general approach to determining discretionary accruals? |
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Definition
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Term
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Definition
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Term
| Why were comment letters and testimonials not in favor of pooling? |
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Definition
• Growth in high tech industry would be hampered
• Combinations that make sense would not be done
• U.S. Firms would be at a disadvantage |
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Term
| Markey and Levitt explored Employee stock options; what were their findings? |
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Definition
- Manager abuses to expensing intrinsic value
- Attempt to expense fair value in early 1990s |
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Term
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Definition
o Managers are rational (just like investors are)
o Securities markets are efficient |
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Term
| What are the three types of hypotheses used under the PAT? |
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Definition
1. Bonus Plan
2. Debt Covenant
3. Political Cost |
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Term
| Healy studied the ___ hypothesis |
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Definition
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Term
| Dichev and Skinner studied the ___hypothesis |
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Definition
| debt covenant hypothesis: |
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Term
| Jones studied the ___hypothesis |
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Definition
| political cost hypothesis |
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