Accounting Theory

First Mid-Term Review

1) Who regulates the financial markets in Canada?

a) SEC
b) CICA
c) several commissions
d) it is self-regulated

2) Information asymmetry:
a) Occurs when the balance sheet contains more useful information than the
income statement
b) One party to a contract has more information than the other party
c) Is a key factor in the concept of insider trading
d) All of the above

3) Adverse selection
a) The person with the information advantage exploits that advantage
b) Increases the cost of capital
c) Allows for shirking
d) Increases risk to investors

4) Moral hazard
a) The person with the information advantage exploits that advantage
b) Increases the cost of capital
c) Allows for shirking
d) Increases risk to investors

5) The fundamental problem of financial accounting theory is

a) The best measure of net income to control adverse selection is not the same
as the best measure to control moral hazard
b) Authorities have to mediate the conflict between the best interests of
investors and managers in financial reporting
c) Authorities have to mediate the trade-off between relevance and reliability
d) All of the above

6) Accounting rules
a) Have been set exclusively by the CICA
b) Have been set exclusively by the securities commissions and administered
by the CICA
c) Can be set by either the securities commissions or the CICA
d) Give the accounting profession considerable leeway

7) What are ideal conditions?

a) Perfect and complete markets
b) First best
c) A lack of information asymmetry
d) A lack of uncertainty
8) Under ideal conditions:
a) Assets and liabilities would be valued at expected present value of future
cash flows
b) Regulations would ensure present values equaled market values
c) The Income Statement would be more important than the Balance Sheet
d) Information would be reliable and relevant

9) Under ideal conditions:

a) All information is known so there is no provision for uncertainty
b) Present value would equal market value
c) Present value would equal historic value
d) Market value would equal historic value

10) Under ideal conditions, inventory is recorded at the:

a) Present value as determined by discounting the value of cash receipts from
future sales
b) Market value at any given time
c) Historical cost, i.e. the price paid for the inventory when it was purchased
d) The lesser of cost and market

11) Under ideal conditions, revenue would be recognized:

a) When the inventory is manufactured or purchased
b) At different times depending on which accounting system is used
c) According to the Revenue Recognition Principle
d) When cash is received

12) Under ideal conditions, if a company has one asset that generates $100 for each of
its two year life, and has no salvage value, it would record its assets on the Balance
Sheet at:
a) ($100/1.10) + ($100/(1.10)2)
b) $200
c) The price the company paid for the asset
d) The market price that the company could get for selling the asset

13) In the situation given in 12), the amortization expense for the first year would be:
a) ($100/(1.10)2)
b) $100, regardless if the straight line or declining balance method was used
c) Is not relevant as the Income Statement provides no information of value
d) Is equal to the decline in the market value

14) What would a Perfectly Informative Information System look like?

15) What would a Non-Informative Information System look like?

16) If the financial statements of a firm were “good” and the Information System that
was Perfectly Informative, showed the probability of rising share prices given good
news was 1, then the probability of prices rise is:
a) 100%
b) Not known unless prior probabilities of P(H) and P(L) are given
c) Can be calculated using Bayes’s Theorem
δ) β

17) The decision usefulness approach to accounting theory

a) Requires that accounting information should be useful in showing the true
value of a firm
b) Requires that accounting information should be useful in making decisions,
form does not matter
c) Requires that accounting information should be in a form that makes
decisions easier to make
d) Is just one of several approaches

18) The decision usefulness approach to accounting theory raises two questions:
a) Who will use the information, and in what form would be best for them?
b) Who will use the information, and what will they use it for?
c) What will the information be used for, and what would be the best form to
present it?
d) What will the information be used for, and how will that affect the users?

19) According to SFAC1, the main users of accounting information are:

a) Accountants for the love of it
b) Managers for making decisions
c) Government for taxation purposes
d) Investors for making decisions

20) Bayes’s Theorem is:

a) Used to calculate the probability of the best return on an investment.
b) A mathematical formula used to calculating conditional probabilities.
c) Requires ideal conditions.
d) None of the above

21) When using the Expected Monetary Value, (EMV), as an investment decision
criterion:
a) A series of potential returns on the investment and the probabilities of those
returns occurring must be assigned.
b) Only three possible outcomes can be considered at one time.
c) The probabilities must be objective.
d) None of the above statements is true.
22) Given the following information, state which investment choice you would make.
Investment A will yield a guaranteed $500.
Investment B will yield $1000 if (i) occurs, -$100 if (ii) occurs and no return if (iii)
occurs.
The prior probability of (i) occurring is 0.05, of (ii) occurring is 0.70 and (iii)
occurring is 0.25
If B’s financial statements are seen as “good”, the probability of (i) occurring is
0.40, of (ii) occurring is 0.10 and (iii) occurring is 0.50. The statements were good.
a) A, because EMV(A) equals $500, and EMV(B) equals $390
b) A, because EMV(A) equals $500, and EMV(B) equals $600
c) B, because EMV(A) equals $500, and EMV(B) equals $390
d) B, because EMV(A) equals $500, and EMV(B) equals $600

23) Beta
a) Is the standard covariance between return on a share and return on the
market
b) Is the only relevant risk measure for a reasonably diversified investor
c) Can be measured
d) Is stationary

24) Accounting information competes with

a) News reports
b) Financial analysts’ projections
c) The investments themselves
d) CMA recommendations

25) Accounting information must compete on the basis of:

a) Relevancy
b) Reliability
c) Timeliness
d) Cost Efficiency

26) The Semi-Strong Form of efficient securities markets assumes:

a) Prices reflect all price and volume data
b) Prices reflect all publicly available information
c) Prices reflect all publicly and privately known information
d) Investors with large amounts of money, but only limited information will
determine price

27) Under the Semi-Strong Form of efficient securities markets:

a) Prices only respond to new news
b) Prices adjust quickly to news, preventing unfair profits
c) Prices reflect the quality of publicly known news
d) Prices will not react to earnings reports
 28) Efficient securities markets are desirable because:
a) They allocate capital to its most effective use
b) They allocate capital to its most efficient use
c) They allow for a large number of transactions to be conducted each day
d) They provide large profits for rational investors

29) What are the implications for financial statements if we assume the Semi-Strong
Form of efficient securities markets?
a) Content, not form, is important
b) Strive for full disclosure, including the MD&A
c) No need to worry about the naïve investor
d) Accountants compete with other sources of information

30) Under the Investor Behaviour Model:

a) Investors have prior beliefs about a firm’s future performance
b) Upon release of new information, some investors will revise their
expectations
c) Some investors react to these revisions
d) Investors’ reaction should be consistent with the shock of the new news

31) The Ball and Brown study is considered a major study. You should understand the
procedure they used, and what it shows

32) The Earnings Response Coefficient should be:

a) Lower with higher risk
b) Lower with firms that have more debt to equity
c) Lower with firms that have less earnings persistence
d) Lower with firms that have lower earnings quality
e) Lower with firms that have lower growth potential
f) Lower when analysts’ forecasts cover a larger range
g) dependent on the firm’s size

33) A Public Good

a) is a good that when used by one person is not destroyed for use by another
b) can not be assigned a price
c) prevents the use of ERC to be used to determine the best accounting
information
d) should be provided by the government

34) The Measurement Perspective is:

a) A theory that argues that the size of the market’s reaction to good news/bad
news can be measure based on the deviation of actual earnings from the
average of analysts’ expectations
b) Argues for greater use of Fair Value in the financial statements proper
c) Is decreasing in favour
d) Is consistent with the Information Perspective
35) The Measurement Perspective has gained more support recently due to:
a) Securities markets are not efficient
b) Ohlson’s Clean Surplus Theory
c) Low ERC
d) Auditor liability

36) The Prospect Theory

a) Assumes that investors look at individual investments rather than their entire
portfolio
b) Supports the Measurement Perspective
c) Assumes investors become overconfident in their investment decision ability
d) Assumes financial information is underweighted by investors