NAME:

MATRIC NUM:
2nd

BKAF3083
semester 2012/2013

KARNAN A/L MUNIANDY

207381

SAROJA A/P MANOHARAN

221690

KU AZWA BINTI KU AZMI

221915

LOOI SAIK WOEN

223882

LECTURER NAME: PN. NORAZITA MARINA BINTI ABDUL

AZIZ

Question 1
a)In trying to explain shareholders' subdued reaction to Affin's
Research report on Malaysian Airline System Bhd (MAS), explain
whether on how you could use the following approaches to
accounting theory construction:
1)Decision usefulness
Decision usefulness approach to financial reporting is an approach to the preparation of financial accounting
information that emphasis on the theory of investor decision making in order to infer the nature and types of
information that investors need. It focused on developing theories to ensure that accounting reports would provide
the information most useful for making the decision that the theorists believe to be most important.

2)Positive accounting theory

Positive accounting theory is concerned mainly with explaining the reason for current practice and predict the role
of accounting and associated information in the economic decision of individuals, firms and other parties that
contribute to the operation of the marketplace and the economy. Investor need higher yield that would be required
from a comparable company paying fully franked dividends.

(continued)
3)Scientific approach
Scientific approach observe the real world behavior that does not concur with the theory, it treated that
anomaly as a research issue and express it as a research problem to be explained. It develop a theory to
explain the observed behavior and use that theory to generate testable hypotheses that will be
corroborated only if the theory holds and the follow precise and highly structured or predetermined
procedures for data collection and after subjecting the data to mathematical or statistical techniques,
we can validate or refuse the hypotheses testes. Scientific approach has an inherent assumption that
the world to be researched in objective reality capable of examination in term of large scale or average
statistics. This type of research is carried out by incremental hypotheses which are the combined to
provide greater understanding or better predictions of accounting.

Question 1
b)Explain why principles-based standards require a conceptual
framework.
It is because the conceptual framework provides a framework for the
development of a body of coherent standards based on consistent
principles. It presents the basic ideas which underpin the development
of the standard and assist user in their interpretation of standard

Question 1
c) Why is it important that the IASB and FASB share a
common conceptual framework
A common goal of the IASB and FASB is for their standards to be clearly
based on consistent and appropriate principles. These principles must be
rooted in fundamental economic concepts rather than based on a collection
of arbitrary conventions. To provide the best foundation for developing
principle based, common standards, the boards are undertaking a joint
project to develop a common and improved conceptual framework. Such a
framework is essential to fulfilling the Boards goal of developing standards
that are principles based, internally consistent, and internationally converged.

Question 1
d)Describe briefly FOUR (4) main differences between Islamic
Accounting and Conventional Accounting.
Conventional Accounting

Differences

Islamic Accounting

Accounting process aim to allow

informed decisions whose ultimate
propose is to efficient (profitable)
uses by providing information
efficiency in the market (without
compliance to Islamic shari`ah)

Definition

Accounting process which provides

appropriate information ( not only
financial data only) to stakeholders of
an entity that will enable them to
ensure that the entity is continuously
operating within the limit of Islamic
shari`ah and delivering on its
socioeconomic objectives

Performs everything within the limit

of Islamic shari`ah.

Operation

Allow everything to maximize their

profit

Conceptual based on the Islamic principles

Nature

Conceptual based on principles Of

secularism and capitalism.

al-Quran and sunnah or Islamic

syari`ah.

Governance

Accounting and commercial law and

security ethic

Question 2 (a)
a) Conditions related to the measurement on the valuation of the assets and liabilities
) Historical cost is the price paid to acquire an asset or the amount received when a
liability is incurred in an actual transaction.
) Fair value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement
date.
) Replacement cost is the price that would be paid to acquire an asset with equivalent
service potential in an orderly market transaction at the measurement date.
) Settlement amount is the amount at which an asset could be realized or a liability
could be liquidated with the counterparty, other than in an active market.

Question 2 (b)
(i)

Financial capital concept

a profit is earned only if the amount of net assets at the end of a period exceeds the
amount at the beginning of the period, excluding any inflows from or outflows to
owners, such as contributions and distributions. It can be measured either in nominal
monetary units or constant purchasing power units.
(ii) Physical capital concept
a profit is earned only if the enterprise's productive or operating capacity at the end of a
period exceeds the capacity at the beginning of the period, excluding any owners'
contributions or distributions.

Question 2(c)
Reasons why income concept is very important in
accounting
1. judgment of performance
- efficiency
- effectiveness
2. description of economic processes
- integrated
- partial
3. determination of the financial strength

Question 2 (d) (i)

Why the management is prone to choose stable earnings trend?

To maintain investors
Provide good information for analyst to make decision
Higher share price
-The stock become safer and potentially a better investment

Question 2(d)(ii)
Two methods used to adjust earnings bay management

1. Adjustment of Operating and Investing Activities

Example: Managing production, inventory, and sales
2. Adjustment of financing activities
Example: Repurchasing outstanding stocks

Question 3(a)
Identify the 5 theories or concept that contributes to conflicts between
owners and managers.

A- Effort Adverse
B- Cost of Shareholder Management Conflict
C- Reservation Utility
D- Non- cooperative Game Theory
E- Self-interested Behavior

Question 3 (b) Discuss any 3 reasons of market failures of

providing first-best information and how it is related to
designing a contract between owners and managers
1. First version of adverse selection problem, which states that if opportunities exist for
industries to generate excessive profit by trading on basis of insider information, it causes
outside investors to not perceive securities market as a level playing field. They will
either reduce the amount they are willing to pay or withdraw from market. Information
production is not first-best since useful information is held from market for insiders
benefit.

2. Second version of adverse selection problem, which arises when managers who know
bad news regarding firm do not disclose the information to avoid or postpone negative
firm consequences. This lacks timeliness and contributes to failure of producing first- best
information.

3. Net income does not completely provide information regarding effort. This is a reason
why managers are able to disguise shirking, thus moral hazard problem will arise and
earnings management problem which consequently leads to market failure.

Question 3 (c) Criticize 4 options for owners in

designing contract to control moral hazard.
1. Direct monitoring. It is the method where owners costlessly monitor managers chosen
act. But, first- best contract is frequently unattainable because it is unlikely for owners to
monitor agents efforts in managerial setting as seen in owner-manager contact. This leads
to information asymmetry.
2. Indirect monitoring. It is when managerial effort is not directly observable, it is still
possible to impute the efforts under some conditions. But, it cannot be relied on to ensure
the attainment of a first-best contract.
3. Owner rents to manager. Owner gives manager rights to 100% of payoff after paying a
fixed rental price to owner. But this is not a common relationship. The owner is often worse
off since contracting agreement has inefficient risk sharing.
4.Profit sharing. It is widely used. This gives manage a share of profits and aligns
managers incentives with owners and thus maximizes both. However, net income is not
always informative. There is also a lag of management efforts.

Question 3 (d) How accounting standards reduce

moral hazard and promote high quality information
- Provide guidelines for accountants to follow during the preparation of
financial statements. By following accounting standards, financial statements
would have higher quality information.
- Accounting standards require full disclosure. Therefore, firm have to fully
disclose the financial information to the users of financial statements. This
would prevent information asymmetry from occurring and users could make
better economic decisions.
- Accounting standards serves as law to be followed and to be complied with.
Those who do not comply with the accounting standard would cause
violations. In short, it could help the detection of moral hazard in the
company.

Question 4 (Part A)
1)Why do some Malaysian companies issue
sustainability reports ?

To show companies the relevance of sustainability and how to practice

sustainability in a more meaningful manner. Source of reference for directors
in assisting them to understand the growing relevance of sustainability and
how companies can embed sustainability within the organization.

2) What advantages do companies perceive in

obtaining assurance for sustainability reports ?
I) Improved board and CEO level engagement :
With increased interest in sustainability disclosures and their importance for driving improvements in
organizational strategy, performance and reputation, sustainability issues are moving up to the Board
Room and C-Suite levels. Disclosures and data which are believed to be trustworthy and credible are
more likely to be used for internal decision making
II) Strengthened internal reporting and management systems :
Internal robust reporting systems and controls play an important role in stain ability performance and
impacts. External assurance can help confirm that internal systems and controls are robust, and can
recommend any necessary improvement
iii) Improved stakeholder communication :
Assurance processes may involve the review of a reporters stakeholder engagement processes. Some
organizations use their reporting processes and/or sustainability reporting as the basis for on-going
dialogue with stakeholders. Both of these can help promote mutual communication and understanding

3)Why has the practice of sustainability

reporting varied around the world ?
- A report containing disclosure of governance
approach and of the environmental, social and
economic performance and impacts of organizations

Ques tion 4 Par t B

Disc uss any fi ve (5) re asons why the sample companies might both bel ieve in se cur itie s marke ts e ffic iency and e ngage in Earning Manageme nt.

-Taxation Motivations
-Changes of CEO
-IPO
-To communicate information to investors
-Political Motivations

Taxation Motivations
Taxation authorities impose their own accounting rules for calculation of taxable
income, reducing the firms ability to manoeuvre. Taxation should not play a major
role in EM decisions in general. An exception occurs with respect to the choice of
LIFO versus FIFO inventory method. During periods of rising prices, LIFO will
usually result in lower reported profits and lower taxes, relative to FIFO. Much PAT
research has tried to explain and predict firms inventory policy choices. Dopuch and
Pincus (1988) reported evidence that tax savings are high for LIFO firms and that
firms keep using FIFO do not suffer large tax consequences, for reasons including
low amounts of inventory, high variability of inventory levels, high inventory
turnover, and low effective tax rates.

Changes of CEO
The bonus plan hypothesis predicts that CEOs approaching retirement would be particularly likely to
engage in a strategy of income-maximization. CEOs of poorly performing firms may incomemaximize to postpone termination. This motivation also applies to new CEOs, especially if large
write-offs can be blamed on the previous CEO.Murphy and Zimmerman (1993) (MZ) examined the
behaviour of four discretionary variables: research and development, advertising, capital
expenditures, and accruals. MZ found that reducing R&D, advertising, and capital expenditures
might be effective to increase current earnings but can potentially be quite costly. The accrual and
accounting policy variables are less costly, since for the most part they are strictly paper devices.
These studies face difficult methodological problems. (1) Could be difficult to tell whether lower
discretionary variable values are due to EM or poor operation performance. (2) Could be difficult to
tell whether any apparent EM is due to the new CEO or the old.

Initial Public Offerings

Firms making initial public offerings (IPOs) do not have an established market price,
which raises the question of how to value the shares. Evidence found by Clarkson,
Dontoh, Richardson, and Sefcik (1992) raises the possibility that managers of firms
going public may manage the earnings reported in their prospectuses in the hope of
receiving a higher price for their shares.
Friedlan (1994) concluded that IPO firms did indeed make income-increasing
discretionary accruals in the latest period prior to the IPO, relative to accruals in a
comparable previous period. Accrual management seemed to be concentrated in the
poorer-performing sample firms and in the smaller sample firms.

To Communicate Information to Investors

Earnings management used to communicate information to investors may
seem questionable in view of efficient securities market theory. However,
markets are only efficient in terms on publicly available information so if
earnings management can reveal inside information, it can actually improve
the informative nature of financial reporting.
Management has the best (inside) information about future earnings prospects.
So, responsible use of EM can increase the main diagonal probabilities of the
information system.

Political Motivations
Many companies are quite politically visible and may manage earnings to reduce
their visibility, achieved through accounting practices and procedures to minimize
reported net income, especially in highly prosperous periods. If they do not, public
pressures may lead to increased government regulation or other means to lower
profitability. This motivation underlies the size hypothesis of PAT.
Jones (1991) found use of greater income-decreasing accruals during the year of ITC
investigation than in years outside the investigation. Cahan (1992) found that firms
under investigation for monopolistic practices used more income-decreasing accruals
during investigation years relative to other years sampled.

THANK YOU