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Module 1: Accounting under ideal conditions
 Ideal conditions; certainty and uncertainty (including differences & similarities), dividend
irrelevancy, arbitrage, accretion of discount, abnormal earnings
 RRA - SFAS69; weaknesses of RRA (relevant but not as reliable)
 Historical Accounting Revisited mixed measurement model, (relatively reliable but lacks
relevance), revenue recognition, recognition lag
 Relevance VS Reliability -> tradeoffs (Without ideal conditions, complete relevance &
reliability are not jointly attainable therefore necessary to trade off these two desirable
characteristics, NI does not exist as a well-defined economic construct
Module 2: Decision usefulness approach to financial reporting
 Decision Usefulness Approach - theory of investor decision making in order to infer the
nature and types of information that investors need.
 PV Model (doesn’t work well in practice)
 Single Person Decision theory (concept of utility, investor maximizing his/her return; prior &
posterior probabilities; Bayes Theorem)
 Information System (conditional probabilities; main & off main diagonals; progression of
GN/BN -> future expected earnings -> future expected returns; positive relationship b/w F/S &
payoffs)
 Rational Risk Averse Investor (risk averse, chooses highest expected utility)
 Principle of Portfolio Diversification (trade-off b/w risk and expected return; firm specific &
market wide factors, beta risk)
 Optimal Investment decisions (including / ignoring transaction costs)
 Beta Risk (covariance calc, portfolio expected value & variance)
 Decision Usefulness approach & standard setting bodies (primary user groups,
characteristics of information required)
Mod 3 Efficient Securities Market
 Efficient Securities Market (semi strong form, relative concept, fair game, random walk)
 Market Prices reflecting all available information (Beaver study -consensus forecast,
rational expectations)
 Beaver’s arguments - Implications for financial reporting (4 points)
 Informativeness of Price (noise traders, partially informative)
 Capital Asset Pricing model (cost of capital, separation of expected and unexpected returns,
calculate abnormal return)
 Information asymmetry (adverse selection; timeliness of reporting; estimation risk)
 Social significance of properly working securities markets (penalties & incentives)
 Full disclosure -> MD&A
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Module 4 Information Perspective on decision Usefulness
 Information Approach to Decision Usefulness – extent of security price change indicates
decision usefulness
 Predicting Investor Behavior (4 points; Beaver - increase in volume of share trading)
 Factors which complicate finding the market response (3 points)
 Ball & Brown study (market responding to GN & BN in earnings, possible reasons for
anticipation effect, recognition lag)
 Earnings Response Co-Efficients (ERC – magnitude of unexpected return)
 Beta
 Capital Structure
 Earnings Quality
 Persistence (price irrelevant, transitory, permanent; look at components of F/S notes
to identify which items are persistent and which are non-persistent)
 Growth Opportunities
 Similarity of Investors’ Expectations
 Informativeness of price
 Implications of ERC research – importance of disclosure
 Measuring Investors’ Earnings Expectations - Time series approach, Analysts’ forecasts
 Greatest Market Price Response =Best accounting policy? (public good VS private good,
investor use of information)
 Information content of RRA - reasons for weak results for explanatory power of RRA
Module 5: Measurement Approach to Decision Usefulness
 Measurement approach - more fair values incorporated into F/S proper
 Are Security Markets Efficient? (limited attention, overconfidence; representativeness, selfattribution bias; share price momentum)
 Prospect Theory (Kahneman and Tversky)
 Is Beta dead? (beta not stationary)
 Excess Stock Market Volatility
 Stock Market Bubbles
 Efficient Security Market Anomalies
 post announcement drift (Bernard & Thomas)
 market response to accruals (Sloan)
 implications of securities market inefficiencies for financial reporting
 other reasons supporting a measurement approach (market not as efficient)
 Value relevance of financial statement info (Lev’s study on earnings quality)
 Ohlson’s Clean Surplus Theory
 Auditor’s Legal Liability (supports use of valuations)
 Current Value Accounting (value in use, fair value)
 Measurement Oriented Standards – lower of cost or market, revaluation IAS 16, ceiling tests
for PPE, IAS 36, IAS 2, IFRS 6; OPEB’s; IAS 19, SFAS 87
 Financial Instruments –
 IAS39 (must know 4 categories); excess net income volatility, mismatch
 Hedging - purpose of hedging and why a company would not hedge; fair value and cash flow
hedges, differences between SFAS 133 and IAS 39; supplemental disclosures
 Extensive supplementary disclosure (to better assess risk)
 Accounting for intangibles
 accounting for purchased goodwill
 self developed goodwill (Lev & Zarowin - R&D)
 clean surplus model revisited
 Reporting Risk – management approach/investor approach, beta risk
 Stock Market Reaction to other risks (MD&A; risk related disclosures, sensitivity analysis
and value at risk)
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Module 6 Economic Consequences
 Economic Consequences -changes in accounting policies & constituency reaction; reasons
why; standard setters’ actions as a result
 Employee Stock Options (definitions, accounting approaches, Black/Scholes model, tactics
used to increase the value of ESO’s)
 Positive Accounting Theories
 Bonus Plan Hypothesis
 Debt/Equity Hypothesis
 Political Cost Hypothesis
 Efficient and Opportunistic versions of PAT
Module 7 – An Analysis of Conflict
 Non co-operative games of mgr-investor conflict (Nash equilibriums, Danielson –> straight
forward maximization, constrained maximization)
 Co-operative Game Theory Models (binding agreements, moral hazard, reservation utility,
disutility of effort)
 Manager’s Information Advantage
 Revelation Principle
 Owner-Mgr employment contracts (first best; second best fixed & moving support, agency
costs)
 Bondholder-Mgr Lending contracts
 Holmström Agency Model (2 performance measures in compensation contract)
 Characteristics of good performance measures – sensitivity and precision
 Contracts (incomplete and rigid)
Module 8 Conflict Between Contracting Parties
 Are Incentive contracts necessary? (managerial labour market, shirking, earnings
management)
 Managerial Compensation Plans (bogey, cap)
 Manager Compensation – Share price VS Net Income (pros & cons)
 Role of Risk in Manager Compensation (methods to reduce risk)
 Empirical Compensation Research
 Politics of Executive Compensation (Jensen & Murphy)
 Power Theory of Executive Compensation – compensation contracts are more consistent
with opportunistic version of PAT
 Patterns of Earnings Management
 Taking a bath
 Income Minimization
 Income maximization
 Income smoothing
 Earnings Management (Healy’s study)
(1) Control various accruals (discretionary VS non discretionary -look at components of
F/S notes to identify which items are discretionary and which are non discretionary)
(2) Change accounting policies
Beneficial & adverse effects of earnings management
 Other Motivations for Earnings Management - contractual; meet investors’ expectations,
IPO’s, communicate information to shareholders
 Why does earnings management persist? – costly to find out inside info, use of discretionary
accruals to provide inside info
 Good Earnings Management (efficient contracting mgr behavior, blocked communication)
 Bad Earnings Management (opportunistic mgr behavior)
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Module 9: Standard Setting: Economic Issues
 Regulation of Economic Activity – central authority, standard setting, costs and benefits of
standard setting, proprietary information
 How to characterize information production
 Finer information
 Additional information
 Credibility
 First best information production
 Externalities and Free Riding
 MARKET FAILURES – externalities, free riding,
 Adverse Selection (insider trading, withholding bad news)
 Moral Hazard
 Unanimity (lack of)
 CONTRACTUAL INCENTIVES (for regulation of info production)
 Manager incentive contract; Debt Covenants -> concept of internalization
 MARKET BASED (non contractual) INCENTIVES (for regulation of info production)
 Managerial Labour Market
 Efficient Securities Market (Capital Market)
 Takeover Market
 Other INFORMATION PRODUCTION INCENTIVES
* Disclosure Principle
* Signalling
* Private Information Search
 Securities Market Response to full disclosure – market liquidity, market depth, bid-ask
spread
 Empirical Test of Disclosure Models (high quality disclosures, impact of estimation risk)
 Decentralized regulation – management choice of reporting -> improved relevance, less
costly
 Cost & benefits of regulation
Module 10: Standard Setting: Political Issues
 Two Theories of Regulation - Public Interest Theory (first best approach); Interest Group
Theory, interest groups, legislature
 Conflict and Compromise – IAS 39, which applies to investments in debt and equity
securities, macro hedging
 Distribution of the Benefits of Information (Regulation FD) - fair disclosure
 Criteria for Standard Setting - decision usefulness; reduction of info asymmetry; economic
consequences; political aspects (reasonable compromise)
 International Integration of Capital Markets – convergence of standards, enforcement of
standards, benefits of high quality stds, accounting challenges for adverse selection and moral
hazard
 Ethical Perspective on Standard Setting – internal & external motivation, Bayles consumer
perspective -> client interests most important
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