adms 4510 accounting theory

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ADMS 4510 ACCOUNTING THEORY. Prof. Kate Bewley 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


  • ADMS 4510 ACCOUNTING THEORYProf. Kate Bewleykbewley@yorku.caOffice: ATK 258CSecretary: Vita Sabatini 416 736 5210

    Acknowledgement: These slides are based on a presentation originally created by Paul Dunn, PhD.

  • ADMS 4510 web linksPowerpoint slides for the sessions- print Powerpoint slides -Select Print from File menuIn the Print dialog box under Print what? select: -> Handouts (3 per page is recommended) -> Pure black and white

  • ADMS 4510 - SESSION 1 ACCOUNTING THEORY- OVERVIEWObjective of course-to explore theory that has been developed to explainwhy accounting existsthe way accounting ishow it got that way how it should be, given differing circumstances

  • OVERVIEWN.B. accounting has been developed by humans, to fill human and social needs largely driven by trading and other forms of contractingthus the theories of accounting are not like the theories explaining natural physical/scientific phenomena

  • OVERVIEWaccounting is best seen as a social science that is at the intersection of economics, psychology, and sociologyaccounting uses techniques and methods drawn from these fields such as statistics, probabilities, income, welfare, optimization, etc.

  • OVERVIEWTwo important views of accounting that have been developed in recent years research are 1. decision usefulness 2. information economics

  • ACCOUNTING AS INFORMATION - information economicsAccounting is an information systemFinancial info is a commodity, a productThere is a demand for this productThere is also a supply of financial info

  • DEMAND FOR INFORMATIONFinancial information users include:investors & creditorsmanagementlaboursuppliers governmentsocietyConflicts may exist among these parties due to information asymmetry [ adverse selection & moral hazard]

  • SUPPLY OF INFORMATIONSources of financial information : firm disclosures, other firms, analysts, government, etc.Financial disclosure costs :collection & processing costslitigation costspolitical costscompetitive disadvantageconstraints on managerial behaviour

  • INFORMATION ASYMMETRYWhen one party has more information than another2 types: adverse selection moral hazard

  • INFORMATION ASYMMETRYAdverse selection (hidden information) one party has information advantage over the otherMoral hazard (hidden action) one party cannot fully observe the other's actions

  • ADVERSE SELECTIONAssumptions :Investors are rational & want reasonable returnLarge numbers of rational investors trade in a properly working, efficient marketFull disclosure => investors have sufficient information to make rational predictions about firm performance=> Accounting information is useful to investorsDecision usefulness perspective (CICA s.1000, FASB)

  • MORAL HAZARDAssumptions : Firm is a nexus of contractsContracts facilitate agency relationshipsContracts use accounting numbers, e.g. bonus contracts, debt covenants=> Accounting policies matter because they influence managements compensation and debt restrictionsEconomic consequences perspective( Positive accounting theory )

  • FUNDAMENTAL PROBLEM OF FINANCIAL ACCOUNTING THEORYBest measure of net income to inform investors and control adverse selection will be reliable AND relevant about future economic prospectsBest measure of net income to control moral hazard will be highly correlated with managers past efforts, and within managers controlCan one bottom line do both ?

  • Value-based accounting(Ideal)


    Contracts-compensation-debt covenantsHardNet IncomeInsideinformationInvestmentdecisionFulldisclosureRegulation- Accounting standardsettingFramework of accounting theory - Figure 1-1

  • Standard-setting: Accounting conceptsBACKGROUNDFASB1978 Statement of Financial Actg Concepts #1 - for businesses1980 SFAC #4 - for non-business, not-for-profits & governmentCICA1988 Handbook Section 1000 financial statement concepts1991 Section 1000 extended to non-profits

  • CICA Section 1000Financial statement conceptsObjectives of financial statementsSection 1000.15 --> joint perspectiveCommunicate information that is useful for : making investment & resource decisions and/or assessing management stewardship Unlike U.S., both are equally important

  • CICA - Section 1000Financial statement conceptsObjectives of financial statementsCost- benefit constraint, materialityQualitative characteristics :relevance & reliabilityunderstandability & comparabilitytrade-offsElements, recognition, measurementGAAP (basis on which f/s are normally prepared)

  • RELEVANCE AND RELIABILITYRelevancethe information can make a difference in the users decisionpredictive & feedback value, timelinessReliabilitythe information faithfully represents underlying economic substanceverifiable, unbiased, conservative

  • THE CASE FOR HISTORICAL COSTHistorical cost accounting reflects a particular trade-off between RELEVANCE & RELIABILITY. Which one does it favour ? ? ? ?RELIABILITY by waiting until changes in value are REALIZED income is more certainby smoothing out cash flows income reflects the longer-run earnings power of the business

  • REMAINDER OF SEMESTERDecision usefulness approach Investor's point of viewEconomic consequences model Management's point of view7 weeks of specific accounting issues Earnings managementEconomics and politics of standard setting


    Notes -Notes -Notes -Notes -Notes -Notes decision usefulness is largely descriptive why?information economics has descriptive aspects it looks at what information is prepared and how it is usedbut also has normative aspects what information should be reported, what standards and regulations are justified to ensure this information is made available?Notes -Notes -Notes -Notes -Notes -Notes -Notes -The presentation of accounting theory in the Scott book is organized as shown in Figure 1-1 Starting at the left, we consider an ideal form of accounting, where there is no uncertainty about future returns, rates of return are also known, and so the precise present values of all assets are known and can be used in presenting the balance sheet, and the income in each period.Working across the diagram, the top three green boxes present the investor decision-usefulness perspective while the bottom three pink boxes represent the economic consequences-managers perspective.The first problem encountered is information asymmetry- from the investor perspecitve this information asymmetry is hidden information, which can harm their investment decision and be addressed by accounting that provides full disclosure-from the managers perspective information asymmetry is hidden effort or actions, which can be addressed through contracting on accounting information, requiring accounting to be hard in the sense that it is reliable and objective and verifiable (though perhaps not as relevant for investors decisions)These two separate streams of theory illustrate the fundamental problem that one accounting number cant meet all needs, not even these two primary ones.The resolution to the fundamental problem is provided by regulation: accounting standards are set that attempt to balance the competing needs of investors and managers, however this cannot be done perfectly and is subject to limitations such as cost-benefit constraints and political pressures.


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