ACCT10003 Final: APA Exam Key Points
19 Jun 2018
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APA Exam Key Points
Lecture One
LO #1: Define the nature of data and information
Data: raw facts/ numbers = inputs
Information: data organised in a meaningful way = outputs
Primary qualities of information should include:
1. Relevance
i. Predictive value ii. Feedback value iii. Timeliness
2. Reliability
i. Verifiable ii. Neutrality iii. Representational faithfulness
LO #2: Define the problems created by information asymmetry in accounting
When one party has more or more useful information than the other. Has greater material knowledge.
E.g. Lemons vs. Cherries.
Buyers do not know the value and so will settle to pay the average price. Cherry owners will not take the
lower price and so eventually only lemons will be left.
- Sellers have no credible disclosure technology
- Deficiency of effective public quality assurances
Two major types of information asymmetry:
1. Adverse selection: one or more parties to a potential transaction or business transaction have an
information advantage over other parties. Controlled by timely and credible conversion of inside
information to outside information.
2. Moral hazard: one or more parties to a contract can observe their actions in fulfilment of the
contract but other parties cannot.
Accounting net income is a measure of managerial performance
- Net income an input to executive compensation contracts to motivate manager performance
-Net income can inform the managerial labour market (reputation effect).
Arrows impossibility theorem: It is not possible to combine differing preferences of individuals into
a societal preference ordering that satisfies reasonable conditions.
LO #3: Describe techniques firms can use to signal the quality of their accounting information
There are high and low quality firms. Each firm knows their true quality however outsiders do not. Should
firms signal or not?
High Low
Signal A C
Don’t signal B D
Signalling is a viable strategy for high quality firms when A>B and D>C. A separating equilibrium: high
quality firms should signal and low quality firms should not.
“Cheap talk” can be reduced through cost-less non-binding and unverifiable information and through
reducing pay-off (increase the cost) of false signalling.
find more resources at oneclass.com
find more resources at oneclass.com
There are benefits to honest signals and costs to dishonest signals. A signal is an action taken by a high-
type manager that would not be rational if that manager was low-type.
- Gives credibility
- Binding- costly commitment
- Verifiable- by a third party auditing
Managers will signal unobservable quality of their firm via observable quality in their financial statements.
E.g. of signalling in slides.
LO #4: Outline the role of accounting and auditing in reducing the agency problem
The agency problem is that a manager may pursue self-interest to the detriment of the principals.
(excessive consumption of perquisites, empire-building, dividend retention, horizon problem). There is a
situation of information asymmetry which gives rise to the problem.
Agents are induced to act in the principles best interests through
- Bonding costs- alignment of interests e.g. compensation schemes
-Residual costs- the remaining value loss to managers
- Monitoring costs- costs of producing and verifying by external audit the financial report assertions
of management
Managers will incur monitoring and bonding costs to the extent there is a marginal reduction in the agency
costs of equity. i.e. not all information asymmetry can be eliminated by disclosure, verification and
contracting.
Regulation mediates conflicting interests of investors and managers. Addresses the market failure caused
by the public good nature of accounting info.
Information disclosure:
Types of information:
1. Mandatory (regulated)
i. External- financial and tax
ii. Produce at lowest cost
Mandatory information disclosures: financial reports…
- Must be in compliance with corporations law and accounting standards and must be audited.
- Choice of auditor
- Conservative vs. aggressive accounting
- Conservatism is a sign of quality- reduces adverse selection through providing reliable info and
reduces moral hazard in efficient contracting.
Still have a wide variety of choice within GAAP (e.g. fair values, provisions and other estimates)
2. Discretionary (voluntary)
i. Internal- managerial or external
ii. Value of information is the MB
Voluntary information disclosures include
- Press release
- Earnings forecast
- CSR(corporate social responsibility)/Sustainability reports.
Issues include:
- Incentive to signal high type
- Proprietary information
- Costs vs. benefits
- Good news vs. bad news
- Credibility
find more resources at oneclass.com
find more resources at oneclass.com
Lecture Two
Lecture 2: Value relevance of non-financial information
LO#1: Describe the expanding domain of corporate reporting
- GPFR’s (notes included) are having increased narrative/ textual disclosures. Including
Management Discussion & Analysis (MD&A) and risk disclosures (e.g. climate risk).
- Sustainability/CSR reporting
- Integrated reporting where auditors will report financial and sustainability. Includes 6 capitals:
financial, manufactured, intellectual, human, social & relationship, natural.
The ASX has Corporate Governance Code Principles & Recommendations including:
- Principle 3: a listed entity should act ethically and responsibly
- Principle 7: recognise and manage risk. Recommendation 7.4: … should disclose whether it has
any material exposure to economic, environmental (e.g. GHG emissions water use) and social
(e.g. human rights, product safety, anti-corruption, taxation payments) sustainability risk and
how it manages those risks.
The objective of providing increased disclosures to improve the usefulness of information to decisions
is to:
- Help future and current investors understand financial statements
- Discuss the information that is not fully reflected in the financial statements
- Discuss important trends and risks, including those which will affect future performance
- To provide information about the quality (and potential variability) or earnings and cash flows.
Financial, environmental and social- “triple bottom line”
LO#2: Explain why sustainability information is value-relevant
Stakeholders in companies will have a higher interest in the firm’s sustainability reporting than
financial reports.
LO#3: Identify sustainability reporting frameworks
There are sustainability reporting frameworks which set standards and benchmarks/criteria for
entities to report against. CDP and Dow Jones Sustainability Indexes provide companies with ratings
from 1-100. Higher ratings will increase market value. Firms who choose to be recognised, are
recognised publically as reporting sustainably. The SASB aims to standardise sustainability reporting
and make them equal to the accounting standards.
LO#4: Give examples of the application of sustainability information in financial and managerial
accounting
- Internationally there is an ETS (emissions trading scheme). Carbon price creates a market for
firms to buy and sell carbon units- can be financial assets or liabilities. Increased prices of
these units makes pollution more costly and so will reduce it.
- In Australia the National Greenhouse and Energy Reporting Act makes mandatory reporting of
emissions and assurance for large emitters.
- Voluntary carbon footprint reporting means companies can choose which information they
want to include and omit from the reports. Representational faithfulness must be observed for
companies to report emission levels at those which are actually emitted.
- Companies have adopted the use of ‘shadow’ carbon price in capital budgeting. Net present
value and future cash flows will include the price of carbon.
- Companies are also being forced into looking into product design and process for more
renewable sources, product retention and mix, risk management and compliance with rules
and regulations.
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Lo #1: define the nature of data and information. Information: data organised in a meaningful way = outputs. Primary qualities of information should include: relevance, predictive value, feedback value, timeliness, reliability, verifiable, neutrality, representational faithfulness. Lo #2: define the problems created by information asymmetry in accounting. When one party has more or more useful information than the other. Buyers do not know the value and so will settle to pay the average price. Cherry owners will not take the lower price and so eventually only lemons will be left. Two major types of information asymmetry: adverse selection: one or more parties to a potential transaction or business transaction have an information advantage over other parties. Controlled by timely and credible conversion of inside information to outside information: moral hazard: one or more parties to a contract can observe their actions in fulfilment of the contract but other parties cannot. Accounting net income is a measure of managerial performance.
