ACTG 4P11 Study Guide - Midterm Guide: Moral Hazard, Adverse Selection, Information Asymmetry
Document Summary
Chapter 1: introduction (adverse selection and moral hazard) Conservative accounting: anticipate no profits, anticipate all losses. Ideal conditions: future cash flows and probabilities are known. Revenue recognized as reserves are proved: adverse selection: some parties may have an information advantage over others before the transaction occurs. If quality cannot be assessed, buyer is willing to pay at most a price that reflects the average quality but seller of good items will not want to sell at the price for average quality. Investors will not buy bad securities so the market will not function well: moral hazard: parties can observe their actions in fulfillment of the transaction but other parties cannot after the transaction occurs. Incentive to behave differently once an agreement is made. Sarbanes-oxley act made it illegal for a registered public accounting firm to provide non audit services to a client at the same time as an impermissible audit (public company accounting oversight board)
