Financial Accounting Theory Essays (DOC)
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Added on 2020-04-15
Financial Accounting Theory Essays (DOC)
Added on 2020-04-15
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Running head: FINAL EXAMFINANCIAL ACCOUNTING THEORY AND RESEARCH
Final Exam 1EssaysQuestion 1Answer: The underlying premise of the clean surplus theory is that the components of all profit and loss go through the income. It is applied to determine the value of firm’s equity. The valuation of the equity is based on the book value at the beginning of the period plus the present value of expected abnormal earnings which are to be occur in future. Abnormal earnings are defined as the earnings which are in excess of expected normal earnings.Question 2Answer: a.According to Eugene Fama, the one who formulated efficient market hypothesis (EMH), “market efficiency means that at a given point of time, the stock prices fully reflect all the relevant and available information about a particular stock or market”. ("Eugene Fama's Efficient Market Is a Sound Guiding Principle for Investors and Policymakers", 2013).b.The EMH implies that, if the hypothesis is correct the investors can understand the accounting information easily and response to it quickly and that, the accounting information should be reflected in the stock prices. If prices respond to information then that information will be valuable to investors ("Eugene Fama's Efficient Market Is a Sound Guiding Principle for Investors and Policymakers", 2013).c.The three forms of EMH areWeak form efficiency: it means that current price of stock will reveal the information enclosed in historical prices.Semi-strong form efficiency: it suggests that the stock price fully reflect all theinformation which is publically available. It includes not only the historical prices but also the data mentioned in company’s final accounts.Strong form efficiency: it asserts that the stock price reflects all the information, both publically and privately available. It sometimes include inside information also. Question 3Answer:a.The Capital Asset Pricing Model (CAPM) is an economic theory used to measure an expected return on the risky asset. It is a model which explains the relationship between the required rate of return and the security risk. The theory says that the expected return equals to the risk-free return adding a risk premium which is multiplied by the beta factor. The beta is used to predict the securities’ price which is risk- based (Sharifzadeh, 2010).b.The market model states that the return on security is based on the return of market portfolio and on the extent of the security response. Also, the return also depends upon the unique conditions of the business ("Definition of "Market model" - NASDAQ Financial Glossary", 2017).
Final Exam 2Question 4Answer:One of the weaknesses of the research is that it is not easy to define cause and effect relationship between information and prices of securities due to the continuous price movements caused by new information. Also it becomes challenging to segregate the effect of one piece of information, as the security prices are affected by a large bunch of information. Another weakness is, it is a combine examination of both efficiency of market and information. If prices do not respond, then it is interpreted as that the examined information content has no data in it. This elucidation will be true only if the market is efficient. Whereas in inefficient market, it is not possible to interpret the absence of price response. Question 5Answer:A systematic effect on security prices is caused due to alternative policies of accounting. If the security prices respond to the income levels that are different, with no consequences of cash flow, then there is a support for the hypothesis. Some research findings have examined the response of security prices to a changing accounting policy of the company. Several studies used different accounting method to compare the companies. Evidence of this research claims that there is no information content in policy changes and the findings are also considered as a rejection to hypothesis.One of the change in policies is changing the inventory accounting to LIFO brings a positive security price movement. Tax expenses are lower for the companies which uses LIFO. Later studies oppose these findings stating no evidence of price response or negative price response. Research findings also determined the effect of indirect cash flow consequences on price of securities such as reduction in ability of paying dividend. A negative price response have been found in this area (Wolk, Dodd & Rozycki, 2012).Q6.Answer: In accounting research, PEAD is also known as SUE effect. Firms that reports good quarterly earnings, their abnormal security returns tend to drift upwards after the earning announcement. Whereas firms that report bad earnings, their abnormal security returns are likely to drift downwards. This phenomenon is called post- announcement drift.One of the possible cause for this phenomenon is that that the financial analyst do not properly react to the fundamental signals which led to the errors in forecast, which eventuallyresults in incomplete security price adjustments. Another reason may be that costs of transactions are higher than the gain earned from mispricing of securities (Chordia, et al. 2009).Q7.Answer:
Final Exam 3Cross-sectional analysis is a type of analysis done by the investors or portfolio managers to compare one company with the industry in which it operates or directly compare the company with the competitors operating in the same industry in order to measure performance and investment opportunities. This analysis has been used by several researchers in order to determine that pension plan assets and liabilities of the firm, which are reported in footnotes must be in compliance with their on balance sheet assets and liabilities. Other studies have also used this approach in examination of the disclosures of nonperforming loans and risk of interest rate in banks. Boththe factors are negatively associated with the firm’s value. Another study stated that the disclosure of “fair market value” of securities by banks is related with the market value. This finding gives authority to SEC’s and FASB’s aim for market accounting. Q8.Answer:The study conducted by Loh and Mian (2006) shows that accurate earning forecasting results in superior investment forecasting. The condition expressed in the study is that a trading strategy cannot be implemented by using the analysis of the relation between accuracy and recommendation profitability. To implement it, accuracy must be known at the recommendation announcement date. The accuracy and recommendation profitability should be measure for the same period in time (Gell, 2012).Q9.Answer:Uniformity concept tend to overlay with comparability in accounting literature. According to Sprouse, comparability is both a process and the end result of the process. However, it is seenin latter context, while uniformity is considered as the concept that effects comparability. In accounting literature, the amount of comparability, depends upon the extent of uniformity present in the financial statements. This is how uniformity relates to comparability (Wolk, Dodd & Rozycki, 2012).Q10.Answer:The economically significant circumstances which broadly affects the similar events are known as relevant circumstances. They are known as general factors which are related with complex events and will have an impact on cash flows. They are of two types. First, present magnitudes are those conditions which can be known at a time of event. Second, future contingencies are the factors which are determined at a later date. (Wolk, Dodd & Rozycki, 2012).Question 11.Answer:
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