Summary Financial accounting theory

ISBN-10 0135119154 ISBN-13 9780135119150
316 Flashcards & Notes
19 Students
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This is the summary of the book "Financial accounting theory". The author(s) of the book is/are William R Scott. The ISBN of the book is 9780135119150 or 0135119154. This summary is written by students who study efficient with the Study Tool of Study Smart With Chris.

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Summary - Financial accounting theory

  • 2.1 Overview

  • we define relevant information as information about the firm's future economic prospects
  • the firms net income seems tot play no role in firm valuation under ideal conditions. the reason is that future cash flows are known with certainty and can be discounte to provide balance sheet valuations. 
  • By certainty we mean that future cash flows of the firm and the interest rate in the economy are publicy known with certainty. We denote this as ideal conditions
  • accretion of discount is also referred to as ex ante, or expected net income. Since all conditions are known with certainty, the expected net income will equal the realized net income 
  • under ideal conditions note that as long as investors can invest any dividends they receive at the sae rate of return as the firm earns on cash flows not paid in dividends the present value of an investors overall interest in the firm is independent of the timing of dividends. This is also called dividend irrelevancy
  • any attempt by management to hide assets and liabilities, or bis inputs into the present value calculation, and any calculation errors, would be immediatly discovered since the various inputs are publicly known
  • 2.3 The Present Value Model Under Uncertainty

  • Uncertain future events that affect firms performance, such as the state of economy are called states of nature. 
  • ideal conditions under uncertainty are characterized by 1. a given fixed interest rate 2. a complete and publicly known set of states of nature 3. state probabilities objective and publicly known 4. state realization publicly observable.
  • the risk arising from not knowing which state of nature will happen is called estimation risk 
  • the major difference between certainty and uncertainty cases is that expected and realized net income ned no longer be the same under uncertainty, and the difference is called abnormal earnings. 
  • 2.4 Reserve Recognition Accounting (RRA)

  • critique of RRA consists of 1. only the proved reserves are included 2. average oil price is used 3. there is a fixed interest rate
  • the concept of proved reserves is itself a matter of judgement since proved essentially means reasonable certainty of recovery under current economic, operating and regulatory conditions
  • 2.5.1 Comparison of Different Measurement Bases

  • Historical cost accounting is relatively reliable since the cost of an asset or liability to a firm is usually a verifiable number that is less subject to errors of estimation. However historical costs may be low in relevance. 
  • Current valuation of assets implies revenue recognition as changes in current value occur. Under historical cost valuation implies revenue recogition as inventory is sold
  • 2.6 The Non-Existence of True Net Income

  • An important conclusion is that under the real world condition net income does not exist as a well defined economic construct. A basic problem is the lack of objective state probabilities.
  • greater relevence requires more estimates but more estimates decrease reliability. So reliability and relevence must be trade-off
  • 3.1 Overview

  • Decision usefulness is the ability of financial accounting information to help users make good decisions
  • 3.2 The Decision Usefulness Approach

  • Under non-ideal conditions it is not possible to read the value of the firm directly from the financial statements. 
  • Stewardship is the role to report on management's succes, or lack thereof, in managing the firms redources
  • Decision theory is important to accountants because it underlies pronouncements of accounting standard setters. 
  • Decission theory is gestoeld op 4 elementen 1. It is the investors responsibility to make investment decission 2. Role of financial reporting is to supply information that is usefull for investors to make good investment decissions 3. to prepare useful information accountants must know investor's decision needs 4. an understanding of how investors make decisions helps the accountants to know their decision needs
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