QUIZ

ACCOUNTING THEORY

1. Explain why a firm’s manager might both believe in securities market efficiency and engage
earnings management?

2. For an earnings management strategy of taking a bath, the probability of the manager receiving
a bonus in a future years rises. Explain why?

3. A new accounting standard requires a firm to accrue mayor new liabilities for employee pensions
and benefits. As a result, its debt-t-equity ratio rises to the point where technical violation of
covenants in its borrowing agreements is threatened. Management knows that renegotiation of
these covenants would be difficult and costly.
Suggest some accounting policy choices that could reduce the likelihood of technical violation.
Ideally, any changes in policies should not violate accounting standard and GAAP, not affect the
firm’s real operations, and not reduce cash flows. Justify your suggestions.

4. Information has both cost and benefits to a firm. What are the costs and benefits of information
production to a firm? How much information should the firm produce?

5. To what extent do (i) security market forces and (ii) managerial labor market forces operate to
motivate managers to operate their firms in the best interests of the shareholders? In your
answer, identify how financial accounting information enables the market forces to operate.