LIST OF KEY TERMS
A considered are investors and lenders. The agents most
a posteriori: once a statement has been developed, its
validity is assessed based on objective empirical
evidence.
a priori: the application of syntactic rules to test the
validity of a statement ‘from first principles’, as
opposed to testing the validity of a statement from
observation of real-world events.
abnormal item: a large or unusual item of revenue or
expense incurred during normal operations that is
required to be disclosed separately because of its size
and impact on the operating profit.
abnormal return: the difference between the expected
and the actual return. For example, if the market
average return on a particular investment is 10% and
a return of 17% is achieved, then 7% represents an
abnormal return.
accounting conceptual framework: a structured
theory of accounting that is a coherent, interrelated
theoretical description of the purpose, structure and
components of accounting. It is intended to guide
accounting practice.
accounting theory: logical reasoning in the form of
a set of broad principles that (1) provide a general
framework of reference by which accounting practice
can be evaluated and (2) guide the development of
new practices and procedures. Accounting theory is a
logically derived description, explanation, prediction
or prescription of accounting practice.
accumulated benefits fund: a superannuation fund
that provides a pension directly from the total
contributions of the pension recipient; also known as
a defined contribution fund.
additivity: the ability to add together values that are
expressed in like values. For example, past costs cannot
be added to future expectations or current market
prices.
agency costs: costs that arise from agency relationships,
for example because of the separation of ownership
from control of an entity. Three types of agency
costs have been identified: (1) monitoring costs,
(2) bonding costs and (3) residual loss. Agency
costs can be initially incurred by both principals and
agents. However, principals are able to adjust how
much they pay agents, so agents will ultimately bear
at least some, and possibly all, of the incurred
agency costs.
agency relationship: arises where one party (the
principal) engages another party (the agent) to
perform some service on the principal’s behalf.
Decision-making authority is delegated to the agent.
In accounting theory, the principals most usually
3_60_18158_AccThry7e_key terms.indd 503
usually considered are managers.
agency theory: a theory developed to explain and predict
the actions of agents (e.g. managers) and principals
(e.g. shareholders or lenders). The theory assumes that
both the agent and the principal are utility maximisers
(i.e. they seek to maximise their returns) whose
interests are not necessarily aligned. As a result, an
agency relationship has agency costs.
agent: a person appointed by a principal to manage the
principal’s affairs. See agency relationship.
agreements equally proportionately unperformed
(AEPUs): a type of contract where both parties have
yet to perform the same percentage of their individual
obligations under the contract; also referred to as a
wholly executory contract.
amortisation: systematic allocation of a prepaid expense
to the periods in which the benefit from the expense
is received. For example, the payment of building
insurance 3 years in advance would be amortised
(allocated) across each of the 3 financial years covered
by the insurance, rather than fully expensed in the year
the insurance is paid.
anomalies: problems that cannot be solved and which
contradict the dominant pattern.
arctan model: a non-linear, S-shaped relationship
between accounting numbers and share prices.
Extreme gains or losses have a declining impact on
prices because they are only temporary gains and
losses.
asset: a resource controlled by an entity as a result of
past events and from which future economic benefits
are expected to flow to the entity.
asset substitution: occurs when managers invest in
riskier investments than debtholders expected at
the time they entered into the debt agreement. This
reduces the value of the debt. Debtholders do not
benefit from the increased returns that high-risk
projects can provide; however, they can share in the
possible losses. Debt lenders are therefore assumed
to be risk averse and prefer firms to engage in less
risky projects that increase the recoverability of
their debt.
B
behavioural accounting research (BAR): the study of
the behaviour of accountants or the behaviour of
non-accountants as they are influenced by accounting
functions and reports. BAR research is concerned with
improving the quality of decision making.
beta (β): a measure of systematic risk; the non-
diversifiable (market) risk in an investment.
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 biological assets: a living animal or plant.
bonding costs: costs incurred by agents when they
establish mechanisms to signal to principals that they
will behave (or have been behaving) in the interests
of the principals, or that they will compensate the
principals if they fail to act in the principals’ interests.
bonus plan hypothesis: the prediction that managers
of firms with bonus plans are more likely to choose
accounting procedures that shift reported earnings
from future periods to the current period. This
happens because a risk-averse manager is assumed to
prefer a guaranteed bonus in one year, as opposed to a
possible bonus the next year. It assumes that managers
are paid bonuses based on firm profits.
Brunswik lens model: a model that provides an
analytical framework for investigating the decisions,
judgements or predictions made by information users.
The model has been used to consider the decision-
usefulness of accounting information.
C accounting system based on exit values, which are
capital: the money invested in, or the productive
capacity of, the entity, provided by the residual
equityholders. It is the difference between the sums of
the total assets and total liabilities.
capital asset pricing model (CAPM): a model that
predicts the returns on a firm’s securities as a function
of marketwide risk and the risk-free asset.
capital maintenance: maintenance of the value of the
original and any subsequent capital base (the base
is equivalent to the input by the firms’ owners). The
value maintained depends on the concept of capital
and how it is measured.
capital maintenance adjustment: the amount a firm
would need to retain, in addition to the amount of
capital originally invested, to maintain the value of the
capital.
capital market research (CMR): empirical research
using statistical methods to test hypotheses concerning
capital market behaviour.
cash flow: the inflow and outflow of cash or cash
equivalent assets/liabilities.
claim dilution: where a firm enters into a debt
agreement that has a higher priority than debt that has
already been issued.
commander theory: the focus of accounting activity is
drawn from the perspective of those who control (or
command) the economic resources of an entity. The
unit of experience and the point of view taken should
be of the people who have the power to deploy assets.
In most modern corporations, this is the management
team, which is often a group separate from the owners
(shareholders).
comparability: comparable financial statements are
produced in a consistent manner allowing users to
compare the reports of entities at one time and over
time.
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conceptual framework: a coherent system of interrelated
objectives and fundamentals that is expected to
lead to consistent standards and that prescribes the
nature, function and limits of financial accounting
and reporting. A conceptual framework attempts
to provide a definitive statement of the nature and
purpose of financial accounting and reporting. It can
consist of various levels, from stating the objective of
financial reporting, to identifying and defining the
basic elements of an accounting report.
constructive obligation: an obligation that is inferred
from the circumstances of a particular situation, rather
than a legal obligation.
contingent asset or liability: an asset or liability whose
‘existence’ for a particular entity depends on the
outcome of future events or the non-occurrence of
possible future events. For example, a liability arising
from a legal decision that is yet to be handed down is
a contingent liability.
continuously contemporary accounting (CoCoA): an
deemed to occur in the normal course of business; that
is, the values are not determined by the prices they
would realise in immediate liquidation.
contributed capital: capital that is contributed to the
entity from members, such as those acquiring ordinary
shares.
control: the power to govern the financial and operating
policies of an entity or business so as to obtain
benefits from its activities.
convertible note: a document that is evidence of a
company’s indebtedness for a specific amount, paying
a fixed interest rate until maturity. On maturity,
convertible notes may be converted to ordinary shares
or redeemed in full.
cost: the amount of cash or cash equivalents paid or the
fair value of the other consideration given to acquire
an asset at the time of its acquisition or construction
or, where applicable, the amount attributed to that
asset when initially recognised in accordance with the
specific requirements of other standards.
costs attach theory: a theory based on the assumption
that the value of any commodity, service or condition
used in production passes to the object or product for
which the original item was expended and attaches to
the result, giving it value. There are two components
of the theory: (1) displacement cost, which denotes
what has been given up and is synonymous with
opportunity cost, and (2) embodied cost, which
relates to the factors of production and what has been
outlaid rather than forgone.
critical event: the point at which revenues should be
recognised by an entity. The event relates to the stage
of the operating cycle which is most appropriate to the
revenue earning activity in which the entity is engaged.
current cost: cost to acquire an asset at current
prices. This cost normally reflects the change in
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 expected returns from holding the asset. Current
and replacement cost are likely to differ the older
the asset is, because of factors that normally relate
to technological advances or changes in market
demand.
current cost accounting: accounting based on the
current buying price of assets; that is, expensing and
matching resource usage using current replacement
values.
D discretionary accruals: accruals that are recorded based
debenture: a fixed-term loan to a company, secured
by either a fixed or floating charge over a company’s
assets, that pays a fixed rate of interest. A trustee is
appointed to protect the interests of debtholders.
debt contract: a contract between a lender and a
borrower of funds. The contract sets the terms and
conditions of the loan and usually contains debt
covenants devised to restrict the borrower’s behaviour
and protect the lender.
debt covenant: a term or condition written into a debt
contract that restricts or prescribes the behaviour of
management to ensure that debtholders’ interests
are protected. For example, a covenant may require
that the firm may not allow its ratio of debt to total
tangible assets to exceed 60%.
debt hypothesis: the prediction that the larger a firm’s
debt to equity ratio, the more likely it is that the firm’s
manager will select accounting procedures that shift
reported profits from future periods to the current
period. Such action reduces the chances of a firm
technically breaching a debt covenant.
deduction: reasoning from general to specific statements;
opposite of induction. A logical argument that
proceeds from a general statement to a specific
conclusion; the opposite of induction.
deductive reasoning: the act of logically reaching a
specific conclusion from known or supposed general
facts.
defeasance: the release of a debtor from the primary
obligation for a debt.
defined benefits fund: a superannuation fund under
which the amounts paid to an employee through the
fund are (at least partially) a defined proportion of the
employee’s salary.
deprival value: the loss that would be expected to be
incurred by the firm if it were deprived of the service
potential or future economic benefits of assets at the
reporting date.
derived measurement: a measurement that depends on
the measurement of two or more other properties.
Examples in accounting are profit, which is derived
from the deduction of expenses from revenue, and
asset values, which are derived from the historic
purchase cost less accumulated depreciation.
3_60_18158_AccThry7e_key terms.indd 505
descriptive pragmatics: a method of accounting theory
construction which relies on repeatedly observing the
methods and techniques of practising accountants.
differential information hypothesis: implies that
the information in accounting reports should be
more important for smaller firms than for larger
firms, because of the alternative information sources
available regarding large firms. For example, financial
analyst reports and media coverage are more likely to
be available on large firms than on smaller firms.
on management’s choice rather than necessity; that
is, accruals recorded at the manager’s discretion. See
‘taking a bath’.
dividend retention: a result of managers retaining the
company’s profits in the company in an attempt to
‘empire build’ the company and hence maximise their
own personal benefits, rather than pay out the higher
level of dividends that the shareholders prefer.
dogmatism: accepting the truth of a statement because
it has been made by someone from the establishment,
an expert or someone in authority, rather than
examining the statement for logical or empirical
content.
E
earning process: the full range of activities undertaken
by a firm to generate revenues.
earnings response coefficient (ERC): the security price
reaction evident from investors’ reactions based on
their assessment of the earnings persistence of the
release of unexpected profits information.
economic resource: a resource that can be used
to generate an economic benefit. For example,
a company’s property, plant and equipment are
regarded as an economic resource.
economic value: subjective value which relates to the
preference or desire people have for one item as
opposed to others.
efficient contracting: minimises agency costs and
ultimately increases the wealth available to agents and
principals. Agents (in recognition of price protection
and ex post settling up) enter into contracts aligning
their interests with those of the principal, or behave as
if their individual interests are aligned.
efficient market hypothesis (EMH): prediction that the
capital market adjusts rapidly to new information.
Three forms of capital market efficiency have been
proposed: (1) Weak-form efficiency assumes that
a security’s price at a particular time reflects the
information contained in its sequence of past prices.
(2) Semi-strong efficiency assumes that a security’s
price fully reflects all publicly available information,
including and in addition to past prices.
(3) Strong-form efficiency suggests that a security’s
price fully reflects all information, including
information that is not publicly available.
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 empirical research: analysis of practices, activities
or behaviour based on direct observation and/or
experience.
enterprise theory: adopts the viewpoint that
organisations have a key role in society and have
responsibilities to report on activities to a range of
stakeholders, including shareholders, employees,
creditors, government agencies and the public.
entity theory: adopts the viewpoint that the firm is a
separate entity with its own identity and is not merely
an extension of the activities and objectives of its
owners. Accounting procedures are adopted from the
viewpoint of the separate entity.
entry price value: a ‘buying’ price value.
environmental report: stand-alone document reporting
on the environmental performance of an organisation.
environmental reporting: the disclosure of information
on environment-related issues and performance by an
entity, for example, disclosure of emissions targets.
epistemology: the study of the acquisition of knowledge.
Concerned with the origin, nature, methods and limits
of human knowledge.
equitable obligation: an obligation that arises out of
a moral or social obligation, rather than as a legal
requirement.
equity: the residual interest in the assets of the entity
after deducting all its liabilities.
equity method: the method of accounting whereby
the investment is initially recognised at cost and
subsequently adjusted for the post-acquisition change
in the investor’s share of net assets of the associate.
The profit or loss of the investor includes the investor’s
share of the profit or loss of the investee.
ethical/environmental investment funds: investment
funds which screen potential investments for not
only economic performance, but also social and
environmental attributes, for example, whether the
company conducts experiments on animals or is
involved in armaments.
ex ante (efficiency) perspective: assumes that accounting
policies are selected ‘before the event’ to maximise the
value of the firm and to reduce agency costs.
ex post opportunism: managers are assumed to act
opportunistically. Accounting policies are therefore
chosen ‘after the event’ in order for managers to
maximise their own wealth by transferring wealth
from other parties.
ex post settling up: an agent’s past behaviour is taken
into account in either renegotiation or entering into
new principal/agent contracts, so that agents are
penalised for not acting in principals’ interests.
excessive dividend payments: a method of transferring
wealth from debtholders to shareholders. Dividends
are paid at a rate that is higher than was expected
when the debt was priced and borrowed by the firm.
exchangeability: refers to the ability of an asset to be
sold separately from other assets
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exit price accounting: accounting for assets, liabilities
and expenses by valuing them at current selling prices
exit price value: an asset’s expected selling price; used to
estimate its value.
expense: decreases in economic benefits during
the accounting period in the form of outflows or
depletions of assets or incurrences of liabilities that
result in decreases in equity, other than those relating
to distributions to equity participants.
externality: cost that results from the organisation but
is borne by other parties, for example, greenhouse gas
emissions from an industrial site.
extraordinary item: items of revenue and expense
attributable to events of a type that are outside the
ordinary operations of the company or the economic
entity and are not of a recurring nature.
F
fair value: the amount for which an asset would be
exchanged in an arm’s-length transaction between
knowledgeable, willing parties.
falsification: all hypotheses must be framed so that
they are capable of being falsified if they are not
true. Under this epistemological approach, science
advances by falsifying weak hypotheses and replacing
them with stronger hypotheses which are not as
easily falsified.
fiat measurement: arbitrarily established and indirect
measurement, for example, when expenses are
determined as a function of revenue according to
accounting standards.
finance lease: a lease where the rights and obligations
associated with ownership reside with the lessee. It is
a noncancellable lease where the lease generally is for
75% or more of the useful life of the leased property,
or the present value of the minimum lease payments
equals or exceeds 90% of the fair value of the lease
property at the inception of the lease.
financial capital: the amount of capital required to
maintain the initial financial investment in the
firm; the monetary value invested in residual equity.
Financial capital can be adjusted by an inflation index
to reflect real financial capital.
firm: in contracting theory, the firm is classified as a
legal nexus (connection) of contractual relationships
among suppliers and consumers. It is assumed that
firms exist because they are an economically rational
alternative to individuals transacting in the market.
forward exchange contract: a type of hedging agreement
where two parties enter into a contract to exchange
currencies at an agreed exchange rate in the future.
framing effects: in behavioural accounting research,
judgement or decision problems are often developed
to support the research. Devising problems creates
framing effects, in that the wording of the problem can
drive or influence results in a manner that cannot be
measured or adjusted.
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 free-rider: a user of accounting information who bears
little of the cost of producing the information and
therefore has incentive to demand increased levels of
disclosure.
fund theory: adopts the view that the firm is a set of
funds, where a ‘fund’ is a unit of operations, a centre
of interest, with a specified purpose or set of activities,
consisting of assets and equities. The focus is on an
impersonal fund, rather than adopting a personality
perspective, such as the proprietor of an entity.
fundamental measurement: where numbers can be
assigned to the property by reference to natural laws
(such as length).
future economic benefits: access to assets or resources
to support the activities of an entity resulting from a
prior expense.
G I
gain: increases in net assets from peripheral or incidental
transactions (from events that are not part of an
organisation’s mainstream trading activities). Gains
arise from subsidiary rather than main activities and
are often largely beyond the control of the firm.
going concern: the ability of the business to continue
operations in the foreseeable future.
H inductive tests: testing the truth of a proposition by
heuristics: a type of probabilistic reasoning used by
individuals using rules of thumb in order to simplify
complex judgement tasks. Three heuristics have been
identified: (1) representativeness — the degree to
which a particular event corresponds to an appropriate
mental model; (2) availability — the assessment
of a probability of an event based on the ease with
which instances of that event come to mind; and
(3) anchoring — a general judgement process in
which responses by an individual serve as an anchor
(or base) in an individual’s decision process when
additional information is introduced.
historical cost accounting: the traditional system of
accounting, based on double-entry bookkeeping
and reporting of transactions at the amount paid or
liable. Gains and losses are only recognised when
actually realised. The matching principle underlies
the historical cost method, where expenses are offset
against the revenues they support.
holding gains and losses: separately measuring gains
and losses on assets and liabilities determined by the
increase or decrease over the reporting period of their
current costs. An opportunity gain or loss is made by
management because they make the decision to buy
early.
horizon differences: shareholders (principals) and
managers (agents) have different time horizons with
respect to the firm. The classical valuation of security
prices (the value of a share is the present value of
all future cash flows attributable to it) means that
3_60_18158_AccThry7e_key terms.indd 507
shareholders have an infinite horizon. Managers
are assumed to be interested only in the cash flows
attributable to their intended employment in the
company.
human information processing (HIP): a subset of
behavioural accounting research that examines how
and why decisions are made by accountants or users of
accounting information.
human judgement theory (HJT): a subset of behavioural
accounting research that concentrates on examining
the judgements made by users of accounting
information, such as auditors.
hypothesis: a predictive statement derived from a theory.
Hypotheses can be stated in the null (no association
between variables of interest) or positive/negative
forms.
income: an increase in an asset or a decrease in a liability
will result in income, unless the increase or decrease
results from an equity contribution (such as cash
raised through share capital). Because of this broad
definition, income is further dissected into revenue
and gains.
induction: reasoning from the particular (specific) to the
general; the opposite of deduction.
observing a subset of real-world observations or
events. The epistemological development of a theory
under this method requires widespread and repeated
tests under varying conditions.
information asymmetry: the difference in the quantity
and quality of information available to a firm’s
managers compared with the information that is
available to others about a firm. The existence of
information asymmetry results in people outside the
firm being unsure of the true meaning and nature of
the information that managers disclose.
information content of accounting information:
impact of accounting information on decision making.
Capital market research assesses the information
content of profits by empirically testing the direction
and/or magnitude of the abnormal return of a
security’s return.
information hypothesis: prediction that accounting
information is produced to enable investors to make
good investment decisions.
information transfer: the information released by
one firm in a particular industry may also provide
information applicable to the pricing of securities
for other firms in the same industry. Information
transfer assumes that the release of unexpected profits
information for one firm in a particular industry will
have a flow-on effect to the pricing of securities of
other firms in the same industry.
intangible asset: a non-physical asset, such as goodwill,
patents or trademarks.
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 interest rate swap: occurs when two entities enter into
a contract to swap interest payments but remain
obligated to their original creditors.
interval scale: a scale that uses numbers which have rank
order and equal intervals, such as a temperature scale,
but uses an arbitrary point of reference. An example in
accounting is standard costing and variance analysis.
investor theory: adopts the view that the objective of
accounting is to serve the information needs of those
who provide capital to an entity. This relates to both
debt and equity funds.
L materiality: the quality applicable to information which,
lease: an agreement conveying the right from a lessor
(owner of the asset) to a lessee (another party) to use
property for a stated period of time in return for a
series of payments by the lessee to the lessor.
leverage: the use of debt to finance an entity, often
measured as the amount of debt to equity or as the
amount of liabilities to assets.
liability: present obligations of an entity arising from
past events, the settlement of which is expected to
result in an outflow from the entity of resources
embodying economic benefits.
life-cycle analysis: an analysis of the environmental
impact of a product or process from raw materials
until disposal, that is, tracking the environmental
impact from the mining or collection of the raw
materials, through production, to sale to the consumer
and ultimately the disposal at the end of its useful life.
liquidation value: the value of an item derived from
immediate ‘fire sale’ (forced sale) liquidation.
lobbying: actions taken by interested parties to influence
the actions or outcomes of decisions made by another.
logical positivism: a school of thought where the view
is held that only the methods of the natural sciences
provide ‘positive knowledge’ of ‘what is’. It is a
theoretical approach where all meaningful statements
must be capable of verification. Hence, all logical
positive theories must be capable of being empirically
tested.
loss(es): decreases in the value of net assets as a result
of peripheral or incidental transactions. For example,
if a retail firm’s retail outlet building is uninsured and
destroyed by a fire, this is a loss.
M no-effects hypothesis: the capital market only
management contracts: contracts between managers
(agents) and owners (principals). See agency theory.
market efficiency: the degree to which the market
efficiently reflects information subsets. For example, a
market that reflects all information contained in past
prices is deemed to be a weak-form efficient market.
See efficient market hypothesis.
market model: a model of how returns on a security
have been determined. The model controls
marketwide and firm-specific risk, thus allowing the
508 LIST OF KEY TERMS
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specific security price effect of an action to be assessed.
For example, the market model can be used to assess
the security price impact of the release of accounting
information.
market value: the value of an asset placed on it by
the market for that asset. The market is normally
represented by many buyers and sellers operating at
arm’s length.
matching concept: the accepted accounting process of
recognising revenues, then deducting the expenses
incurred to support these revenues. This requires that
expenses are allocated to a specific accounting period.
if it was omitted, misstated, or not disclosed in the
financial statements, could adversely affect users’
decisions about the allocation of scarce resources.
measurement: the process of determining the monetary
amount at which an asset, liability, income or expense
is reported in the financial statements.
mechanistic hypothesis: assumes that the capital market
is deceived by accounting changes, regardless of the
cash flow implications of the change
monetary items: assets and liabilities which are
accounted for at the dollar amounts for which they
will be redeemed or repaid; claims to fixed amounts in
dollar terms.
monitoring costs: costs associated with observing
(monitoring) the agent’s behaviour, for example,
mandatory audit costs.
multivariate models: models of behaviour or events that
include two or more factors that explain the variable
of interest.
N
naturalistic method: an unstructured research design,
which has no preconception of the research problem
or the form of the ultimate discovery. Under this
epistemological approach, information is discovered
by unobtrusive researchers without a predetermined
research methodology.
negative heuristic: the central core or basic assumptions
or propositions that have been accepted by scientists
as the central core of a research program.
net realisable value: the selling price of an asset less
expected selling costs.
reacts to accounting changes that have a cash-flow
consequence.
nominal: scale using numbers as labels, for example,
numbers on the shirts of football players.
non-monetary items: claims to assets or liabilities which
may appreciate or depreciate in value.
normative theory: a prescriptive theory that is stated
in terms of what should occur in order to achieve the
theory’s objective. Normative accounting theories
prescribe the ‘correct’ way to account.
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 null hypothesis: a prediction or proposition extracted
from a theory that states a positive association
between the variables of interest.
O returns due to a particular profit announcement are
ontology: study of the nature of ‘being’ or the
conception of what exists.
operating (earnings) cycle: the different points at which
revenue might be recognised by a firm.
operating lease: a lease under which the lessor (owner
of the property that is leased) effectively retains
substantially all the risks and benefits associated with
ownership of the property.
opportunity cost: the value of the next best alternative
forgone.
ordinal scale: using numbers to rank or order between
alternatives, for example, ranking firms according to
the amount of their profitability.
owners’ equity: the residual interest in the assets of the
entity after deducting its liabilities. A firm’s equity
cannot be defined independently of its assets and
liabilities. Rather, it is the balance remaining when the
two are netted.
P
paradigm: a particular school of thought. A paradigm
incorporates the background knowledge and research
procedures that provide the guidance and rules for
scientists working within the paradigm.
percentage-of-completion method: relates to the
periodic estimation of profit from an ongoing contract
or activity. This method is applied to construction
contracts under IAS 11/AASB 111.
physical capital: the firm’s ability to produce a given
level of output or services; operating capability.
political cost hypothesis: prediction that managers of
larger firms have greater incentives to reduce reported
profits and hence reduce their perceived ability to bear
political costs.
political costs: wealth transfers away from a firm due
to its political exposure. The amount of the transfer
is often related to the size and/or visibility of the
firm. For example, extractive industry firms may incur
political costs due to the actions of protesters; tariffs
may be reduced, based on an industry’s ability to
compete internationally.
political economy theory: used to describe a process
by which an organisation will try to pre-empt a threat
to organisational legitimacy, that is, the organisation
is a powerful participant in society able to lobby and
change expectations of performance.
political perspective of standard setting: acknowledges
the role of accounting in economic markets and
recognises that accounting information is an artificial
construction of specific types of information. This
construction is guided by the interests and priorities
of various parties, who lobby to achieve the types of
accounting standards they prefer.
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positive accounting theory: an empirically tested theory
that describes, explains or predicts accounting practice.
post-announcement drift: occurs when the abnormal
not immediately reflected in a security’s price at the
announcement date, but are reflected progressively
after the announcement date. The existence of post-
announcement drift raises questions about whether
the capital market is efficient.
pragmatic: the effect of words or symbols on people;
their real-world effect.
predictive value: the relevance of the accounting
information to facilitation of decisions about the
future actions and value of an entity.
preference shares: a form of equity in a company that
receives preference over ordinary shares in either or
both dividend payments and the distribution of assets
on the winding-up of a company.
present value: a value based on the calculation of future
net cash receipts associated with the future services
or benefits of an asset. Three variables are required to
measure present value: future cash amounts, discount
rate and time horizon (length of time).
price protection: the ability of principals to transfer
the bearing of agency costs to the agent. For example,
when an agent’s contract is negotiated, principals
are in a position to be able to adjust the contract to
compensate for the costs that they expect to incur due
to the agent’s self-interested actions.
principal: the individual or group who appoints an
agent to act on their behalf.
private-interest theory: assumes that regulation, and
hence standard setting, is regulated by the relative
political power of various interest groups.
probabilistic judgement paradigm: a model used to
assist in situations where initial predictions need to be
adjusted in light of additional information. The initial
likelihood estimation is adjusted by a likelihood ratio,
which is the amount by which prior expectations
should be revised.
probable: the conceptual framework uses the expression
‘probable’ to mean more rather than less likely, that is,
there is more than a 50% likelihood that something
will occur.
profit: the excess of revenues over expenses. Profit is
generated only when a firm’s beginning amount of
capital is maintained.
profit persistence: the expectation of investors that
unexpected profit changes (increases or decreases) will
continue and eventually be reflected in permanent
changes in dividends.
proprietary theory: adopts the perspective of the owner
(proprietor) in determining accounting methods
and reporting. The purpose of the firm, the nature of
capital and the meaning of accounts are defined in
terms of the owner’s perspective.
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 public-interest theory: justifies the mandatory
requirement of accounting standards as a means of
reducing the likelihood of market failures in response
to public demands for the control of accounting
information.
R resources such as stationery or printing facilities for
ratio scale: type of scale where the rank order is known,
intervals are equal and the scale has a unique origin or
natural zero point. Under a ratio scale we can compare
the relative performance of firms and legitimately use
accounting numbers as ratios.
realisation: the point at which the sale of an asset,
product or service results in a transfer of assets
(normally cash) or reduction in liabilities for an entity.
The revenue may have been previously recognised, but
now that assets have flowed to the entity (or liabilities
reduced), the transaction is referred to as ‘realised’.
recognition criteria: guidelines used or adopted to
determine whether an asset or liability should be
formally included (recognised) in an entity’s financial
statements and records.
recognition of financial statement elements: the
item ‘recognised’ appears on the face of financial
statements. Australian standards require that financial
statement elements, such as assets and liabilities,
are recognised when there is a probability that the
elements exist and they can be measured reliably.
recognition principle: revenues are recognised in the
period during which the major economic activities
necessary to the creation and disposition of goods and
services have been accomplished (provided objective
measurements of the results of those activities are
available).
regulatory capture theory: assumes that individuals
are economically rational and hence will act in their
own self-interest. Therefore, although the purpose of
standard setting is to protect the public interest, this is
not achieved because the regulatee comes to control or
dominate the regulator.
relevance: relevant financial information helps users
make predictions about future situations or confirms
the past predictions of users.
reliability: a qualitative characteristic that ensures
information corresponds with the events it reports.
Reliable financial information faithfully represents
transactions and events without bias or undue error.
REM: (rational, evaluative utility maximiser) the term is
often applied to predict how managers will act and is
derived from the assumption that individuals will act
in a manner to maximise their self-interest.
replacement cost: the amount that would be paid
to acquire the best asset available to undertake the
function of the asset that is to be replaced.
reproduction cost: the amount that would be paid now
to reproduce an asset identical to the one currently
being used.
510 LIST OF KEY TERMS
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residual loss: monitoring and bonding activities
cannot completely align principals’ and agents’
interests because it is not cost-effective to do so.
Therefore, the costs associated with the continuing
difference are known as a residual loss. For example,
residual losses result when agents use company
their own use.
restoration: the process of restoring, for example, an
abandoned mine site.
revenue: the gross inflow of economic benefits during
the period arising in the course of the ordinary
activities of an entity when those inflows result in
increases in equity, other than increases relating to
contributions from equity participants.
risk aversion: unwilling to accept a fair gamble. Agency
theory assumes that managers prefer a low rather than
a high level of risk because, compared with investors,
they are unable to diversify their risk level associated
with working for one firm. Hence, managers are
assumed to prefer to invest the firm’s money in
lowrisk investments. It is predicted that they prefer
to minimise their own risk rather than maximise the
value of the firm.
S
scientific method: an epistemological approach whereby
systemic, structured or controlled research design leads
to the acquisition of knowledge or conclusions.
semantics: the correlation of a word, sign or symbol
with a real-world object or event.
share dividend: a return of profit to shareholders that
is issued by way of new shares rather than a cash
dividend; also referred to as a bonus share issue.
signalling theory: assumption that managers of all
firms have incentives (albeit different) to maintain
their credibility with the market through reporting
the firm’s performance. Therefore, signalling theory
predicts that firms will disclose more information
than is demanded. Signalling theory goes on to
predict what information firms will signal, how
and when.
social contract: a theory describing the interaction
between individuals or organisations within society
through implicit or explicit boundaries of behaviour
(implicit boundaries are moral obligations, explicit
boundaries are regulatory requirements).
social reporting: sometimes referred to as social
accounting or social responsibility disclosure. It is the
disclosure of information on social-related issues and
performance; for example, the reporting of policies on
equal opportunity and minorities.
statement of cash flow: provides information about the
cash payments and cash receipts of an entity during a
period.
statement of changes in equity: a financial statement
prepared in accordance with IAS 1/AASB 101 for
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 inclusion in general purpose financial reports. The
statement reports on the changes in the entity’s equity
for the reporting period. Changes in equity disclosed
may include movements in retained earnings for
the period, items of income and expense recognised
directly in equity, and movements in each class of
share and each reserve.
statement of comprehensive income: a financial
statement that reports on the entity’s revenues and
expenses for the reporting period.
statement of financial position: a financial statement
that presents assets, liabilities and equity of an entity
at a given point in time.
subjective value: an estimate of the current value of an
asset or liability based on the estimated benefit or
cost over the term of a liability or life of an asset, as
determined by management.
sustainability: the equitable consumption of resources
that does not compromise the needs of future
generations.
syllogism: a set of propositions from which a logical
conclusion is drawn.
syntactic relationship: an analytical or logical
methodology for formulating propositions.
T its ability to satisfy human wants. At its broadest level,
‘taking a bath’: involves decreasing profits, through the
use of discretionary accruals, in one year to enable
profits to be increased in future years. This increases a
manager’s future earning potential.
technical perspective of standard setting: based on the
belief that accounting involves the measurement of
facts and that standard setting should be concerned
with measurement issues and ensuring that
accountants provide factual information.
thin trading: occurs when a company’s shares are not
traded frequently (or only at relatively low volumes).
Its existence reduces the efficiency of the market.
transaction costs: costs associated with negotiating the
terms of a contract. Transaction costs can include the
costs of legal advice and the time spent by managers in
developing a contract or the costs of brokerage when
selling shares.
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triple bottom-line reporting: the reporting of economic,
social and environmental performance of an entity.
It is also a possible means of quantifying a trade-off
between these three aspects of performance.
trust deed: written contract between the lender and
the borrower detailing the terms and conditions of a
debenture.
U
underinvestment: occurs if entering into a project has
a net present value level that will repay at least some
of the firm’s debt, but not provide any benefits to the
owners of the firm. In such cases, owners have no
incentive to enter into the project.
unrealised gain: a change in the value of an asset (or
reduction in the value of a liability) which has not
actually been taken by an entity, but reflects the
change in the current or market value of an asset or
liability. Unrealised gains are recognised at a point in
time, normally balance date.
unsecured note: written evidence of a company’s
indebtedness which is issued when the lender does
not have security over the company’s
assets.
utility: in economic theory, the utility of a commodity is
a commodity is regarded as useful because of what it
can be used to produce.
V
value: within accounting the term ‘value’ commonly
refers to economic value, which is a function of
expectations about the future benefits that will be
derived from an asset or cash generating unit.
value of a good: the market price of a good is believed to
reflect its value.
W
wholly executory contract: a contract where each party
to the contract has yet to perform exactly the same
percentage of its obligations under the contract; also
referred to as agreements equally proportionately
unperformed (AEPUs).
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