Kwame Nkrumah University of

Science & Technology, Kumasi, Ghana

ACC 559/ACF 655

ACCOUNTING THEORY
Lesson 6: Decision Usefulness of Accounting
Information, Financial Reporting; Information
Perspective and Measurement perspective

Department of Accounting and Finance

Dr Abukari Salifu Atchulo

1
 Lecture Outline
• Overview of Accounting Information
• A Brief History on Decision Usefulness
• The Decision Usefulness Approach to Financial
Reporting
• The Information Perspective on Decision Usefulness
• The Measurement Perspective on Decision Usefulness

www.knust.edu.gh

2
 Financial Accounting Information
• Accounting information
“More information always equates to less uncertainty, and …
people pay more for certainty. In the context of financial
information, the end result is that better disclosure results in a
lower cost of capital” (Foster [2003, p. 1]) cited in Lambert, Leuz
and Verrecchia, (2007).

www.knust.edu.gh

3
 Financial Accounting Information Cont’d
• Financial accounting is a set of concepts and techniques that are used to
measure and report financial information about an economic unit or
entity.
• Information is evidence that has the potential to affect an individual’s
decision.
• Here, we define Financial accounting information as financial statements
presented for a particular period that are capable of influencing its users’
decision making.
• The process through which financial accounting information is presented
is what is termed as Financial Reporting.

www.knust.edu.gh

4
 Financial Accounting Information Cont’d
• Who are these users of financial accounting information?
• Internal users: These are made up of owners, employees and
management
• External users: These are made up of prospective owners,
creditors and lenders, labour unions, customers, governmental
units and the general public.
• All these users need financial accounting information to make
informed decisions based on their interests.
• But are the needs of the users really met in the financial
reports?
www.knust.edu.gh

5
 Decision Usefulness of Accounting Information
• Financial reporting in its actual form is based on many theories
that have been developed the over fifty years.
• Some of these theories are positive and the others are
normative.
• This leads to an important concept in accounting: Decision
usefulness
• The ability of financial accounting information to help users in
making good and informed decisions about providing resources
to, or doing business with, the reporting entity (ICANZ, 1994).

www.knust.edu.gh

6
 Decision Usefulness of Accounting Information
Cont’d
• Decision usefulness approach to financial reporting is an
approach to the preparation of financial accounting information.
• Emphasizes on the theory of investor decision making in order
to infer the nature and types of information that investors need.
• Satisfies the information needs of the primary users of the
financial reports of reporting entities: investors and creditors.

www.knust.edu.gh

7
 Decision Usefulness of Accounting Information
Cont’d
• In adopting this approach, the question of decision problems of
users of financial statements emanates.
• By understanding these decision problems, accountants will be
better prepared to meet the information needs of the various
constituencies.
• In other words, tailoring financial statement information to the
specific needs of the users of those statements will lead to
improved decision making. In this way, the financial statements
are made more useful
www.knust.edu.gh

8
 Decision Usefulness of Accounting Information
Cont’d
• Financial reporting communicates financial information useful
for making investment, credit, and other business decisions
(Scott, 2003).
• Accounting standard-setting bodies have adopted the theory as
a guide to the preparation of useful financial accounting
information.
• It is ethical for entities to make financial information very
useful to identified users

www.knust.edu.gh

9
 Decision Usefulness of Accounting Information
Cont’d
• To better understand this approach, theories other than the
present value model have been adopted from economics and
finance.
• Here, we take a look at the single person decision theory.

www.knust.edu.gh

10
 Single Person Decision Theory
• It purports that the rational individual makes optimal decisions
in the presence of uncertainty.
• It requires the decision maker to identify a set of acts from
which one must be chosen.
• The optimal decision is the one that maximizes the decision
maker’s expected utility based on the probabilities of the states
of nature.
• Decision theory is relevant to accounting because financial
statements provide additional information that is useful for
many decisions.
www.knust.edu.gh

11
 ILLUSTRATION
Bill Cautious has $10,000 to invest for one period. He has
narrowed down his choice to two investments: Buy shares of X
Ltd. at current market price, or buy government bonds yielding
2v1/4%. We will denote the act of buying the shares by a 1 , and
the bonds by a 2 . If he buys the shares, Bill faces risk. 4 That is,
the future performance of X Ltd. is not known when Bill makes
his decision. In the face of this risk, he defines two states of
nature:
• State 1: X Ltd. future performance high
• State 2: X Ltd. future performance low
www.knust.edu.gh

12
 ILLUSTRATION CONT’D
• Now consider the state probabilities. Bill subjectively assesses
the probability of state 1 (the high-performance state) as P(H) =
0.30. The probability of state 2 is then P(L) = 0.70.
• These subjective probabilities incorporate all that Bill knows
about X Ltd. to this point in time. They are called prior
probabilities

www.knust.edu.gh

13
 Importance Of The Single Person Decision Theory
• It helps to understand how individuals make rational decisions
under uncertainty and appreciate the concept of information.
• It sets out a formal procedure whereby individuals can make the
best decision by selecting from a set of alternatives.
• It allows decision makers to update their subjective beliefs
using the financial statements as a source of information.

www.knust.edu.gh

14