Accounting Theory, 7th Edition Jayne Godfrey, Allan Hodgson, Ann Tarca, Jane Hamilton, Scott Holmes

Type:

Test Bank

Resource:

Accounting Theory

Edition:

7th Edition

Author(s):

Jayne Godfrey Alan Hodgson Ann Tarca Keryn Holmes Jane Hamilton

Test Bank to accompany

Accounting Theory 7th edition PREPARED BY

Barbara Burns CHAPTER 1 Introduction

© John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

Chapter 1: Introduction True/False 1. The main purpose of accounting theory is to prescribe accounting rules for practitioners. a. True *b. False Feedback: The main purpose of accounting theory is to explain current accounting practice and to provide the basis for development of such practice.

Section "Overview of accounting theory"

2. As a result of accounting prescription being developed in a haphazard way there are follow-on inconsistencies in practice. *a. True b. False Feedback: Because of the haphazard development of prescriptive accounting practice the theories underlying the practice have developed in an unstructured manner resulting in inconsistent practices eg. different measurement methods for different classes of assets.

Section "Overview of accounting theory"

3. An example of an inconsistency in accounting practice is for a company to depreciate some of its assets using the straight-line method and some using the reducing-balance method. a. True *b. False Feedback: This is not an example of an inconsistency in accounting practice but a choice available so that the amount of depreciation charged best reflects the way in which the asset contributes to the earning of revenue.

Section "Overview of accounting theory"

1.2 © John Wiley & Sons Australia, Ltd

Chapter 1: Introduction

4. No systemic theory of accounting was devised from the time of Pacioli in the 15 th century until the opening of the 19th century. *a. True b. False Feedback: For 300 years following Pacioli's 1494 treatise, progress in accounting concentrated on refining practice rather than on developing theory.

Section "Overview of accounting theory"

5. The period 1800 - 1955 has been labelled the empirical period in accounting development. *a. True b. False Feedback: The period 1800 -1955 has been labelled the empirical period in accounting development. The emphasis was on real-world observation to explain why accountants account as they do.

Section "Overview of accounting theory"

6. The development of a conceptual framework has solved the problem of inconsistency in the application of accounting in practice. a. True *b.

False

Feedback: Because conceptual frameworks seek to provide universal guidance they have proved too general to provide a clear set of guidelines which totally resolve inconsistencies in accounting practice.

Section "Overview of accounting theory"

7. During the normative period of accounting theory development, theorists were concerned with explaining and understanding current accounting practice. a. True *b. False Feedback: During the normative period theorists were more concerned with developing theories about what accounting practitioners ought to be doing rather than what practitioners were actually doing.

Section "Overview of accounting theory" 1.3 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

8. The normative period of accounting theory ended because empirical testing proved the theories developed during this period to be false. a. True *b. False Feedback: In fact, one of the reasons that the normative period drew to a close was the lack of testing methods available for the theories.

Section "Overview of accounting theory"

9. The 'debt hypothesis' predicts that the larger the 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 current periods - this is to reduce the likelihood of the firm technically breaching its debt covenants. The theory underlying this hypothesis would be a positive theory. *a. True b. False Feedback: The objective of positive accounting theory is to explain and predict accounting practice. A normative theory, which this is not, would prescribe what the accountants ought to do as the firm's debt covenants come close to a technical breach.

Section "Overview of accounting theory"

10. An example of a positive accounting theory is the bonus plan hypothesis. This predicts that managers who are not remunerated via bonus plans use profit-increasing accounting methods more than managers who are remunerated via bonus plan. a. True *b.

False

Feedback: It is the other way around. According to bonus plan hypothesis, managers who are remunerated via bonus plans use profit-increasing accounting methods more than those who are not remunerated via bonus plans in order to maximise profits in the accounting period when they are likely to receive bonuses.

Section "Overview of accounting theory"

1.4 © John Wiley & Sons Australia, Ltd

Chapter 1: Introduction

11. Behavioural research, which is concerned with the broader sociological implications of accounting numbers and the associated actions of 'key players' as they react to accounting information, was first used in an accounting context in the 1980s. a. True *b. False Feedback: While the definition of behavioural research provided in the statement is correct, behavioural research in accounting started in the 1950s not the 1980's.

Section "Overview of accounting theory"

12. While the accounting profession has sought to use accounting theories to unify accounting practice and make it more useful, academics use accounting theories to understand the role and impact of accounting information. Therefore, academic research on accounting is not useful for professional practice. a. True *b. False Feedback: While the statement about the differing priorities of academics and professionals is true, it is not true to state that academic research is not useful for professional practice. Standard setters and other accounting professionals can use the output of positive research, e.g. the impact that a new statement will have on accounting practice, to refine the development of accounting prescriptions.

Section "Overview of accounting theory"

13. The ultimate objective of international accounting standards is to make all countries use the same standards so that there are no differences in reported information across international reporting boundaries. a. True *b. False Feedback: Even if every country adopted international accounting standards outright there will always be differences in the way firms report the same information as accounting standards cannot fully remove the element of choice that will always exist within those standards.

Section "Overview of accounting theory"

1.5 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

14. The current Australian conceptual framework consists of SAC 1, SAC 2, SAC 3, and SAC 4. a. True *b. False Feedback: SAC 3 and SAC 4 have been replaced by the International Accounting Standard Board's (IASB) conceptual framework. Therefore the current Australian conceptual framework consists of SAC 1, SAC 2, and the IASB's conceptual framework.

Section "Overview of accounting theory"

1.6 © John Wiley & Sons Australia, Ltd

Chapter 1: Introduction

Multiple choice

15. The statement that best defines what is meant by a theory is: a. A coherent set of hypothetical, conceptual and pragmatic principles forming the general framework for a field of inquiry b. A deductive system of statements of decreasing generality c. A set of ideas used to explain real-world observations *d. All of the above Feedback: As stated in the text, the term 'theory' can be used in different ways. Answers a., b. & c. are all accepted definitions of the term theory.

Section "Overview of accounting theory".

16. Which of these characteristics is the least important for an accounting theory to be considered acceptable? a. How well the accounting theory has been constructed b. How acceptable the implications of the accounting theory are *c. How prescriptive the accounting theory is in relation to accounting practice d. How well the accounting theory explains and predicts reality Feedback: An acceptable theory does not have to be prescriptive. In other words, it does not have to state what ought to be, it is sufficient for an acceptable theory to explain and predict reality.

Section "Overview of accounting theory".

17. The statement that best defines the term 'empirical analysis' is: a. Reasoning from the general to specific statements b. Testing the truth of a proposition by observing a subset of real world observations or events *c. Understanding practices, activities or behaviour based upon direct observations and/or experience d. Actions undertaken by interested parties to influence the actions or outcomes of decisions made by others

Feedback: Answer a. is the definition of 'deduction', answer b. is the definition of 'induction', answer d. is the definition of 'lobbying'.

Section "Overview of accounting theory".

1.7 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

18. Which of these is an era of accounting theory development during which the emphasis was on providing an overall framework to explain and develop accounting practice by using the empirical analysis method? *a. The general scientific period b. The pre-scientific period c. The practical approach period d. The normative period Feedback: The period 1800 - 1955 is often referred to as the 'general scientific period'. Its emphasis was on providing an overall framework to explain why accountants account as they do using real world observations.

Section "Overview of accounting theory".

19. The rapid increase in demand for both management accounting and financial accounting information in the 1800s can be explained by: a. The rapid development of technology during this time b. The 'birth' of the corporation c. Increasing separation of business management from ownership *d. All of the above Feedback: All of the factors described in a., b. & c. contributed to the rapid rise in the demand for management and financial accounting information.

Section "Overview of accounting theory".

20. Which of these would be an example of normative research (research based upon a normative theory)? a. A researcher, through observation, documents the breeding cycle of the gnat b. An economist develops a method of using last month's share market prices to predict unemployment levels *c. In order to ensure consistency in schooling outcomes an education researcher recommends that all final year school students undertake the same six subjects for assessment purposes d. An accounting researcher predicts that auditors will perform faster audits when the audit materials are presented in graphical rather than tabular form

Feedback: This is the only situation that is prescriptive - the researcher is stating that consistency in education outcomes is paramount and prescribing a practice that he/she believes will achieve this outcome.

Section "Overview of accounting theory".

1.8 © John Wiley & Sons Australia, Ltd

Chapter 1: Introduction

21. The major focus of the normative accounting theories during the period 1956 - 1970 was: a. Refining accounting practices *b. The impact of changing prices on the value of assets and the calculation of profit c. Providing explanations of accounting practices d. The broader sociological implications of accounting numbers Feedback: A is the focus of accounting developments during the pre-theory period; C is the focus of positive accounting theories; D is the focus of behavioural research.

Section "Overview of accounting theory".

22. The two groups that dominated the normative period of accounting theory development were: a. The proponents of historical cost accounting and the conceptual framework proponents b. The critics of historical cost accounting and the conceptual framework opponents c. The proponents of historical cost accounting and the conceptual framework opponents *d. The critics of historical cost accounting and the conceptual framework proponents Feedback: The critics of historical cost accounting and the conceptual framework proponents dominated the normative period.

Section "Overview of accounting theory".

23. Which of these is one of the two main factors that prompted the demise of the normative period of accounting research? *a. The availability of financial economic principles and testing methods b. Severe criticisms from positive accounting theorists c. The resurgence of behavioural research d. The increased popularity of a conceptual framework Feedback: The two main factors that prompted the demise of normative period were (1) the unlikelihood of acceptance of any particular normative theory and (2) the availability of financial economic principles and testing methods.

Section "Overview of accounting theory".

1.9 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

24. Which of the following arguments are reasons why normative theories cannot be empirically tested? i. It is impossible to demonstrate empirically what ought to be ii. Normative theories are based on value judgements iii. There is no access to empirical data sets a. i, iii *b. i, ii c. ii, iii d. i, ii, iii Feedback: The criticisms of normative theories outlined in the text include i and, ii. Despite the increased access to empirical data sets, it is still difficult to test normative theories as they are based on subjective opinions of how accounting should be practiced and therefore it is impossible to obtain general acceptance of any particular normative accounting theory.

Section "Overview of accounting theory".

25. Behavioural accounting research is concerned with the broader sociological implications of accounting numbers. As such it is mainly concerned with the reactions of which of the following groups to accounting numbers? a. Auditors and managers b. Shareholders and government c. Creditors *d. All of the above Feedback: Behavioural accounting research can investigate the effects of accounting numbers on any individuals or groups who are potentially affected by those numbers.

Section "Overview of accounting theory".

1.10 © John Wiley & Sons Australia, Ltd

Chapter 1: Introduction

26. In which of the following situations would you probably not apply a behavioural theory if you wanted to undertake accounting research? a. You want to know whether investors use disclosures when deciding whether to invest in a firm *b. You are interested in understanding the effect of unexpected earnings announcements by firms on share prices c. You want to know what factors loan managers consider when assessing the riskiness of a new client firm d. You want to determine whether individuals are quicker at analysing financial information using graphs or tables Feedback: This situation involves capital markets research as it is concerned with the effects of accounting numbers at the aggregate level.

Section "Overview of accounting theory".

27. The statement that best describes the interaction of academic and professional research interests with respect to accounting theory, is: a. Academic and professional research interests are incompatible as academic research centres on positive theories which are not prescriptive b. Academic researchers use positive accounting theories whereas the accounting profession uses normative theories *c. While accounting profession researchers seek normative (prescriptive) theories for accounting practice, these theories are not incompatible with academic (positive) theories which can be used to advise accounting professionals in the development of prescriptive practices d. None of the above Feedback: Standard setters and other accounting professionals can use the output of positive research, e.g. the impact that a new standard will have on accounting practice, to refine the development of accounting prescriptions.

Section "Overview of accounting theory".

28. Which of the following is not regarded as a period of accounting theory development? a. The normative period *b. The pre-scientific period c. The positive accounting theory period d. The mixed development period Feedback: The 'pre-scientific' period does not feature - all other periods do feature.

Section "Overview of accounting theory".

1.11 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

29. Select the pair of periods of accounting theoretical development that are based on a similar approach. *a. The general scientific and the positive periods b. The normative and positive periods c. The general scientific and the normative periods d. None of the above Feedback: The general scientific and the positive periods of accounting theoretical development are both based on an empirical approach.

Section "Overview of accounting theory".

30. The statement that is not descriptive of positive theories is, a. They are descriptive rather than prescriptive b. They avoid making value-laden judgements c. They explain why people behave in a certain manner *d. Their primary concern is developing policy recommendations for accounting practice Feedback: This statement is descriptive of normative accounting theories not positive theories.

Section "Overview of accounting theory".

31. The research question that is most unlikely to be tested using positive methodology is: a. Which firms are more likely to use straight-line depreciation rather than diminishingbalance depreciation? *b. Is the quantitative data derived from given sets of operations, based on an overall accounting theory, useful to users of financial statements? c. How do changes in tax rules affect a firm's leverage position? d. Are firms with more intangible assets more likely to repurchase their shares?

Feedback: A, C, and D are examples of research questions covered by positive accounting theory because they attempt to explain and describe the reasons for current accounting practices. B is a typical question under normative theory (decision-usefulness approach) as it concerns the usefulness of accounting data.

Section "Overview of accounting theory".

1.12 © John Wiley & Sons Australia, Ltd

Chapter 1: Introduction

Essay Questions

32. "Many accounting prescriptions on how to account were developed to resolve problems as they arose., hence the theory underlying those prescriptions also developed in a largely unstructured manner. This has led to inconsistencies in practice". J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.5. Discuss the quotation, including in your discussion at least three examples of inconsistencies in accounting practice.

33. Give a brief overview of the development of accounting theory in: · the pragmatic period (1800-1955) · the normative period (1956-1970) · the positive period (1970's-2000 )

34. Compare and contrast the normative approach to accounting theory with the positive approach.

35. 'The positive and normative approaches to accounting theory are not incompatible.' Explain and discuss.

1.13 © John Wiley & Sons Australia, Ltd

Test Bank to accompany

Accounting Theory 7th edition PREPARED BY

Barbara Burns CHAPTER 2 Accounting theory construction

© John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

Chapter 2: Accounting theory construction True/False 1. The descriptive pragmatic approach to accounting theory construction is a deductive approach as it is based upon continual observation of accountants in order to copy their accounting procedures and principles. a. True *b. False Feedback: It is an inductive approach not deductive, i.e. it must be tested by reference to empirical evidence, i.e. do accountants, in fact, act in the way the theory suggests.

Section "Pragmatic theories"

2. The psychological pragmatic approach differs from the descriptive pragmatic approach in that under the psychological approach, the users' response to accounting information is observed rather than the accountants' behaviour. *a. True b. False Feedback: Section "Pragmatic theories"

3. Normative theory researchers in the 1950s and 1960s concentrated on deriving a single measure for assets and a correct profit figure, even though there was no agreement on what constituted a correct or true measure of value and profit. *a. True b. False Feedback: Normative theorist in this period concentrated either on deriving the true profit for an accounting period or on discussing the type of accounting information which would be useful in making economic decisions.

Section "Normative theories"

2.2 © John Wiley & Sons Australia, Ltd

Chapter 2: Accounting theory construction

4. The concept of realism under the decision-usefulness approach asserts that for an accounting theory to be valid it must hold as a description of the reality that underlies the accounting phenomena. *a. True b. False Feedback: Under the realism approach, an accounting theory is only valid when it serves as more than an instrument for forecasting, that is, it must give relevant feedback or be descriptive of what has occurred in reality.

Section "Normative theories"

5. Positive and normative theories are mutually exclusive; it is not possible for the theories to complement each other. a. True *b. False Feedback: While normative and positive theorists may dismiss each other's viewpoints, it is reasonable to argue that positive accounting theory can be used as a basis for developing accounting practice using normative theories. Section "Positive theories"

6. The main difference between normative and positive theories is that normative theories are descriptive whereas positive theories are prescriptive. a. True *b. False Feedback: It is the other way around. Normative theories are prescriptive because they prescribe what ought to be done, whereas positive theories are descriptive because they describe how people behave and explain why they behave in a certain manner.

Section "Normative theories"

7. The naturalistic approach to theory development looks at specific situations to understand what is happening in that particular situation - generalisability is not an underlying concern. *a. True b. False Feedback: The naturalistic approach is intended to answer the question "What is going on here?" not to provide generalisable conditions for wide segments of society.

Section "Different perspectives"

2.3 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

8. Under the naturalistic approach to research an appropriate research methodology is case studies. *a. True b. False Feedback: The usual way to undertake naturalistic research is to use individual case studies and detailed fieldwork.

Section "Different perspectives"

9. Results from naturalistic research may be more difficult to generalise compared to results from scientific research. *a. True b. False Feedback: Naturalistic research aims at solving individual problems which may be firm- specific, and therefore, the results may be more difficult to generalise.

Section "Different perspectives"

10. Under the Morgan and Smircich classification, Category 1 assumes that the world is unstable and that individuals do not share a common understanding of how the world works. a. True *b. False Feedback: Category 1 assumes that individuals' behaviours will always conform to a set of behavioural rules and therefore their actions are highly predictable and stable. The description given is of Category 6.

Section "Different perspectives"

11. Applying a scientific approach to accounting is an attempt to make scientists out of accounting practitioners. a. True *b. False Feedback: Scientists (i.e. accounting researchers) and accounting practitioners have different roles that can complement each other. Accounting researchers use a scientific approach to find empirical evidence to support accounting practices, so that accounting practitioners can recommend the appropriate methods for given situations based on this evidence.

Section "Scientific approach applied to accounting"

2.4 © John Wiley & Sons Australia, Ltd

Chapter 2: Accounting theory construction

12. Mautz and Sharaf, in 1961, attempted to generalise the existing auditing literature and provide a comprehensive theory of auditing. *a. True b. False Feedback: Mautz and Sharaf, in 1961, attempted to generalise the existing auditing literature and provide a comprehensive theory of auditing.

Section "Issues for auditing theory construction."

13. Recent experimental auditing research has found a negative link between the size of audit firms and the quality of audits performed, i.e. the larger the firm the poorer the audit. a. True *b. False Testbank Feedback: Recent experimental auditing research has found a positive link between the size of audit firms and the quality of audits performed, i.e. larger audit firms have 'more to lose' by failing to report a discovered breach in a client's records.

Section "Issues for auditing theory construction."

2.5 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

Multiple choice

14. Which of these is not a criticism of the descriptive pragmatic approach to theory construction? a. It does not allow for accounting techniques to be challenged *b. Some of the users of accounting information may be illogical in their responses c. The focus is on the accountant's behaviour not on measuring the attributes of the firm d. There is no assessment of whether the accountant reports in the way he or she should Feedback: This criticism has been applied to the psychological pragmatic approach to theory construction.

Section "Pragmatic theories"

15. Concentrating on decision theories and testing them on large samples of people overcomes a major criticism of which of the following approaches to accounting theory construction? a. The positive approach *b. The psychological pragmatic approach c. The naturalistic approach d. The descriptive pragmatic approach Feedback: This method can overcome the problem of users reacting in an illogical manner, having preconditioned responses, or not reacting when they should.

Section "Pragmatic theories"

16. Which of these statements is a criticism levelled at syntactic and semantic accounting theories? *a. There will be a great number of accounting techniques which are different but still acceptable under general accounting principles of practice b. The assumptions underlying the theories were rarely subjected to empirical testing c. The theories developed are not prescriptive, that is they do not guide accounting practice d. It does include an analytical judgement of the quality of an accountant's actions Feedback: The other criticisms have been levelled at the other theory construction approaches described in the chapter.

Section "Syntactic and semantic theories"

2.6 © John Wiley & Sons Australia, Ltd

Chapter 2: Accounting theory construction

17. Which of these is not an assumption used in normative theory construction? a. Financial accounting is useful for making economic decisions *b. There are multiple available profit measures c. Markets are inefficient and can be fooled by 'creative accountants' d. All of the above are not assumptions used in normative theory construction Feedback: In fact, the assumption is that there is one unique profit measure.

Section "Normative theories"

18. The criticism of traditional historical cost accounting that is based on a Popperian approach to science is: a. Accounting reports prepared using traditional historical cost accounting may have perfect syntax but little value in practice b. The existence of accounting doublethink *c. Many of the propositions of historical cost accounting are not falsifiable d. All of the above Feedback: Under the Popperian approach, all hypotheses must be capable of falsification. Many propositions of historical cost accounting, such as the definition of depreciation, are criticised because they are not falsifiable. A and B are incorrect because they are Chambers' criticisms of historical cost accounting.

Section "Syntactic and semantic theories"

19. The research question that is most unlikely to be tested using positive methodology is: a. Which firms are more likely to use straight-line depreciation rather than diminishingbalance depreciation? b. How do changes in tax rules affect firm's leverage position? c. Are firms with more intangible assets more likely to repurchase their shares? *d. Is the quantitative data derived from given sets of operations based on an overall accounting theory, useful to users of financial statements?

Feedback: A, B, and C are examples of research questions covered by positive accounting theory because they attempt to explain and describe the reasons for current accounting practices. D is a typical question under normative theory (decision-usefulness approach) as it concerns the usefulness of accounting data.

Section "Normative theories"

2.7 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

20. The statement that is false is: a. Normative theories rely on both semantic and syntactic approaches b. Questionnaires are often used by positive theorists to test accounting hypotheses *c. Naturalistic research starts with an accepted theory and when an anomaly occurs a new theory is developed to explain it d. Normative theorists hold the assumptions that accounting should be a measurement system and that there is only one unique profit measure Feedback: Statements A, B, and D are true. C is false as naturalistic research starts with realworld situations which may be firm-specific. The research structure described in Statement C is the scientific approach of theory formulation.

Section "Different perspectives"

21. Which of these is not a criticism of the historical cost accounting theoretical model? a. There is no independent, empirical operation to verify the calculated outputs such as 'profit' or 'assets' b. Poor syntax whereby different types of monetary measures are added together c. Many hypotheses associated with the model are unable to be tested as per the falsificationist approach *d. All are criticisms Feedback: See discussion pages Section "Syntactic and semantic theories".

22. The statement that is not descriptive of positive theories is: a. a. They are descriptive rather than prescriptive b. They avoid making value-laden judgements c. They explain why people behave in a certain manner *d. They are concerned with developing policy recommendations for accounting practice Feedback: This statement is descriptive of normative accounting theories not positive theories.

Section "Positive theories"

2.8 © John Wiley & Sons Australia, Ltd

Chapter 2: Accounting theory construction

23. Which of these is not a typical approach to testing hypotheses under positive accounting theory? a. Questionnaires b. Surveys *c. Taking output data of specific accounting systems to determine whether the data helps users to make the right decisions d. Testing the assumed importance of accounting outputs in the marketplace Feedback: A, B, and D are the typical methods used to test hypotheses under positive accounting theory. C is an approach used in normative theory especially under the decision-usefulness approach.

Section "Positive theories"

2.9 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

24. A comparison of scientific and naturalistic research

1

Scientific Research 2

Naturalistic Research • Reality is socially

constructed and a product of human imagination 3 • Accounting is

objective reality 4

5 • Holistic

6 • Reductionism • Testing of individual

• Irreducible laws

hypotheses • Laws capable of

generalisation Methodology

7 • Unstructured

8 • Prior theoretical base • Empirical validation

of extension Methods

9 • Case studies

10 • Empirical induction

to form hypotheses • Appropriate

• Experience of events

statistical methods

2.10 © John Wiley & Sons Australia, Ltd

Chapter 2: Accounting theory construction

Which word/phrase should be inserted in position 9 in the table above? *a. Syntactic model formulation b. Exploration by flexibility c. No prior theory d. d. Piecemeal advancement of knowledge Feedback: See Table 2.2 on page 32 of the text.

Section "Different perspectives".

2.11 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

25. A comparison of scientific and naturalistic research

1

Scientific Research 2

Naturalistic Research • Reality is socially

constructed and a product of human imagination 3 • Accounting is

objective reality 4

5 • Holistic

6 • Reductionism • Testing of individual

• Irreducible laws

hypotheses • Laws capable of

generalisation Methodology

7 • Unstructured

8 • Prior theoretical base • Empirical validation

of extension Methods

9 • Case studies

10 • Empirical induction

to form hypotheses • Appropriate

• Experience of events

statistical methods

2.12 © John Wiley & Sons Australia, Ltd

Chapter 2: Accounting theory construction

Which word/phrase should be inserted in position 5 in the table above? a. Exploration by flexibility *b. Piecemeal advancement of knowledge c. Reality is objective and concrete d. Ontological Assumptions Feedback: See Table 2.2 on page 32 of the text.

Section "Different perspectives".

2.13 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

26. A comparison of scientific and naturalistic research

1

Scientific Research 2

Naturalistic Research • Reality is socially

constructed and a product of human imagination 3 • Accounting is

objective reality 4

5 • Holistic

6 • Reductionism • Testing of individual

• Irreducible laws

hypotheses • Laws capable of

generalisation Methodology

7 • Unstructured

8 • Prior theoretical base • Empirical validation

of extension Methods

9 • Case studies

10 • Empirical induction

to form hypotheses • Appropriate

• Experience of events

statistical methods

2.14 © John Wiley & Sons Australia, Ltd

Chapter 2: Accounting theory construction

Which word/phrase should be inserted in position 3 in the table above? a. Exploration by flexibility b. Piecemeal advancement of knowledge c. Reality is objective and concrete *d. Accounting is constructed reality Feedback: See Table 2.2 on page 32 of the text.

Section "Different perspectives".

2.15 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

27. A comparison of scientific and naturalistic research

1

Scientific Research 2

Naturalistic Research • Reality is socially

constructed and a product of human imagination 3 • Accounting is

objective reality 4

5 • Holistic

6 • Reductionism • Testing of individual

• Irreducible laws

hypotheses • Laws capable of

generalisation Methodology

7 • Unstructured

8 • Prior theoretical base • Empirical validation

of extension Methods

9 • Case studies

10 • Empirical induction

to form hypotheses • Appropriate

• Experience of events

statistical methods

2.16 © John Wiley & Sons Australia, Ltd

Chapter 2: Accounting theory construction

Which word/phrase should be inserted in position 10 in the table above? *a. Exploration by flexibility b. Piecemeal advancement of knowledge c. Reality is objective and concrete d. Accounting is constructed reality Feedback: See Table 2.2 on page 32 of the text.

Section "Different perspectives".

2.17 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

28. A comparison of scientific and naturalistic research

1

Scientific Research 2

Naturalistic Research • Reality is socially

constructed and a product of human imagination 3 • Accounting is

objective reality 4

5 • Holistic

6 • Reductionism • Testing of individual

• Irreducible laws

hypotheses • Laws capable of

generalisation Methodology

7 • Unstructured

8 • Prior theoretical base • Empirical validation

of extension Methods

9 • Case studies

10 • Empirical induction

to form hypotheses • Appropriate

• Experience of events

statistical methods

2.18 © John Wiley & Sons Australia, Ltd

Chapter 2: Accounting theory construction

Which word/phrase should be inserted in position 2 in the table above? a. Exploration by flexibility b. Piecemeal advancement of knowledge *c. Reality is objective and concrete d. Accounting is constructed reality Feedback: See Table 2.2 on page 32 of the text.

Section "Different perspectives".

29. Which of these arguments describes the symbolic interactionists' view? a. Behaviour will always conform to a set of behavioural rules *b. People form their own separate impressions through a process of human interaction and negotiation c. Reality is a concrete structure d. Outcomes of decisions and actions are highly predictable

Feedback: Symbolic interactionist is the term used for category 4-6 in Morgan and Smircich's classification of ontological assumption sets (Table 2.1). The symbolic interactionists believe that reality is embodied in the meanings that result from people's interpretation of the situations and events they experience.

Section "Different perspectives".

30. Which of these arguments is not a criticism of scientific method? *a. Results from scientific-based research are difficult to generalise b. Hypotheses are based on the use of share market prices or surveys which are remote from the world of practitioners c. Large-scale statistical research tends to lump everything together d. Hypotheses are not commensurate with the concerns of many individual accountants Feedback: B, C and D are criticisms of scientific method. A is a criticism of the naturalistic approach.

Section "Different perspectives".

2.19 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

31. The following research methods are used by naturalistic researchers, except: a. Case studies b. Experience of events *c. Syntactic model formulation d. Exploration by flexibility Feedback: A, B, and D are methods used in naturalistic research, whereas C is used in scientific research. (Refer to Table 2.2).

Section "Different perspectives".

32. Which of these is the epistemology of naturalistic research? a. Reductionism b. Laws capable of generalisation *c. Holistic d. Testing of individual hypotheses Feedback: Refer to Table 2.2.

Section "Different perspectives".

33. The statement concerning Mautz and Sharaf's work on auditing theory in the 1960's that is not correct is: a. They attempted to provide a comprehensive theory of auditing *b. They believed that in essence auditing was a practical exercise c. They developed eight postulates as a foundation for the theory of auditing d. The concepts they developed are embedded in current auditing standards Feedback: A, C and D are correct statements, B. is incorrect. Mautz and Sharaf, in their work, were attempting to counter the view then prevalent, that audit was a practical subject without any professional underpinnings.

Section "Issues for auditing theory construction".

2.20 © John Wiley & Sons Australia, Ltd

Chapter 2: Accounting theory construction

Essay Questions

34. Explain and discuss the criticisms of historical cost accounting for poor syntax and semantic deficiencies. In your discussion refer to counter arguments that have been raised in defence of these criticisms.

35. "The main difference between normative and positive (accounting) theories is that normative theories are prescriptive, whereas positive theories are descriptive, explanatory or predictive". J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.29.

Explain and discuss the quotation. Include in your answer an opinion as to whether the two approaches are compatible or incompatible.

36. "Most researchers now accept that the most appropriate approach depends on the nature of the research question being considered". J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.5. p.

30. Compare the scientific method with the naturalistic approach to accounting research.

37. The scientific approach to accounting research assumes there is an absolute truth that accounting should achieve and that accounting practitioners should become scientists' Explain why both parts of this statement are misconceptions.

38. Briefly outline developments in auditing theory associated with i. the normative era, and, ii. the positive era.

2.21 © John Wiley & Sons Australia, Ltd

Test Bank to accompany

Accounting Theory 7th edition PREPARED BY

Barbara Burns CHAPTER 3 Role of theory in accounting regulation

© John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

Chapter 3: Role of theory in accounting regulation

True/False 1. In the application of agency theory to accounting the principals most often considered are investors and lenders and the agents most usually considered are managers. *a. True b. False Feedback: In the application of agency theory to accounting the principals most often considered are investors and lenders and the agents most usually considered are managers. Section "The theories of regulation relevant to accounting and auditing"

2. Atkinson and Feltham state that agency theory mainly concentrates on the demand for information for the decision-making purposes. a. True *b. False Feedback: According to Atkinson and Feltham, agency theory considers mainly the stewardship demand for information.

Section "The theories of regulation relevant to accounting and auditing"

3. Agency theory assumes that the interests of principals and agents are generally aligned. a. True *b. False Feedback: Agency theory assumes that the interests of principals and agents are not necessarily aligned.

Section "The theories of regulation relevant to accounting and auditing"

4. Under the regulatory capture theory of regulation interest groups are assumed to try to gain control of the regulator to achieve their desired wealth distribution. *a. True b. False Feedback: Under the regulatory capture theory of regulation interest groups are assumed to try to gain control of the regulator to achieve their desired wealth distribution.

Section "The theories of regulation relevant to accounting and auditing" 3.2 © John Wiley & Sons Australia, Ltd

Chapter 3: Role of theory in accounting regulation

5. Regulatory capture is more likely to occur when the regulatory agency has individual members who have the potential to be employed in the future by the industry they are involved in regulating. *a. True b. False Feedback: Regulatory capture is more likely to occur when the regulatory agency has individual members who have the potential to be employed in the future by the industry they are involved in regulating. Section "The theories of regulation relevant to accounting and auditing"

6. Private interest theory suggests that government intervention in the standard setting process is to rectify failures in the market for accounting information. a. True *b. False Feedback: It is public interest theory that suggests that government intervention in the accounting standard setting process is to rectify failures in the market for accounting information. Section "How theories of regulation apply to accounting and auditing practice"

7. Public-interest theory shows that capital markets are performing more efficiently as a result of government intervention in the standard-setting process. a. True *b. False Feedback: None of the regulatory theories is able to tell whether capital markets are performing more efficiently as a result of government intervention in the standard-setting process. This is because of the difficulties of measuring the effectiveness of government regulation of financial reporting. Section "How theories of regulation apply to accounting and auditing practice"

8. A limitation of theories of regulation such as public interest theory and capture theory is that they are not mutually exclusive. *a. True b. False Feedback: A limitation of theories of regulation is that they are not mutually exclusive, that is, events explained by one theory may be explained equally well by another. Section "How theories of regulation apply to accounting and auditing practice"

3.3 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

9. Under IAS 38 'Intangible Asset, Australian companies are permitted to carry forward existing intangible asset values at 1 January 2005. a. True *b. False Feedback: Under IAS 38 'Intangible Asset, Australian companies are not permitted to carry forward existing intangible asset values at 1 January 2005. The AASB lobbied the IASB for this to happen but their request was declined. Section "How theories of regulation apply to accounting and auditing practice"

10. In Australia all corporate governance requirements are embodied in the Corporations Act. a. True *b. False Feedback: In Australia some basic requirements of corporate governance are embodied in the Corporations Act but other requirements reflect 'best practice' recommendations and were developed by the private sector. Some requirements are required by the relevant stock exchanges.

Section "The regulatory framework for financial reporting"

11. The development of international accounting standards began in 1990 with the formation of the International Accounting Standards Board. a. True *b. False Feedback: The development of international accounting standards began in 1973 with the formation of the International Accounting Standards Board.

Section "The institutional structure for setting accounting and auditing standards"

12. In 2008 the SEC agreed to permit foreign registrants to file accounts that follow international accounting standards without reconciliation with US GAAP. *a. True b. False Feedback: In 2008 the SEC agreed to permit foreign registrants to file accounts that follow international accounting standards without reconciliation with US GAAP. Section "The institutional structure for setting accounting and auditing standards"

3.4 © John Wiley & Sons Australia, Ltd

Chapter 3: Role of theory in accounting regulation

13. The Norwalk Agreement is the name of the IASB and the FASB convergence program. *a. True b. False Feedback: The Norwalk Agreement is the name of the IASB and the FASB convergence program established in 2002.

Section "The institutional structure for setting accounting and auditing standards"

14. International standard setting is now dominated by the IASB and the FASB. *a. True b. False Feedback: The US has been greatly involved in the convergence project with the IASB following the Norwalk Agreement in 2002 which now dominate international standard setting.

Section "The institutional structure for setting accounting and auditing standards"

15. US GAAP have been described as principles-based standards and IAS standards as rulebased. a. True *b. False Feedback: It is the other way around. US GAAP have been described as rule-based standards while IAS standards aim to be principles-based.

Section "The institutional structure for setting accounting and auditing standards"

16. Individual countries must decide the extent to which IASB standards will be followed by public sector entities. *a. True b. False Feedback: The IASB sets standards for the private sector only and individual countries must decide the extent to which IASB standards will be followed by public sector entities.

Section "The institutional structure for setting accounting and auditing standards"

3.5 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

17. The IASB sets standards for the private and the public sectors. a. True *b. False Feedback: The IASB sets standards for the private sector Section "The institutional structure for setting accounting and auditing standards"

only.

18. International Standards on Auditing (ISA) are developed by the IASB. a. True *b. False Feedback: International Standards on Auditing (ISA) are developed by the International Auditing and Assurance Standards Board (IAASB).

Section "The institutional structure for setting accounting and auditing standards"

3.6 © John Wiley & Sons Australia, Ltd

Chapter 3: Role of theory in accounting regulation

Multiple choice questions

19. Proponents of the free-market approach to the provision of accounting information advocate that: a. Market mechanisms cannot achieve a socially ideal equilibrium price for accounting information *b. Market forces can be depended upon to generate any desired information c. The free-rider effect will result in an under-production of accounting information d. All of the above Feedback: The other statements relate to the pro-regulation Section "The theories of regulation relevant to accounting and auditing"

perspective.

20. Users of accounting information who bear little of the cost of producing the information and therefore have an incentive to demand increased levels of disclosure are know as: a. Agents b. Principals c. Free-agents *d. Free-riders Feedback: Users of accounting information who bear little of the cost of producing the information and therefore have an incentive to demand increased levels of disclosure are know as free-riders, e.g. financial analysts and potential investors.

Section "The theories of regulation relevant to accounting and auditing"

21. Which of these is not an assumption underlying the public-interest theory of regulation? a. There are agents who will seek regulation on behalf of the public interest *b. The government has an independent role to play in the development of regulations c. The interest of consumers is translated into legislative action through the operation of the internal marketplace d. Economic markets are subject to a series of market imperfections or transaction failures Feedback: The assumption is that the government has no independent role to play in the development of regulations.

Section "The theories of regulation relevant to accounting and auditing"

3.7 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

22. Regulatory capture is said to occur in which of the following situations? a. When the regulated entities ensure non-performance by the regulating body b. When the regulated entities co-opt the regulators into a mutually shared perspective c. When the regulated entities control the regulations and the regulatory body *d. All of the above Feedback: The theory is that the regulattee comes to control or dominate the regulator in all of the ways mentioned.

Section "The theories of regulation relevant to accounting and auditing"

23. Which of these is not an assumption underlying regulatory capture theory? *a. Politicians are not neutral arbiters b. The government has no independent role to play in the regulatory process c. All members of society are economically rational d. The regulated comes to control or dominate the regulator Feedback: This is an assumption underlying the private-interest theory of regulation.

Section "The theories of regulation relevant to accounting and auditing"

24. Regulatory capture has been found to be particularly pronounced in which of the following situations? a. Where there are a large number of client entities *b. The regulated industry controls the information needed for regulation c. The information and product lack complexity d. The regulated industry has minimal resources compared to the regulatory agency Feedback: B is correct. For A, C and D, it is the opposite way around, i.e. for A. regulatory capture is particularly where there are a small number of client entities, etc.

Section "The theories of regulation relevant to accounting and auditing"

25. Which theory of regulation assumes that politicians are not neutral arbiters? *a. Private-interest theory b. Public-interest theory c. Regulatory capture theory d. All assume that politicians are not neutral arbiters.

Feedback: Private interest theory, unlike the two other theories, assumes that politicians are not neutral arbiters but are rationally self interested and will 'sell' aspects of their right to coerce others to win votes and raise money to finance election campaigns in order to maximise their 3.8 © John Wiley & Sons Australia, Ltd

Chapter 3: Role of theory in accounting regulation

chances of future electoral Section "The theories of regulation relevant to accounting and auditing"

success.

26. Private interest theory asserts: a. The bigger the interest group size the easier it is for them to use the political process *b. The smaller the interest group size the easier it is for them to use the political process c. The smaller the interest group size the harder it is for them to use the political process d. Regulation arises as a result of government response to public demand Feedback: Private interest theory asserts that the smaller the interest group size the easier it is for them to organise and use the political process. It also asserts that regulation does not arise as a result of government response to public demand but regulation is sought by the 'producer' private interest group and is designed and operated mainly for its benefit.

Section "The theories of regulation relevant to accounting and auditing"

27. In relation to accounting and auditing which of these is not a theory of regulation? a. Public interest theory *b. Life cycle theory c. Regulatory capture theory d. Private interest theory Feedback: In relation to accounting and auditing 'life cycle theory' is not a theory of regulation.

Section "The theories of regulation relevant to accounting and auditing"

28. Who challenged the public-interest and regulatory capture theorists' view that regulation is a result of government response to rectify inefficiency? a. Walker b. Rahman *c. Stigler d. Collett Feedback: Stigler argues that the government and politicians are not neutral arbiters, but are rationally self-interested and seek to maximise their own wealth by selling aspects of their right to coerce others.

This view is known as private-interest theory.

Section "The theories of regulation relevant to accounting and auditing"

3.9 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

29. The abandonment of due process by the ASRB in favour of fast-track approval of AARFsubmitted standards was an example of which regulatory theory? a. Private-interest theory b. Public-interest theory *c. Regulatory capture theory d. None of the above Feedback: The example above shows that although the ASRB was established to ensure protection of the public interest, it was successfully captured by the accounting profession.

Section "How theories of regulation apply to accounting and auditing practice"

30. Which of these is a criticism of the public interest theory of accounting regulation? a. The theory is not the only explanation for observed behaviours b. Managers of businesses have strong incentives to 'correct' market failure perceptions about their business activities. *c. A and B d. Neither A nor B is a criticism Feedback: Both A and B are criticisms of the public interest theory of accounting regulation.

Point B refers to the fact that researchers have found that corrections of market failures perceptions is often achieved, in practice through the release of extensive voluntary disclosure of information and doesn't necessarily require government intervention.

Section "How theories of regulation apply to accounting and auditing practice"

31. Which of these factors should not affect the extent to which particular countries are able to influence the international standard-setting process? *a. The number of accounting standards issued b. National economic significance c. Professional expertise d. English language competence Feedback: The number of accounting standards issued should not be an influence on the extent to which particular countries are able to influence the international standard-setting process.

Section "How theories of regulation apply to accounting and auditing practice"

3.10 © John Wiley & Sons Australia, Ltd

Chapter 3: Role of theory in accounting regulation

32. Which of these theories could explain a move towards government control of accounting standards setting in Australia? a. Public interest theory b. Regulatory capture theory c. Private interest theory *d. All of the above Feedback: A limitation of the theories of regulation is that they are not mutually exclusive, that is, events explained by one theory may be explained equally well by another.

Section "How theories of regulation apply to accounting and auditing practice"

33. In which of these countries does taxation law have the greatest influence on financial accounting? a. Australia b. US c. UK *d. France Feedback: In France (and Germany) taxation law has a great influence on financial accounting.

In these countries, for single entity reporting, the financial accounting rules are the same as the tax rules.

Section "The regulatory framework for financial reporting"

34. Which of these statements in relation to the regulation of auditors is not true? a. The choice of statutory regulation rather than self-regulation may reflect political differences between countries in the approach to management of capital markets b. Statutory regulation is consistent with a country having a more centralised, interventionist approach to regulation *c. The worldwide trend in recent years has been towards more self -regulation for auditors. d. In France and Italy regulation was from earlier times the responsibility of state authorities.

Feedback: In recent years the worldwide trend has been towards less self-regulation for auditors and greater statutory regulation.

Section "The regulatory framework for financial reporting"

3.11 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

35. Prior to 2005 International Accounting Standards (IAS) were influential in which of the following ways?

I They were adopted for use in countries without national standards II They were used in the development of national standards III They were used voluntarily in preparing consolidated accounts in some countries *a. i, ii, iii b. i. ii c. ii, iii d. ii Feedback: Prior to 2005 International Accounting Standards (IAS) were influential in all of the ways mentioned.

Section "The institutional structure for setting accounting and auditing standards"

36. The IASB sets standards for: *a. The private sector b. The public and private sectors c. The public, private and not-for-profit sector d. The private and not-for-profit sector Feedback: The IASB sets standards for the private sector Section "The institutional structure for setting accounting and auditing standards"

only.

37. International standards on Auditing (ISA) are developed by: a. Public Company Accounting and Oversight Board (PCAOB) *b. International Auditing and Assurance Standards Board (IAASB). c. International Accounting Standards Board (IASB) d. The International Organisation of Securities Commissions (IOSCO) Feedback: International standards on Auditing (ISA) are developed by the International Auditing and Assurance Standards Board (IAASB) operating under the auspices of the International Federation of Accountants (IFAC).

Section "The institutional structure for setting accounting and auditing standards"

3.12 © John Wiley & Sons Australia, Ltd

Chapter 3: Role of theory in accounting regulation

Essay Questions

38. Briefly describe the public interest and the private interest theories of regulation and, for each discuss, a situation where the theory can be used to explain an aspect of accounting regulation.

39. "Standard setting is a political process'. Explain and discuss.

40. "While regulatory frameworks vary between countries, they often have common elements'. J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.70.

Discuss some of the commonalities and differences in regulatory frameworks between Australia and the USA.

41. Explain why, with the adoption of IFRS by the EU in 2005, each member state was required to set up an independent enforcement body. Do you agree that such a body is a necessary part of an overall system for enforcement of financial reporting requirements?

42. 'The central economic reason for the origins of government intervention in the operations of various markets in the "public interest" is that of market failure.' J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.57.

Briefly outline the public-interest theory of regulation of financial reporting including the assumptions on which it is based and discuss the circumstances when market failure is most likely to occur.

3.13 © John Wiley & Sons Australia, Ltd

Test Bank to accompany

Accounting Theory 7th edition PREPARED BY

Barbara Burns CHAPTER 4 Theory underpinning accounting standards

© John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

Chapter 4: Theory underpinning accounting standards True/False 1. In Australia, in the latter years of the 1990's, more progress was made on developing the conceptual framework than in promulgating individual accounting standards. a. True *b. False Feedback: It is the other way around. In Australia in the latter years of the 1990's more progress was made in promulgating individual accounting standards than in developing the conceptual framework.

Section "The role of the conceptual framework"

2. Taxation rules are not a source of authority in accounting. a. True *b. False Feedback: There are many sources of authority in accounting, including, in some instances, taxation rules. For example, the US Internal Revenue Service accepts the last-in-first-out (LIFO) method for inventory valuation and the accelerated method of depreciation; hence the methods are accepted by the accounting profession.

Section "The role of the conceptual framework"

3. One of the benefits of a conceptual framework, put forward by Australian standard setters, is that preparers and auditors would find it easier to understand the financial reporting requirements they face. *a. True b. False Feedback: One of the benefits of a conceptual framework, put forward by Australian standard setters, is that preparers and auditors would find it easier to understand the financial reporting requirements they face.

Section "The role of the conceptual framework"

© John Wiley & Sons Australia, Ltd

4.2

Chapter 4: Theory underpinning accounting standards

4. The IASB's concept statement encompasses special and general-purpose financial reporting. a. True *b. False Feedback: In fact, it has restricted its domain to general-purpose external reports.

Section "Objectives of conceptual frameworks"

5. In the IASB Framework the qualitative characteristic of reliability is defined as the ability to influence the economic decisions of users by helping them to evaluate past, present or future events or confirm or correct their past evaluations. a. True *b. False Feedback: In the IASB framework it is the qualitative characteristic of relevance that is defined as the ability to influence the economic decisions of users by helping them to evaluate past, present or future events or confirm or correct their past evaluations.

Section "Objectives of conceptual frameworks"

6. Since its conceptual framework was first published in 1989 no new standards have been issued by the IASB that conflict with the Framework. a. True *b. False Feedback: Since its conceptual framework was first issued in 1989 several new standards have been issued by the IASB that conflict with the Framework. For example, IAS 139 Financial Instruments: Recognition and Measurement.

Section "Objectives of conceptual frameworks"

7. The IASB Framework includes four principal qualitative characteristics, understandability, relevance, reliability and comparability. *a. True b. False Feedback: The IASB Framework includes four principal qualitative characteristics, understandability, relevance, reliability and comparability (paras.

24-42).

Section "Developing a conceptual framework"

© John Wiley & Sons Australia, Ltd

4.3

Testbank to accompany Accounting Theory 7e by Godfrey et al

8. Surveys have shown that a majority of company managers and security industry officials favour a conceptual framework that would result in significant changes in financial reporting. a. True *b. False Feedback: Surveys have shown that a majority of company managers and security industry officials favour a conceptual framework that would affirm the status quo in financial reporting.

Section "A critique of conceptual framework projects"

9. Gerboth views conceptual frameworks as policy documents based on the professional values and self-interest of accountants *a. True b. False Feedback: Gerboth considers it is the sense of personal and professional responsibility of accountants that provides an explanation of conceptual frameworks.

Section "A critique of conceptual framework projects"

10. One of the key concepts of the auditing theory of Mautz and Sharaf is auditor independence. *a. True b. False Feedback: One of the key concepts of the auditing theory of Mautz and Sharaf is auditor independence.

Section "A conceptual framework for auditing standards"

11. In the 1990's there was a shift away from consideration of audit risk and a shift towards a greater emphasis on substantive testing. a. True *b. False Feedback: It is the other way around. In the 1990's there was a shift towards greater emphasis on audit risk and a shift away from substantive testing.

Section "A conceptual framework for auditing standards"

© John Wiley & Sons Australia, Ltd

4.4

Chapter 4: Theory underpinning accounting standards

Multiple choice questions

12. A conceptual framework of accounting is a structured theory of accounting. Which of these issues would be dealt with at the operational level of the framework? a. The scope and objective of financial reporting b. The qualitative characteristics of financial reporting c. The elements of financial reporting *d. The basis of recognition and measurement of the elements.

Feedback: See AARF and AASB Section "The role of a conceptual framework"

pyramid

diagram

in

the

text.

13. Which of these is not one of the benefits of a conceptual framework? a. Reporting requirements will be more consistent and logical *b. It may allow firms to reduce their reported profit c. The need for specific accounting standards should be reduced d. Standard setting boards will be more accountable for their actions Feedback: Whether a conceptual framework reduces or increases reported profit is not a relevant consideration.

Section "The role of a conceptual framework"

14. A disadvantage of a conceptual framework is: a. It will be easier to avoid reporting requirements b. It will be more expensive to prepare individual accounting standards c. It will increase political interference in the standard setting process *d. None of the above are disadvantages Feedback: None of the factors listed are disadvantages of a conceptual framework as the reverse of each point is true, turning each point into an advantage. For example it will be harder to avoid reporting requirements with a conceptual framework.

Section "The role of a conceptual framework"

© John Wiley & Sons Australia, Ltd

4.5

Testbank to accompany Accounting Theory 7e by Godfrey et al

15. Both the IASB and the FASB frameworks consider the main objective of financial reporting is to communicate financial information to users. The information is to be selected on the basis of its usefulness in the economic decision-making process. This objective is seen to be achieved by reporting information that is: I Useful in making economic decisions II Useful in assessing cash flow prospects III About enterprise resources, claims to those resources and changes in them a. i, ii b. i, iii c. ii, iii *d. i, ii, iii Feedback: The objective is seen to be achieved by reporting information that is, useful in making economic decisions, useful in assessing cash flow prospects and about enterprise resources, claims to those resources and changes in them.

Section "The objectives of a conceptual framework"

16. In relation to IAS 8 the two statements that are correct are: I When making judgements reference shall be made firstly to the Framework and secondly to standards and interpretations dealing with similar and related issues II When making judgements reference shall be made firstly to standards and interpretations dealing with similar and related issues and secondly to the Framework III Material in the Framework is binding on preparers of financial statements IV Material in the Framework is not binding on preparers of financial statements a. i) and iii) *b. ii) and iii) c. ii) and iv) d. i) and iv) Feedback: According to IAS 8, when making judgements reference shall be made firstly to standards and interpretations dealing with similar and related issues and secondly to the Framework: and also, material in the Framework is binding on preparers of financial statements.

Section "The objectives of a conceptual framework"

© John Wiley & Sons Australia, Ltd

4.6

Chapter 4: Theory underpinning accounting standards

17. To be relevant accounting information should have which of these characteristics? a. The transaction or other event relating to the accounting information should have occurred *b. It must assist in making predictions about future situations or must help confirm past predictions of users c. The financial information should faithfully represent transactions and events without bias or undue error d. To be relevant accounting information should have all of the above characteristics Feedback: B is the correct answer. A is incorrect as future predictions can be relevant; C is incorrect as it is a quality of reliable rather than relevant information.

Section "The objectives of a conceptual framework"

18. Which of these is not a reason why inconsistencies have arisen between the Framework and IAS 139 Financial Instruments: Recognition and Measurement? a. The complexity of the standard b. Areas where the Framework provides inadequate guidance *c. The lack of any possible solutions to issues dealt with by the standard that would be consistent with the Framework d. All of the above Feedback: It is not the lack of any possible solutions to issues dealt with by the standard that are compatible with the Framework that is the problem, but the unacceptability of Framework based solution to preparers of the standard.

Section "The objectives of a conceptual framework"

19. The corporate collapses in 2001-2002 in the United States: *a. Increased the emphasis on principles-based standards b. Increased the emphasis on rules-based standards c. Had no effect on whether standards were rule-based or principles-based d. Led to a reduction in the number of standards issued because of a perception of 'standards overload' Feedback: The corporate collapses in 2001-2002 in the United States, increased the emphasis on principles-based standards. Collapses such as Enron and WorldCom were partly blamed on the previous rule-based approach.

Section "Developing a conceptual framework"

© John Wiley & Sons Australia, Ltd

4.7

Testbank to accompany Accounting Theory 7e by Godfrey et al

20. The decision theory process occurs in which of the following sequences? a. Overall theory of accounting, prediction model of user, individual accounting system, decision model of user *b. Overall theory of accounting, individual accounting system, prediction model of user, decision model of user c. Overall theory of accounting, individual accounting system, decision model of user, prediction model of user d. Overall theory of accounting, prediction model of user, decision model of user, individual accounting system Feedback: See Section "Developing a conceptual framework"

21. A disadvantage of rules-based standards for users of the standards is: a. They may reduce the opportunities for earnings management b. They increase comparability of accounting information *c. They allow for specific structuring of transactions to work around the rules d. All of the above are disadvantages.

Feedback: C is the correct answer. A, and B are advantages for users of rules-based standards.

Section "Developing a conceptual framework"

22. The statement in respect of the IASB/FASB convergence project established in 2002 that is incorrect is: a. A project to develop a joint conceptual framework has been added to the agenda b. The project will focus on changes in the environment since the IASB and the FASB each issued their original frameworks c. Work on several phases of the project will be carried out concurrently *d. Private sector and not-for-profit sector issues will be considered simultaneously.

Feedback: D is the incorrect statement because the IASB/FASB convergence project has decided to initially consider private sector business entity issues and only later the applicability of those issues to the not-for-profit sector.

Section "Developing a conceptual framework"

© John Wiley & Sons Australia, Ltd

4.8

Chapter 4: Theory underpinning accounting standards

23. Stating that Australia and New Zealand follow a 'sector neutral' approach to standard setting means that: *a. Issues relating to the for-profit and the not-for-profit sectors are considered simultaneously with the view to applying the same standards to both sectors b. Issues relating to the for-profit sector are considered before later applying the same principles to the not-for-profit sector c. Issues relating to the not-for-profit sector are considered before later applying the same principles to the for-profit sector d. Issues for-profit and not-for-profit sectors are considered simultaneously but with the purpose of drawing up separate standards for each sector.

Feedback: Stating that Australia and New Zealand follow a 'sector neutral' approach to standard setting means that issues relating to the for-profit and the not-for-profit sectors are considered simultaneously with the view to applying the same standards to both sectors.

Section "Developing a conceptual framework"

24. The group proposed by the IASB and the FASB as the primary user group for general purpose financial reporting is: a. Lenders b. Equity investors c. The public *d. Present and potential capital providers Feedback: The group proposed by the IASB and the FASB as the primary user group for general purpose financial reporting is present and potential capital providers. This group includes equity investors, lenders and other creditors.

Section "Developing a conceptual framework"

25. The constraints on financial reporting identified under the IASB Framework are: *a. Cost versus benefit and materiality b. Timeliness and neutrality c. Understandability and materiality d. Understandability and cost versus benefit Feedback: The constraints on financial reporting identified under the IASB Framework are cost versus benefit and materiality.

Section "Developing a conceptual framework"

© John Wiley & Sons Australia, Ltd

4.9

Testbank to accompany Accounting Theory 7e by Godfrey et al

26. Under the IASB Framework exposure draft, the qualitative characteristic: *a. Reliability has been replaced with faithful representation b. Reliability has been replaced with trustworthiness c. Timeliness has been replaced with exactness d. Relevance has been replaced with significance Feedback: Under the IASB Framework exposure draft the qualitative characteristic reliability has been replaced with faithful representation.

Section "Developing a conceptual framework"

27. The four principal qualitative characteristics recognised by the IASB Framework are: a. Materiality, relevance, timeliness, cost versus benefit b. Relevance, materiality, reliability, comparability *c. Understandability, relevance, reliability, comparability d. Understandability, cost versus benefit, relevance and reliability Feedback: The four principal qualitative characteristics recognised by the IASB Framework are understandability, relevance, reliability and comparability.

Section "Developing a conceptual framework"

28. In June 2009, in relation to the IASB/FASB joint conceptual framework project, one exposure draft relating to the objectives and qualitative characteristics has been issued. Which of these is not a key issue raised by the exposure draft? a. The entity vs proprietorship perspective *b. Measurement of assets c. The primary user group of general-purpose financial reports d. The objective of financial reporting, particularly the place of stewardship.

Feedback: Measurement of assets is not a key issue raised in the exposure draft. Measurement issues will be dealt with in phase three of the joint project.

Section "Developing a conceptual framework"

© John Wiley & Sons Australia, Ltd

4.10

Chapter 4: Theory underpinning accounting standards

29. In June 2009, in relation to the IASB/FASB joint conceptual framework project, one exposure draft relating to the objectives and qualitative characteristics has been issued. Which of these statements concerning the reception of the exposure draft is true? *a. Most respondents agreed with designating present and potential capital providers as the primary user group for general purpose financial reporting b. Most respondents agreed that not designating stewardship as a separate objective was unimportant c. Most respondents agreed with the list of qualitative characteristics included in the exposure draft. d. Most respondents agreed that financial reports should be prepared from the proprietorship perspective Feedback: It is true that most respondents agreed with designating present and potential capital providers as the primary user group for general purpose financial reporting, though there were some minor concerns about what effect this might have on recognition of the needs of other users not included in the primary user group. The other statements are incorrect as there was not majority agreement on any of these issues.

Section "Developing a conceptual framework"

30. Which of these is not a criticism of conceptual framework projects? a. The logic is circular b. The definition of the elements provide no guidance to practising accountants c. There is no prior agreement on objectives *d. The measurement of the elements of financial reporting is too highly specified Feedback: In fact, the projects have been criticised for not clarifying the measurement of the elements of financial reporting.

Section "A critique of conceptual framework projects"

© John Wiley & Sons Australia, Ltd

4.11

Testbank to accompany Accounting Theory 7e by Godfrey et al

31. The point that is not a reason why auditors began to have a greater focus on auditing business risk in the 1990's is: a. The release of the 1992 report Internal Control - Integrated Framework, by the Committee of Sponsoring organisations (COSO) *b. It was a justification to increase audit fees for clients c. Gaps in clients' internal controls provided an opportunity for auditors to sell non-audit services. d. None of these, i.e. all are reasons as to why auditors began to have a greater focus on auditing business risk in the 1990's Feedback: In fact, the greater emphasis on auditing business risk was expected to justify a reduction in resources, costs and audit fees for clients as those with more effective internal controls were seen to be at a lower risk of fraud and error.

Section "A conceptual framework for auditing standards"

Essay Questions 32. Is a conceptual framework necessary? Discuss the arguments for and against having a conceptual framework for accounting.

33. Discuss the strengths and weaknesses of principles-based accounting standards compared to rule-based standards.

34. Discuss the effects on accounting reporting of the movement in the early 1960's from a stewardship objective to a decision-usefulness objective.

35. The IASB Framework includes four principal qualitative characteristics, understandability, relevance, reliability and comparability (paragraphs 24-42). Explain the meaning of each of these characteristics and discuss the changes in the list of characteristics that is proposed by the Framework exposure draft.

36. Explain the difference between business risk auditing and traditional substantive auditing.

What have been some of the benefits and criticisms of a greater emphasis on business risk auditing?

© John Wiley & Sons Australia, Ltd

4.12

Test Bank to accompany

Accounting Theory 7th edition PREPARED BY

Barbara Burns CHAPTER 5 Measurement

© John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

Chapter 5: Measurement True/False 1. Stevens's general description of scales is nominal, interval or ratio. a. True *b. False Feedback: This statement leaves out one of the scales defined by Stevens as ordinal.

Section 'Scales'

2. A nominal scale ranks the objects in question with respect to a given property. a. True *b. False Feedback: This statement is describing an ordinal scale.

Section 'Scales'

3. The weakness of the interval scale is that the zero point is arbitrarily established. *a. True b. False Feedback: The weakness of the interval scale is that the zero point is arbitrarily established.

Section 'Scales'

4. When using an ordinal scale you can use all the fundamental arithmetical operations. a. True *b. False Feedback: When using an ordinal scale you cannot use any arithmetical operations. This is why ordinal scales convey limited information.

Section 'Permissible operations of scales'

5.2 © John Wiley & Sons Australia, Ltd

Chapter 5: Measurement

5. An ordinal scale would be used where the data set consists of the net present value of different projects measured in dollars. a. True *b. False Feedback: A ratio scale would be used where the data set consists of the net present value of different projects measured in dollars.

Section 'Permissible operations of scales'

6. The ratio scale does not allow for all the fundamental arithmetic operations to be performed on the data. a. True *b. False Feedback: The ratio scale does allow for all the fundamental arithmetic operations to be performed on the data. It also allows algebra, analytic geometry, calculus and statistical methods to be performed.

Section 'Permissible operations of scales'

7. Changing from the nominal dollar scale to the purchasing power of the dollar scale for historical cost accounting is an example of invariant transformation. *a. True b. False Feedback: The nominal dollar scale is transformed into the purchasing power of the dollar scale by multiplying it with a constant. When a ratio scale such as the nominal dollar scale is multiplied by a constant, it will remain invariant, i.e., it will leave intact the same general form of the relationship of variables.

Section 'Permissible operations of scales'

8. The major problem with fiat measurement is that the scales can be measured in numerous ways. *a. True b. False Feedback: Since fiat measurement is based on arbitrary definitions and not on a confirmed theory there are numerous ways in which the scales can be constructed.

Section 'Types of measurement' 5.3 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

9. The act of counting is the only measurement that does not necessarily involve errors. *a. True b. False Feedback: Section 'Reliability and accuracy'

10. Since all measurements involve errors, no statement that includes a measurement can be regarded as truthful. a. True *b. False Feedback: To alleviate this imperfection issue limits of acceptable statistical errors are established. If any measurement falls within these limits, then it can be considered as truthful within the scope of statistical accuracy.

Section 'Reliability and accuracy'

11. A measurement may be reliable without being accurate. *a. True b. False Feedback: See page 142.

12. The term 'validity' is often used by social sciences in preference to the term 'accuracy'. *a. True b. False Feedback: This ensures that the term is not confused with 'arithmetic precision'.

Section 'Reliability and accuracy'

5.4 © John Wiley & Sons Australia, Ltd

Chapter 5: Measurement

13. Under current international accounting standards, accounting profit determination is based on a principle that includes increases and decreases in the 'fair values' of assets and liabilities. *a. True b. False Feedback: In contrast with the approach taken before the introduction of international accounting standards, where changes in net assets were not considered as profit, measurement of profit under international accounting standards includes changes in the fair value of net assets.

Section 'Measurement in accounting'

14. There could be many different asset values that are acceptable to an auditor. *a. True b. False Feedback: There could be many different asset values that are acceptable to an auditor as long as the valuation method is applied appropriately and consistently, reasonable assumptions are used and the data used to generate the valuations are valid.

Section 'Measurement issues for auditors'

5.5 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

Multiple Choice 15. The set of data that would be measured on a nominal scale is: a. The height of a group of school children *b. Assets classified into current/non-current and tangible/intangible c. Investment opportunities classified into 'poor', 'average' or 'good' with respect to anticipated returns. d. The share prices of a group of companies Feedback: For the other groups of data A would be interval scale, C would be ordinal scale and D would be ratio scale.

Section 'Scales'

16. Which statement is not true with respect to the interval scale? a. It is less informative than the ratio scale b. The distance between the intervals on the scale is equal and known c. The zero point is arbitrarily established *d. A unique origin exists where the distance from it for at least one object is known Feedback: Statement d. describes a property of the ratio scale.

Section 'Scales'

17. The statement that is false with regard to the ratio scale is: a. The intervals between the objects are equal and are known b. A natural zero point exists where the distance from it for at least one object is known *c. The intervals between the numbers do not tell anything about the differences in the quantity of the property they represent d. The rank order of the objects or events with respect to a given property is known Feedback: Statement C is the weakness of ordinal scale. Section 'Scales'

5.6 © John Wiley & Sons Australia, Ltd

Chapter 5: Measurement

18. Emma has collected data on the ages of students in a third year accounting course. The data has been group into the following age ranges: 0-18 19-24 24-30 31-35 35+ Which of these measurement scales would her data be measured on? a. Nominal *b. Ordinal c. Interval d. Ratio Feedback: She is measuring using the ordinal scale because the distance between the intervals on the scale is not equal and is not known due to the grouping of the age data.

Section 'Scales'

19. Sarah has collected data on the salaries of part-time third-year accounting students. Which of these measurement scales would her data be measured on? a. Nominal b. Ordinal c. Interval *d. Ratio Feedback: This data set would fulfil all the criteria of a ratio scale.

Section 'Scales'

20. Higher than average income Which of these measurement scales would her data be measured on? a. Nominal *b. Ordinal c. Interval d. Ratio Feedback: The scale would be ordinal. The operation of grouping ranks the students' ages (group 2 being the older group), however, the distance on the scale is not equal and known.

Section 'Scales'

5.7 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

21. The operations that can be performed with reference to particular numbers on the interval scale is/are: a. Multiplication and division b. Subtraction c. Addition *d. B and C only Feedback: On the interval scale multiplication and division cannot be used with reference to the particular numbers only to the intervals.

Section 'Permissible operations of scales'

22. Which of these is not the condition of invariance? a. The rank order of the points is unchanged *b. The numbers in the scale are unchanged c. The ratios of the points are unchanged d. The zero point is unchanged Feedback: The numbers in the scale will change over transformations, however, the scale is invariant when the rank order of the points, the ratios of the points, and the zero point of the scale are unchanged.

Section 'Permissible operations of scales'

23. What type of measurement does the following description relate to?

'A measurement that depends on the measurement of two or more other quantities' a. Fiat measurement b. Fundamental measurement *c. Derived measurement d. All of the above Feedback: Section 'Types of measurement'

5.8 © John Wiley & Sons Australia, Ltd

Chapter 5: Measurement

24. Michael measures the varying depths of the seabed around the Australian coastline. These measurements are best described as: *a. Fundamental measurements b. Fiat measurements c. Derived measurements d. All of the above Feedback: Depth can be measured by reference to natural laws and does not depend upon the measurement of any other variable.

Section 'Types of measurement'

25. Which of these is not a source of error in measurement? a. The environment b. Risk and uncertainty c. An unclear attribute *d. All are sources of error Feedback: Measurement operations stated imprecisely, the measurer, the instrument, the environment, risk and uncertainty, and an unclear attribute are all sources of error in measurement.

Section 'Reliability and accuracy'

26. A researcher wishes to measure the success of accountants in using graphs to determine the liquidity of a firm, and compare this with their success when using tables. The researcher has decided to use accounting students in the research and has told the students that their performance in the experiment will form part of their assessment for the accounting course they are enrolled in. A limitation of the study is whether students are an adequate proxy for experienced accountants. Which of the following measurement errors may occur when the experiment is conducted? a. Instrument error b. Environment error c. Attribute unclear error *d. All of the above Feedback: If the researcher decides that 'speed' is a measure of success and uses a stopwatch to time the students, there is a possibility of the stopwatch failing or being read incorrectly (instrument error). The students have been put under pressure to perform and the stress of this may affect their decision-making (environment error). Further, the measures that the researcher decides to use to measure success may not capture success accurately (attribute unclear) - for example, if you only measure the speed of the decision you will neglect accuracy and accuracy 5.9 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

could be argued to be a measure (or a dimension) of success.

Section 'Reliability and accuracy'

27. An example of attribute unclear error is: *a. An accountant measures the value of a manufacturing plant b. A tax officer uses an outdated list of tax rates when calculating tax returns c. A manager misreads a question while completing a survey d. An accountant applies the reducing-balance depreciation method instead of the straight-line method due to pressures from his manager Feedback: The attribute 'value' is vague and unclear because value of the manufacturing plant can be measured using different measurements such as present value, acquisition cost, fair value, etc. B is an example of instrument error (the outdated list); C is an example of measurer error (the manager made a mistake); D is an example of environment error (pressure from manager).

Section 'Reliability and accuracy'

28. The statement that is describing the concept of reliability is: a. The measurements are repeatable or reproducible and as a result demonstrate their consistency b. The agreement of the results among repeated use of the measurement operation as applied to a given property c. The proven consistency of an operation to produce satisfactory results *d. All of the above describe the concept of reliability.

Feedback: All of the statements describe the concept of reliability.

Section 'Reliability and accuracy'

29. What is the main problem in determining accuracy in accounting? a. The measurement is not reliable b. The measurement does not give precise results *c. The true value of the measurement is not known d. There is no repetition of operations in the measurement Feedback: Although the measurement may give precise results and be highly reliable, this does not imply that it is accurate. Repetition of operations does not ensure accuracy either. The reason is that accuracy has to do with how close the measurement is to the true value, and for many measurements the true value is not known.

Section 'Reliability and accuracy'

5.10 © John Wiley & Sons Australia, Ltd

Chapter 5: Measurement

30. Which of these arguments is not a criticism of historical cost valuation? *a. The historical cost allocation system is based on the matching principle b. The derived profit does not measure contemporary resource usage c. Valuation of firms based on outdated historical costs is not useful for economic decision-making d. B and C Feedback: Statement A is not a criticism, but only a description of fact of historical cost.

Section 'Measurement in accounting'

31. The event that was not a contributory factor towards the evolution of capital valuation is: a. The development of joint stock companies with limited liability in England *b. The World War II c. The railway expansion in the United States d. Publication of the first definitive statement on the concepts of capital and profit by Paton and Littleton Feedback: A brief history about the evolution of capital valuation can be found in the text.

Section 'Measurement in accounting'

32. Which of these is not an issue discussed under the FASB/IASB joint project on Financial Statement Presentation? a. The income statement should include the effects of all changes in net assets and liabilities during the period, other than transactions with owners b. Entities should present a single statement of all recognised income and expense items as a component of a complete set of financial statements *c. For debt and equity instruments held for sale, fair value must be used instead of historical cost d. Accounting information should be aimed at decision makers making economic decisions about the entity Feedback: C is not an issue discussed under the FASB/IASB joint project on Financial Statement Presentation.

Section 'Measurement in accounting'

5.11 © John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

33. It has been argued by some firms that IASB fair value accounting fundamentally changes the focus of risk management. Which of these is a way in which the focus may change? a. Firms may increase their hedging activities because they are worried about the impact on accounting profits b. Firms may decrease their hedging activities because they are worried about the impact on accounting profits c. Firms may increase their hedging for pension liabilities as these now must show up as a liability on the balance sheet *d. B and C Feedback: Firms may decrease their hedging activities because they are worried about the impact on accounting profits and increase their hedging for pension liabilities as these now must show up as a liability on the balance sheet.

Section 'Measurement in accounting'

34. The incorrect statement in relation to measurement issues for auditors is: *a. It is easier for the auditor to gather evidence if profit is measured by changes in fair value than when it is determined by matching revenue and expense transactions. b. ISA 540 is the international auditing standard that provides guidance for auditing impairment losses. c. Under the international auditing standard on impairment losses auditors are required to judge if the amount recognised as an impairment loss is reasonable d. Auditors must assess whether the asset or liability values are properly determined from management's significant assumptions.

Feedback: It is harder for the auditor to gather evidence if profit is measured by changes in fair value than when it is determined by matching revenue and expense transactions.

Section 'Measurement issues for auditors'

5.12 © John Wiley & Sons Australia, Ltd

Chapter 5: Measurement

Essay Questions 35. Briefly outline the nominal, ordinal and ratio scales of measurement and explain why the ratio scale is the one most commonly used by accountants. Include in your discussion an example for each of the three scales.

36. 'If all measurement except counting inherently involve errors then how can any statement that includes a measurement be regarded as true'. J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.141 Discuss four sources of error in measurement giving an example related to accounting measurement for each of the four sources you have discussed. Briefly explain how, in overall terms, accountants deal with error in measurement.

37. Discuss how the move away from historical cost towards fair value accounting may affect the reliability and relevance of financial reports.

38. '…when profit is derived from changes in fair values more difficult questions arise for the auditor …' J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.150.

Discuss the implications for auditors of the shift in the focus of profit measurement from matching revenues and expenses to assessing changes in the fair value of the net assets.

5.13 © John Wiley & Sons Australia, Ltd

Test Bank to accompany

Accounting Theory 7th edition PREPARED BY

Barbara Burns CHAPTER 6 Accounting Measurement Systems

© John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

Chapter 6: Accounting Measurement Systems True/False 1. The three major income and capital measurement systems in accounting are based on historical cost, input values and exit values. a. True *b. False Feedback: The three major income and capital measurement systems in accounting are based on historical cost, current cost and current selling prices.

Section 'Three main income and capital measurement systems'.

2. One reason for the growth in importance of accounting information is the use of the corporate form for large organisations. *a. True b. False Feedback: The use of the corporate form has resulted in a separation of ownership from control and hence a growth in the importance of accounting information.

Section 'Historic cost accounting'.

3. Historical cost is more accountable because it is based on actual transactions. *a. True b. False Feedback: Under historical cost accounting, a record of actual transactions is made. This is not the case in 'current value' systems which recognise current prices as value or even income - when these events may or may not occur.

Section 'Historic cost accounting'.

© John Wiley & Sons Australia, Ltd

6.2

Chapter 6: Accounting measurement systems

4. The difference between share market analysis and corporate analysis is that share market analysis focuses on the underlying values of companies whereas corporate analysis mainly tries to ascertain what other investors are thinking. a. True *b. False Feedback: It should be the other way around, share market analysis tries to ascertain what other investors are thinking (investor psychology) whereas corporate analysis focuses on analysing a company for underlying values.

Section 'Historic cost accounting'.

5. The difference between the physical capital concept and the financial capital concept is that holding gains are included in profit under the physical capital concept. a. True *b. False Feedback: It is the other way around.

Section 'Financial capital versus physical capital'

6. Current cost profit is defined as the difference between the present (discounted) value of expected net cash flows of a firm at two points in times, excluding additional investments by and distributions to owners. a. True *b. False Feedback: The above is the definition of economic profit.

Section 'Current cost accounting'

7. One of the criticisms of current cost accounting is that it does not recognise increases in the value of assets before the assets are sold. a. True *b. False Feedback: The criticism is that it does recognise increases in value before assets are sold violating the revenue recognition principle.

Section 'Current cost accounting'

© John Wiley & Sons Australia, Ltd

6.3

Testbank to accompany Accounting Theory 7e by Godfrey et al

8. Including holding gains as a component of profit reflects a financial capital view. *a. True b. False Feedback: Including holding gains as a component of profit reflects a financial capital view.

Section 'Current cost accounting'

9. The term 'current cash equivalent' refers to the asset's realisable price on the basis of an orderly liquidation. *a. True b. False Feedback: The term 'current cash equivalent' refers to the asset's realisable price on the basis of an orderly liquidation.

Section 'Exit price accounting'

10. One of the reasons that MacNeal advocates the use of exit prices is the information gap created by the separation of ownership and control in companies. *a. True b. False Feedback: One of the reasons that MacNeal advocates the use of exit prices is the information gap created by the separation of ownership and control in companies.

Section 'Exit price accounting'

11. Sterling defines profit as the difference between capital at two points in time. a. True *b. False Feedback: Sterling defines profit as the difference between capital at two points in time adjusted for additional investments by and distributions to owners.

Section 'Exit price accounting'

© John Wiley & Sons Australia, Ltd

6.4

Chapter 6: Accounting measurement systems

12. If an asset's exit value differs significantly from its entry price this decreases the risk of holding the asset for the firm. a. True *b. False Feedback: A difference between the entry and exit prices of an asset increases the riskiness of the asset to the firm.

Section 'Exit price accounting'

13. Exit price accounting has been criticised for it does not recognise the possibility of selling assets as one package. *a. True b. False Feedback: The current cash equivalent concept does not recognise the possibility of selling assets as one package.

Section 'Exit price accounting'

14. Exit price accounting considers value in use as one of its key factors. a. True *b. False Feedback: In fact, one of the criticisms of exit price accounting is that it does not consider the concept of value in use.

Section 'Exit price accounting'

15. Exit price accounting can be seen as a short-term approach as it focuses on disposition and liquidation values. *a. True b. False Feedback: Exit price accounting can be seen as a short-term approach as it focuses on disposition and liquidation values.

Section 'Exit price accounting'

© John Wiley & Sons Australia, Ltd

6.5

Testbank to accompany Accounting Theory 7e by Godfrey et al

16. If current cost accounting (CCA) is greater than current cash equivalents (CCE) and CCE is greater than net present value requirement (NPVR), it implies that assets have value in use and the firm should maintain its current operations. *a. True b. False Feedback: Section 'Value in use versus value in exchange'

17. Under international accounting standards, the definition of fair value can vary substantially. *a. True b. False Feedback: Although fair value is normally the transaction price in an active market, the definition of transaction cost is not consistent. For example, under IAS 39 /AASB 139 selling price is considered as the fair value of marketable securities, whereas amortised cost is the fair value for held-to-maturity securities.

Section 'A global perspective and international financial reporting standards'

18. Present measurement requirements in Australia can be criticised for inconsistency with respect to the valuation bases used. *a. True b. False Feedback: Figure 6.1 highlights the inconsistency across Australian Accounting Standards with respect to valuation bases.

Section 'A global perspective and international financial reporting standards'

19. The FASB shows its supports for the financial capital view of current cost accounting in the Statement 33. a. True *b. False Feedback: The FASB was undecided whether to support the financial capital view or the physical capital view of current cost accounting. This is shown in Statement 33 where the FASB decided to call the changes in current cost 'increases or decreases in current cost' rather than holding gains (or losses) or capital maintenance adjustment.

Section 'A global perspective and international financial reporting standards'

© John Wiley & Sons Australia, Ltd

6.6

Chapter 6: Accounting measurement systems

20. Each accounting measurement model creates the same type of misstatement risk for an auditor. a. True *b. False Feedback: Each accounting measurement model creates a different type of misstatement risk. For example, exits prices could be difficult to determine because of a thinly traded market but discounted cash flows require consideration of future cash flow projections and a choice of a discount rate.

Section 'Issues for auditors'

© John Wiley & Sons Australia, Ltd

6.7

Testbank to accompany Accounting Theory 7e by Godfrey et al

Multiple Choice

21. Under the historical cost accounting model the financial statement that is regarded as the most important is: a. Balance sheet b. Cash flow statement *c. Income statement d. They are all equally important Feedback: Under the historical cost accounting model the financial statement that is regarded as the most important is the income statement as profit correlates with the effectiveness of the firm as an operating unit.

Section Reference: 'Historic cost accounting'.

22. Which of these is not a criticism of historical cost accounting? a. It is not objective and is open to manipulation *b. It has been used by business over many centuries c. Historical cost overstates profit in times of rising prices d. It relegates the balance sheet to a secondary position Feedback: It is an argument in favour of HCA that the system that has been used over many centuries by owner-operators to be useful in running their businesses.

Section Reference: 'Historic cost accounting'.

23. The statement in relation to historical cost that is true is: *a. The stewardship objective of historical cost accounting emphasises the contractual relationship between a firm and those who provide resources to it b. Historical cost understates profit in a time of rising prices c. Historical cost is more subjective than alternative systems about what is really going on in a company's business d. A and B are true Feedback: A is the correct statement. B is incorrect: historical cost overstates profit in a time of rising prices because it offsets historical cost against current revenues. C is incorrect: proponents of historical cost contend that historical cost is less subjective about what is really going on in a company's business.

Section Reference: 'Historic cost accounting'.

© John Wiley & Sons Australia, Ltd

6.8

Chapter 6: Accounting measurement systems

24. According to Whitman and Shubik, which of these is not the reason why investors are more interested in share market analysis compared to corporate analysis? a. Investors develop a short-term view because the economics of share market investing is directed towards that end b. Investors deal with highly marketable securities and therefore move in and out of situations readily c. Investors have little knowledge about a company, its management, its policies and objectives *d. Investors are concerned about what is really going on in a company's business Feedback: Because of the reasons stated in A, B and C, investors have no interest in analysing a company for underlying value and are not concerned about what really going on in a company's business.

Section Reference: 'Historic cost accounting'.

25. The statement that is true with respect to current cost accounting is: a. Gains are recorded only when the assets are disposed of b. Holding gains are not included in current operating profits *c. Current operating profit is the excess of the current value of the output sold over the current cost of the related inputs d. None of the above is true Feedback: Section Reference: 'Current cost accounting'.

26. Under the physical capital perspective what capital maintenance adjustment would be needed for the following situation? GHI Company purchased 300 units on 1 March for $25 each. On 31 March, GHI sold all the units for $30 each. On this date the current cost of each unit was $29. a. $1500 *b. $1200 c. $9000 d. $300 Feedback: Because the price was raised by $4 the company needs $1200 ($4 300 units) at the end of the period to maintain its beginning operating capability.

Section Reference: 'Financial capital versus physical capital'.

© John Wiley & Sons Australia, Ltd

6.9

Testbank to accompany Accounting Theory 7e by Godfrey et al

27. On the 1 June, Hazel Ltd commenced business with $10,000 cash and immediately purchased 2000 sprockets for $5 each. On the 30 June it sold all the units for $10. The current cost of the units on 30 June was $5.50.

What would be the profit for Hazel Ltd under the physical capital perspective? *a. $9 000 b. $10 c. $11 d. $12 Feedback: Sales revenue (2000 $10) = $20Cost of sales (2000 $5.50) = $11Current operating profit ($20- $11= $9000, Holding gain = $0, profit ($9000 + 0) = $9000.

Section Reference: 'Financial capital versus physical capital'.

28. Which of these is a criticism of the physical capital concept? a. It is not meaningful if the firm does not continue to replace identical units b. When costs are decreasing a profit may still be recorded when a company sells a product for less than purchase price c. When a company buys and sells in the same market it will record zero profit *d. All of the above Feedback: Section Reference: 'Financial capital versus physical capital'.

29. On the 1 June, Hazel Ltd commenced business with $10,000 cash and immediately purchased 2000 sprockets for $5 each. On the 30 June it sold all the units for $10. The current cost of the units on 30 June was $5.50 each. Under the physical capital perspective, what would be the capital maintenance adjustment for Hazel Ltd for June? *a. $1000 b. $2000 c. $9000 d. $10,000 Feedback: The price rose $0.50 so Hazel Ltd needs $1000 (0.50 2000) to maintain its beginning operating capability.

Section Reference: 'Financial capital versus physical capital'.

© John Wiley & Sons Australia, Ltd

6.10

Chapter 6: Accounting measurement systems

30. Which of these is a defence of current cost accounting? a. It is the most objective of the proposed accounting methods *b. Relevant current events of the accounting period should be accounted for to maintain the usefulness of accounting information for decision-making c. It specifically recognises future technological changes in profit determination d. All of the above are defences Feedback: Section Reference: 'Financial capital versus physical capital'.

31. The argument that is descriptive of exit price accounting is: a. It takes into account the opportunity cost of holding assets b. The values of non-monetary assets are adjusted to measure changes in the market selling prices of those assets c. When considering the financial position of the firm and the results of the firm's operations changes in the general purchasing power of money is taken into account *d. All of the above Feedback: Section Reference: 'Exit price accounting'.

32. Which of the following is not true with respect to the notion of adaptive behaviour? a. It implies a continual attempt to adapt to the competitive business environment for the sake of survival *b. The firm will keep a non-current asset if the present value of the future net cash flows from the use of the asset is less than the present value of the expected net cash flows from an alternative investment of the exit value of the asset b. The firm should consider at all times the alternative opportunities for greater returns for its non-current assets (i.e. if they were sold and the proceeds invested elsewhere) d. All of the above Feedback: The firm will keep a non-current asset if the present value of the future net cash flows from the use of the asset is greater than the present value of the expected net cash flows from an alternative investment of the exit value of the asset.

Section Reference: 'Exit price accounting'.

© John Wiley & Sons Australia, Ltd

6.11

Testbank to accompany Accounting Theory 7e by Godfrey et al

33. Which of these best describes the second era of accounting phases as suggested by MacNeal? *a. There are numerous shareholders who own the company b. The need to ensure that financial statements were reliable established public accounting as a profession c. Doing business is very risky and ventures are usually concluded within few years d. Providing financial reports for external users became an important function of accounting Feedback: A and D are the characteristics of the third era; C is the characteristic of the first era.

Section Reference: 'Exit price accounting'.

34. The alternative that is not an argument in favour of exit price accounting is: a. Valuing all elements in the financial statements at their money equivalents provides one rule that can be applied consistently. b. The financial statements are allocation-free *c. Rather than measuring past events the method measures those that might happen if a firm does something other than what was planned d. Exit price accounting involves references to real-world examples therefore it is more grounded in reality than historical cost accounting Feedback: Alternative C is an argument against exit price accounting not an argument in its favour.

Section Reference: 'Exit price accounting'.

35. Which of these best reflects the approach taken by Sterling in coming to the conclusion that exit prices should be used instead of historical cost? *a. Examination of the types of decisions users are expected to make b. b. The adaptive behaviour of firms and its implications c. A historical perspective d. A value-in-use perspective Feedback: Section Reference: 'Exit price accounting'.

© John Wiley & Sons Australia, Ltd

6.12

Chapter 6: Accounting measurement systems

36. Which of these is not a criticism of exit price accounting with respect to the profit concept? a. Accounting must measure past events b. Exit pricing does not provide relevant data to match against revenues *c. A firm can consider an asset to have value because of its use in business rather than its sale and use by another enterprise d. All of these are not a criticism of exit value accounting with respect to the profit concept Feedback: This is an argument against exit pricing based upon the 'value in use versus value in exchange argument'.

Section Reference: 'Exit price accounting'.

37. One of the key factors identified by Chambers in support of CoCoA is additivity. Which of the following does not support this view expressed by Chambers? a. Using different measurement scales in financial statements renders them unable to provide practical meaning when the values are aggregated. b. The valuation of all elements of the balance sheet at their money equivalents provides one rule that can be applied consistently by any company *c. The cash equivalent of assets can be quite different depending upon the procedure used in selling them d. All of the above do not support the view that CoCoA has additivity.

Feedback: This argument leads to the conclusion that current cash equivalents (exit prices) are not additive as Chambers would argue.

Section Reference: 'Exit price accounting'.

38. Which of these is not true with respect to the assumptions of the value-in-use and the valuein-exchange approaches? a. Additivity of economic phenomena is made in the same unit, adjusted for inflation and price movements b. Up-to-date observations of market prices are more relevant for financial decision making c. Valuation does not depend on a subjective allocation *d. Historical cost accounting is a fairly reliable valuation method Feedback: Both value-in-use and value-in-exchange approaches take the view that historical cost accounting has many defects. Factors A, B and C are held by both viewpoints.

Section Reference: 'Value in use versus value in exchange'.

© John Wiley & Sons Australia, Ltd

6.13

Testbank to accompany Accounting Theory 7e by Godfrey et al

39. What was the main recommendation of SAP 1 Current Cost Accounting, issued in Australia in November 1983? a. That companies disclosed information on profit from continuing operations on a current cost basis for the current financial year b. That companies are not required to report historical cost information if they have disclosed current cost information *c. That companies presented supplementary current cost accounting statements in addition to historical cost financial statements d. That companies used current cost for the main financial statements and historical cost as supplementary data Feedback: A is the requirement of Statement 33 issued by the FASB; B is the requirement of Statement 82 issued by the FASB; D is the requirement of SSAP 16 issued by the Accounting Standards Committee in the UK. Section Reference: 'A global perspective and international financial reporting standards'.

40. The statement that is true in regards to current cost in the UK as recommended by the Sandilands Committee is: *a. The Sandilands Committee decided that holding gains should be disclosed but not included in profit b. b. The financial capital view underlies current cost accounting in the UK c. Historical cost contains as useful information as current cost accounting for the users of financial statements d. Holding gains are indicative of companies' normal activities Feedback: B is incorrect as the committee held that the physical capital view underlies current cost accounting in the UK; C is incorrect as the Sandilands Committee concluded that historical cost statements were of limited usefulness; D is incorrect as according to the Sandilands Committee, holding gains reflect economic conditions that cannot be controlled by management and may not be indicative of normal activities.

Section Reference: 'A global perspective and international financial reporting standards'.

© John Wiley & Sons Australia, Ltd

6.14

Chapter 6: Accounting measurement systems

41. Which of the following is not what IAS 16 / AASB 116 prescribes in relation to asset measurement? a. IAS 16 /AASB 116 allows companies to choose between a cost model and a current cost model b. On acquisition the cost price of the asset is its fair value c. All assets within a class must be valued under the same principles but not all classes must use the same valuation model *d. Assets have to be revalued in a specified period Feedback: Under IAS 16 /AASB 116, there is no specified period that assets have to be revalued.

Section Reference: ‘A global perspective and international financial reporting standards'.

42. Which measurement was agreed as the best basis of measurement by the IASB and the FASB? a. Historical cost *b. Fair value c. Exit price d. Current cost Feedback: The IASB and the FASB agreed (Project Update January 2004) that the best bases of measurement was 'fair value'.

Section Reference: 'A global perspective and international financial reporting standards'.

43. Which of the following use of measurement concepts is not correct according to the international accounting standards? a. Measurement of provisions is determined by the expected present value method *b. The residual value of an asset should be calculated as its discounted value c. Property, plant and equipment may be valued at historical cost or revalued amount d. Financial statements of an entity that operates in a hyperinflationary economy are adjusted using a general price level index Feedback: B is incorrect. IAS 36 /AASB 136 prescribes that residual value of an asset is calculated as the current cash equivalent. Statement A, C, and D are true (refer to IAS 37 /AASB 137, IAS 16 /AASB 116, and IAS 29 /AASB 129 respectively in Figure 6.1 p.200-201.

Section Reference: 'A global perspective and international financial reporting standards'.

© John Wiley & Sons Australia, Ltd

6.15

Testbank to accompany Accounting Theory 7e by Godfrey et al

44. The statement that is not true in relation to auditing and accounting measurement systems is: a. Auditors must contend with a mixed measurement model b. Auditors deal with some valuation issues by seeking expert opinions. *c. Evidence suggests that expert valuations are more reliable than those made by management d. None of the above, i.e. all are true statements Feedback: Evidence suggests that expert valuations are not necessarily more reliable than those made by management.

Section Reference: 'Issues for auditors'.

© John Wiley & Sons Australia, Ltd

6.16

Chapter 6: Accounting measurement systems

Essay Questions

45. Are holding gains a component of accounting profit? Discuss.

46. Outline and discuss the arguments for and against the adoption of the continuously contemporary accounting system.

47. 'While proponents of current cost accounting are convinced that it provides more useful information than historic accounting, they do not agree on all issues. In general supporters can be divided into two camps; (1) those who believe in the financial capital concept, and (2) those who believe in the physical concept. ' J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.205.

Explain the differences between the two concepts and the arguments for and against each viewpoint stating which you approach you believe is the most valid.

48. 'However at the current (most recent) stage the IAS approach can be described as a mixed valuation approach with fair value accounting sometimes defined as current market entry cost prices but also historic cost, selling prices and discounted future cash flows' J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.206.

Explain and discuss the above statement.

49. Explain and discuss the difference between 'value in use' and 'value in exchange' and the two different perspectives they give on the purpose of financial accounting.

© John Wiley & Sons Australia, Ltd

6.17

Test Bank to accompany

Accounting Theory 7th edition PREPARED BY

Barbara Burns CHAPTER 7 Assets

© John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

Chapter 7: Assets True/False 1. Under the IASB standards all wholly executory contracts are recognised as assets. a. True *b. False Feedback: Under the IASB standards some wholly executory contracts are recognised as assets while others are not. For example a finance lease gives rise to an asset and liability while an operating lease does not.

Section "Assets defined"

2. An asset must have future cash generating abilities according to the IASB (AASB) Framework definition. a. True *b. False Feedback: The IASB (AASB) Framework's definition of an asset is " a resource controlled by an entity as a result of past events and from which future economic benefits (not necessarily cash) are expected to flow to the entity".

Section "Assets defined"

3. Exchangeability is a characteristic that supports the existence of an asset, however, it is not an essential characteristic. *a. True b. False Feedback: Exchangeability is a characteristic that supports the existence of an asset, however, it is not an essential characteristic.

Section "Assets defined"

4. The IASB (AASB) Framework does refer to the conservatism (prudence) principle. *a. True b. False Feedback: The Framework states in paragraph 37 that 'Prudence is the inclusion of a degree of caution in the exercise of the judgment needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not © John Wiley & Sons Australia, Ltd

7.2

Chapter 7: Assets

understated.

Section "Asset recognition"

5. The recognition rules for assets contained in the Framework are extensions of the subsidiary objectives (qualitative characteristics) of relevance and reliability of accounting information. *a. True b. False Feedback: The recognition rules for assets contained in the Framework are extensions of the subsidiary objectives (qualitative characteristics) of relevance and reliability of accounting information. (Framework, paras 26-28, 31-32) Section "Asset recognition"

6. IAS 16 and IAS 40 permit, but do not require, the use of a current value measurement model. *a. True b. False Feedback: IAS 16 and IAS 40 permit, but do not require, the use of a current value measurement model.

Section "Asset measurement"

7. Barth and Kasznik reported that, between 1983 and 1995, in the United Kingdom, 20% of firms recorded an asset revaluation reserve. a. True *b. False Feedback: Barth and Kasznik reported that, between 1983 and 1995, in the United Kingdom, 43% of firms recorded an asset revaluation reserve.

Section "Asset measurement"

8. IAS 39 created a separate category of assets and liabilities, financial assets and liabilities, and introduced associated measurement rules. *a. True b. False Feedback: IAS 39 created a separate category of assets and liabilities, financial assets and liabilities, and introduced associated measurement rules.

Section "Asset measurement" © John Wiley & Sons Australia, Ltd

7.3

Testbank to accompany Accounting Theory 7e by Godfrey et al

9. The FASB and the IASB intend to address the issue of measurement of assets in Phase C of the conceptual framework project. *a. True b. False Feedback: The FASB and the IASB intend to address the issue of measurement of assets in Phase C of the conceptual framework project.

Section "Challenges for standard setters"

10. Using fair values for assets could appear less attractive to management (and more risky for auditors) during periods of rising asset values. a. True *b. False Feedback: Using fair values for assets could appear more attractive to management (and less risky for auditors) during periods of rising asset values.

Section "Issues for auditors"

11. Cairns argues that under the IASB standards fair value is used to measure assets on initial recognition but subsequent measurement at fair value is more rare. *a. True b. False Feedback: Cairns argues that under the IASB standards fair value is used to measure assets on initial recognition but subsequent measurement at fair value is more rare.

Section "Challenges for standard setters"

© John Wiley & Sons Australia, Ltd

7.4

Chapter 7: Assets

Multiple choice

12. To fulfil the IASB (AASB) Framework criteria that an asset must have 'future economic benefits' which of the following criteria must be met? i. It must be scarce ii. It must have utility iii. It must be capable of generating cash inflows to the entity *a. i, ii, b. i, iii c. i, ii, ii d. iii Feedback: For a not-for-profit organisation the IASB (AASB) Framework recognises that cash flows is not always the objective, the principle is that the future economic benefit should qualify as helping the entity meet its objectives. The notion of future economic benefits relates to economic resources. There are two main characteristics of an economic resource: scarcity and utility.

Section "Assets defined"

13. Which of these items would meet the asset criteria of 'having future economic benefits' for a local council? a. Air in the park b. A bank overdraft *c. A council park d. A and C Feedback: Even though the council park may not generate net cash inflows for the council it can be argued that it will assist the council in pursuing its objectives as a government agency. Air has no future economic benefits for the council as it is not scarce and so is not "economic".

Section "Assets defined"

© John Wiley & Sons Australia, Ltd

7.5

Testbank to accompany Accounting Theory 7e by Godfrey et al

14. With respect to executory contracts it is true that: a. a. They arise when one party to a contract has performed proportionally more of the contract than the other party *b. They meet the criteria for an asset as defined by the IASB (AASB) Framework c. They are required to be recognised in the financial statements d. All of the above Feedback: While it is mostly agreed that executory contracts meet the definition of assets (and liabilities) according to the IASB (AASB) Framework, due to the controversy surrounding this issue it is not a requirement of the IASB (AASB) Framework that they all be recognised. The current situation is that some executory contracts are recognised as assets while other are not.

Section "Assets defined"

15. Arguments in favour of including 'exchangeability' as an essential criterion for the identification of an asset under the IASB (AASB) Framework include which of the following? *a. That assets should be separable from the entity and have a separate disposal value b. That exchange is only one way to obtain the benefit of an asset c. That economic value depends upon scarcity and utility, but not on exchangeability d. None of the above are arguments in favour of including exchangeability as an essential characteristic of an asset.

Feedback: Section "Assets defined"

16. The criteria that normally need to be recognised for a non-cancellable lease to be capitalised by a lessee IAS 17/AASB 117) is: a. The lease term is for the major part of the economic life of the asset b. At the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset c. Both A and B *d. Either A or B Feedback: For a non-cancellable lease to be normally capitalised by the lessee any one of a number of criteria, including those mentioned in A and B above need to be met.

Section "Asset recognition"

© John Wiley & Sons Australia, Ltd

7.6

Chapter 7: Assets

17. The statement in relation to conservatism (prudence) that is true is: *a. Conservatism is inconsistent with the principle of neutrality b. Conservatism means recording assets early c. Conservatism means not depleting future resources d. All of the statements are true.

Feedback: See discussion pages 236-237.

Section "Asset recognition"

18. The statement concerning asset recognition that is not correct is: a. a. The accounting standards prohibit the recognition of internally generated goodwill as an asset *b. The accounting standards prohibit the recognition of internally generated assets arising from development expenditure c. The accounting standards prohibit the recognition of internally generated assets arising from research expenditure d. None of the statements is incorrect, i.e. all are correct statements Feedback: The accounting standards restricts the recognition of internally generated assets arising from development expenditure by providing strict criteria that must be met, but they do not prohibit recognition. A and C are correct statements. Pages 237.

Section "Asset recognition"

19. The extent and timing of recognition of assets are important because: a. They can affect the decision making for users of financial statements b. They can affect the calculation of ratios which are important inputs for debt covenants c. They can affect management compensation *d. All of the above Feedback: See summary L02 page 250.

Section "Why recognition and measurement criteria are both important and controversial".

Section "Asset recognition"

© John Wiley & Sons Australia, Ltd

7.7

Testbank to accompany Accounting Theory 7e by Godfrey et al

20. Which of these is not an argument in favour of restricting the recognition of internally generated goodwill? a. Good will is not separable from other assets b. There are difficulties in identifying whether and when goodwill will generate future economic benefits *c. Goodwill cannot be sold d. All of the above Feedback: Internally generated goodwill can be sold as part of the sale of an entity as a going concern, so this is not an argument in favour of restricting its recognition.

Section "Asset recognition"

21. The statement concerning the measurement of tangible assets that is not true is: a. The traditional approach has been to measure tangible assets at historical cost *b. IAS 16 requires the use of the revaluation model for subsequent measurement of tangible assets c. IAS 16 permits the use of a current value measurement model for tangible assets d. None of the statements are untrue, i.e. all are true statements Feedback: IASB 16 allows the use of the revaluation model for subsequent measurement of tangible assets but it does not require it. A and C are true.

Section "Asset measurement"

22. The use of a current value model for intangible assets is: a. Common b. Mandatory *c. Rare d. Prohibited Feedback: The use of a current value model for intangible assets is rare.

Section "Asset measurement"

© John Wiley & Sons Australia, Ltd

7.8

Chapter 7: Assets

23. The statement concerning the measurement of financial instruments that is not true is: a. The decision usefulness objective is an argument for valuation at fair value b. Since the 1980's the FASB has required fair value measurement *c. The FASB has followed the IASB's lead in standard setting for financial instruments d. IAS 39 is the standard on financial instruments Feedback: It is the other way around; the IASB has followed the FASB's lead in standard setting for financial instruments.

Section "Asset measurement"

24. The FASB and IASB have concluded that derivatives should be measured at: *a. Fair value b. Cost c. The lower of cost or fair value d. Cost less accumulated amortisation Feedback: The FASB and the IASB have concluded that derivatives should be measured at fair value rather than cost. See IAS 39 (para 9).

Section "Asset measurement"

25. Which of these is correct regarding the IASB's requirements in relation to the measurement of various types of financial assets? *a. Originated loans and receivables - Amortised cost b. b. Held-to-maturity investments - Fair value c. Available-for-sale securities - Fair value with gains and losses arising on remeasurement taken to profit and loss d. Financial assets held for trading - Fair value with gains and losses from remeasurement recognised in equity Feedback: See Table 7.1 Section "Asset measurement"

© John Wiley & Sons Australia, Ltd

7.9

Testbank to accompany Accounting Theory 7e by Godfrey et al

26. The order of the 'fair value hierarchy' nominated by the FASB's SFAS 157 is: i. Quoted prices for similar assets or liabilities in active markets, adjusted ii. Quoted prices for identical assets and liabilities in active reference markets, unadjusted iii. Multiple valuation techniques consistent with the market, income and cost approaches *a. Levels ii, i, iii b. b. Levels i, ii, iii c. Levels iii, ii, i d. Levels ii, iii, i Feedback: Order of the levels: ii. Quoted prices for identical assets and liabilities in active reference markets, unadjusted, i, Quoted prices for similar assets or liabilities in active markets, adjusted as appropriate for differences, iii, Where the information required for levels I and 2 is not available multiple valuation techniques consistent with the market, income and cost approaches shall be used to determine fair value.

Section "Challenges for standard setters"

27. Which approach does the FASB's SFAS 157 'Fair value measurements' recommend to be used in determining fair value? a. The market approach b. The income approach c. The cost approach *d. All are possible approaches which the standard suggests could be used to determine fair value Feedback: The FASB's SFAS 157 'Fair value measurements' suggests that all of the above are possible approaches that could be used to determine fair value.

Section "Challenges for standard setters"

28. A valuation approach used by current IASB standards is: i. Written down historical cost ii. Fair values based on exit values iii. Fair values based on value in use a. i, ii b. i, iii c. ii, iii *d. i, ii, iii Feedback: Section "Challenges for standard setters"

© John Wiley & Sons Australia, Ltd

7.10

Chapter 7: Assets

29. The statement concerning auditing and fair value that is true is: a. Using fair values for assets could appear more attractive to management and more risky for auditors during periods of rising asset values *b. Further research is needed on the auditing of fair values c. Auditors will have to become valuers d. All of the above are true Feedback: A is untrue as using fair values for assets could appear more attractive to management and less risky for auditors during periods of rising asset values, C is untrue as auditors will have to acquire a greater understanding of valuation models but will not themselves have to become valuers.

Section "Issues for auditors"

© John Wiley & Sons Australia, Ltd

7.11

Testbank to accompany Accounting Theory 7e by Godfrey et al

Essay Questions 30. Explain and discuss how an asset can provide future economic benefits. Refer to both profit seeking and not-for-profit organisations.

31. Referring to examples from the current accounting standards, discuss the influence of conservatism (prudence) on the recognition of assets.

32. Explain and discuss the arguments for and against the use of historical cost for the measurement of tangible assets.

33. Explain and discuss some of the issues that arise for auditors from the IASB's move to incorporate more fair value measurements into accounting standards.

34. "Under the IASB standards all wholly executory contracts are recognised as assets." Explain why you agree or disagree with this statement.

© John Wiley & Sons Australia, Ltd

7.12

Test Bank to accompany

Accounting Theory 7th edition PREPARED BY

Barbara Burns CHAPTER 8 Liabilities and owners’ equity

© John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

Chapter 8: Liabilities and owners’ equity True/False 1. Liabilities are present obligations of an entity, whereas owners' equity is a residual interest or claim but not an obligation to transfer assets. *a. True b. False Feedback: Section 'Proprietary and entity theory'

2. A physical capital rather than a financial capital view is appropriate under proprietary theory. a. True *b. False Feedback: It is the other way around. A financial capital rather than a physical capital view is appropriate under proprietary theory.

Section 'Proprietary and entity theory'

3. The entity view of accounting was formulated in response to the shortcomings of the proprietary view concerning the separate legal status of a company. *a. True b. False Feedback: The entity theory was formulated in response to the shortcomings of the proprietary view concerning the separate legal status of a company.

Section 'Proprietary and entity theory'

4. Under the entity theory the assets belong to the owners and the liabilities are the obligations of the owners. a. True *b. False Feedback: Under the entity theory the assets belong to the firm and liabilities are the obligations of the firm.

Section 'Proprietary and entity theory'

© John Wiley & Sons Australia, Ltd

8.2

Chapter 8: Liabilities and owners’ equity

5. Generally speaking accountants are more likely to record liabilities later than assets. a. True *b. False Feedback: It is the other way around. Generally speaking accountants are more likely to record liabilities earlier than assets.

Section 'Liabilities defined'

6. Future warrantee claims should not be recorded as a liability in the balance sheet as there is no objective evidence as to the amount that will be claimed. a. True *b. False Feedback: In many cases, such as for warrantee claims, accountants must use judgement based on relevant past date to estimate the amount of the liability.

Section 'Liabilities defined'

7. Even if a liability meets the Framework definition it still should not be recognised if the amount at which the settlement will take place cannot be measured reliably. *a. True b. False Feedback: Section 'Liabilities defined'

8. An example of where fair value measurement is required subsequent to acquisition is postemployment obligations such as pensions (superannuation) under IAS 19/AASB 119. *a. True b. False Feedback: An example of where fair value measurement is required subsequent to acquisition is post-employment obligations such as pensions (superannuation) under IAS 19/AASB 119.

Section 'Liability measurement'

© John Wiley & Sons Australia, Ltd

8.3

Testbank to accompany Accounting Theory 7e by Godfrey et al

9. Contingent liabilities do not meet the criteria for recognition as liabilities. *a. True b. False Feedback: Contingent liabilities do not meet the criteria for recognition as liabilities, therefore they are not recognised in the financial statements (though they may be recognised as a note).

Section 'Liability measurement'

10. The Framework recommends that capital is conceptualised as the invested money or the invested purchasing power of the entity. a. True *b. False Feedback: The Framework does not provide guidance regarding the capital models or measures that an entity should use.

Section 'Liability measurement'

11. Retained profits and share dividends represent elements of earned capital. a. True *b. False Feedback: Classification of share dividends is difficult as they represent a change in classification from earned to contributed capital.

Section 'Liability measurement'

12. The IASB has decided not to treat share-based remuneration as an expense. a. True *b. False Feedback: The IASB has decided to treat share-based remuneration as an expense.

Section 'Challenges for standard setters

© John Wiley & Sons Australia, Ltd

8.4

Chapter 8: Liabilities and owners’ equity

13. Interpretation of the IASB (AASB) Framework suggests that a liability should cease to be recognised when assets or services have been transferred to other entities in satisfaction of the debt. *a. True b. False Feedback: Section 'Challenges for standard setters'

© John Wiley & Sons Australia, Ltd

8.5

Testbank to accompany Accounting Theory 7e by Godfrey et al

Multiple choice

14. The practice that is not based on the proprietary theory is: a. Considering dividends as distributions of profit b. Not considering the salaries of partners in a partnership as expenses *c. The capital maintenance principle of maintaining the physical level of operations before recognising a profit d. The equity method of accounting for long-term investments Feedback: Maintaining the physical level of operations is based on the entity theory not the proprietary theory as it focuses on the entity's ability to maintain its physical capital without regard to ownership claims. The other practices are based on the proprietary theory.

Section 'The proprietary and entity theory'

15. Under the proprietorship theory of accounting the incorrect statement(s) is/are: i) Assets belong to the proprietor ii) Liabilities are the obligations of the entity iii) Income and expense accounts are subsidiary accounts of proprietorship iv) An objective of accounting is to determine the net worth of the owner a. i, ii, iv *b. ii c. i d. i, ii Feedback: Under the proprietary theory liabilities are obligations of the owner rather than obligations of the entity.

Section 'The proprietary and entity theory'

16. The version of the accounting equation that represents the entity theory of accounting is: a. P = A - L *b. Assets = Equities c. A = L + P d. None of the above Feedback: Under the entity theory the focus of the accounting equation is assets and equities. Net worth of the proprietor is not a meaningful concept because the entity is the centre of attention.

Section 'The proprietary and entity theory'

© John Wiley & Sons Australia, Ltd

8.6

Chapter 8: Liabilities and owners’ equity

17. Which statement concerning the entity theory is correct? a. a. The theory is essentially a restatement of the accounting entity assumption regarding the separation of business and personal affairs b. The theory only applies to companies *c. The accounts must be formulated from the point of view of the entity as an operating unit d. All of the above are correct Feedback: A is incorrect as the theory goes beyond the accounting entity assumption and B is incorrect as, although the theory is especially suitable for corporations, it can also be applied to other forms of organsation such as sole traders and partnerships.

Section 'The proprietary and entity theory'

18. It is correct that: a. In practice the entity theory rather than the proprietary theory is the dominant theory *b. In practice both the entity and the proprietary theories are influential c. In practice the proprietary theory rather than the entity theory is the dominant theory d. The proprietary theory is now obsolete Feedback: In practice both the entity and the proprietary theories are influential.

Section 'The proprietary and entity theory'

19. The Framework recognises that settlement of liabilities can occur in several ways. What is not one of those ways? *a. Cash receipt b. Transfer of other assets c. Replacement of the obligation with another obligation d. Conversion of the obligation to equity Feedback: A liability can be settled with a cash payment not a cash receipt. All the other options are possible ways in which liabilities can be settled.

Section 'Liabilities defined'

© John Wiley & Sons Australia, Ltd

8.7

Testbank to accompany Accounting Theory 7e by Godfrey et al

20. Which of these possible methods for settling liabilities involves the outflow of assets by the entity? a. The provision of services b. Replacement of one obligation with another obligation c. A creditor waiving the obligation *d. Cash payment Feedback: A cash payment is the only one of the four possible ways of settling liabilities that involves the out flow of assets by the entity.

Section 'Liabilities defined'

21. A present obligation that will transfer assets from an entity in the future, exists in which of the following cases? i) A sole proprietor takes out a loan to purchase inventory for her business ii) Employees' wages are owed for the previous fortnight iii) A company issues ordinary shares to increase its capital base a. i, iii b. i, ii, iii c. ii, iii *d. i, ii Feedback: Share issues to not create a present obligation, they create a residual interest or claim for the shareholders.

Section 'Liabilities defined'

22. Which of the following should definitely be recognised as a liability under the IASB Framework? i) Share dividend declarations ii) Cash dividend declarations iii) Convertible notes a. i, iii *b. ii c. ii, iii d. i, ii Feedback: Cash dividend declarations are a liability. A share dividend is not a liability because it does not result in an obligation to transfer assets away from the entity. Convertible notes are controversial.

Section 'Liabilities defined' © John Wiley & Sons Australia, Ltd

8.8

Chapter 8: Liabilities and owners’ equity

23. With respect to the IASB Framework's definition of a liability, and in particular the requirement for a present obligation, which of the following items would be recognised as liabilities? i) An employee has accrued 2 months worth of long service leave with the company ii) An employee has fallen ill and has accrued 12 days of sick leave which she will now use iii) An employee has worked for the company for six years and has accrued 25 days sick leave a. i, iii b. i, ii, iii c. ii, iii *d. i, ii Feedback: Section 'Liabilities defined'

24. The most commonly used measurement method for liabilities is: a. Fair value *b. Historical cost c. Market value d. Replacement value Feedback: Under IFRS the most commonly used measurement method for liabilities is historical cost.

Section 'Liability measurement'

25. Under the Framework the liability of a pension fund that is a separate legal entity: a. Could never be a liability of the employer firm b. b. Is definitely a liability of the employer firm *c. Is likely to be a liability of the employer firm d. Is not a liability if it is unfunded Feedback: Although some firms traditionally have not recognised unfunded commitments as liabilities, under the Framework and IAS 37 (AASB 137) it is difficult to argue that they are not liabilities.

Section 'Liability measurement'

© John Wiley & Sons Australia, Ltd

8.9

Testbank to accompany Accounting Theory 7e by Godfrey et al

26. The usual measurement basis allowed by the IFRS and adopted in practice for subsequent measurement of long-term borrowings in IFRS consolidated financial statements is: a. Cost b. Fair value *c. Amortised cost d. Expected payments Feedback: See Table 8.1 Section 'Liability measurement'.

27. The IAS 37/AASB 137 recognition criteria for provisions: *a. Are consistent with the Framework criteria for recognition of a liability b. b. Are different from the Framework's criteria for recognition of a liability c. There are currently no criteria for recognition for provisions d. None of the above Feedback: The IAS 37/AASB 137 recognition criteria for provisions are consistent with the Framework criteria for recognition of a liability.

Section 'Liability measurement'

28. The statement that is true in respect of appropriations is: *a. Some appropriations are a ploy by a company to make it appear to shareholders that the amount available for dividends has been reduced. b. Appropriations affect profit determination c. Appropriations of retained earnings to specific reserve accounts represent particular assets d. None of the statements are true.

Feedback: A is correct. B and C are incorrect statements.

Section 'Liability measurement'

© John Wiley & Sons Australia, Ltd

8.10

Chapter 8: Liabilities and owners’ equity

29. Which of these items would not meet the definition of a liability under the IASB Framework and the current accounting standards? i) A provision for uninsured losses ii) An unconditional purchase obligation iii) Accrued long service leave. a. i, iii b. i, ii, c. i. ii, iii *d. i, Feedback: A provision for uninsured losses cannot be recognised as a liability under IAS 37 until the occurrence of an event necessitating the sacrifice of assets by the reporting entity.

Section 'Liability measurement'

30. Which of these is a right of creditors? a. Settlement of their claims by a given date through a transfer of assets b. Priority over owners in settlement of their claims in the event of liquidation c. The right to use the assets of the firm only as specified in contracts *d. All of the above Feedback: Section 'Liability measurement'

31. Which of these is not one of the purposes of appropriating retained profits to specific reserve accounts? a. To explain management policy concerning the reinvestment of profits b. To restrict the payment of dividends *c. To provide cash to meet future anticipated losses d. d. None of the above, i.e. all are purposes of appropriating retained profits to specific reserve accounts Feedback: A reserve does not represent cash.

Section 'Liability measurement'

© John Wiley & Sons Australia, Ltd

8.11

Testbank to accompany Accounting Theory 7e by Godfrey et al

32. Preference shares can have characteristics that are consistent with liabilities. These characteristics include: a. Participation in dividends *b. Priority over ordinary shares in the return of capital c. Voting rights d. The claim associated with the preference share is variable Feedback: B is a characteristic of preference shares that is consistent with liabilities, A, C and D are consistent with equity.

Section 'Challenges for standard setters'

33. Which of these is not a possible advantage to a company of an in-substance defeasance arrangement? a. An improvement in the debt to equity ratio b. b. An increase in reported profit for the year *c. An increase in assets reported for the year d. d. None of the above, i.e. all are possible advantages of an in-substance defeasance arrangement Feedback: An in-substance defeasance arrangement cannot result in an increase in assets reported for the year. A and B are both possible advantages.

Section 'Challenges for standard setters'

© John Wiley & Sons Australia, Ltd

8.12

Chapter 8: Liabilities and owners’ equity

Essay Questions

34. Do frequent flyer points give rise to a liability for an airline? Discuss.

35. 'Since pension funds are separate legal entities, it might be presumed that unfunded commitments of the plans are not liabilities of an employer firm that pays into a fund.' J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.273. Explain and discuss.

36. Are preference shares debt or equity and does it matter? Discuss.

37. 'Legal rights should be the only basis of distinction between creditor and owner.' Discuss.

© John Wiley & Sons Australia, Ltd

8.13

Test Bank to accompany

Accounting Theory 7th edition PREPARED BY

Barbara Burns CHAPTER 9 Revenue

© John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

Chapter 9: Revenue True/False 1. Revenue is directly related to the monetary event of value increasing in the firm. *a. True b. False Feedback: The monetary flow involves the event of value in the firm increasing, and revenue applies definitely to value.

Section "Revenue defined".

2. Under the IASB Framework revenue encompasses both income and gains. a. True *b. False Feedback: Under the IASB Framework income encompasses both revenue and gains.

Section "Revenue defined".

3. At present, in most cases, the firm must be a direct participant in a transaction before revenue can be recognised. *a. True b. False Feedback: At present, in most cases, the firm must be a direct participant in a transaction before revenue can be recognised.

Section "Revenue recognition".

4. Revenue can never be recognised before the point of sale. a. True *b. False Feedback: There are situations where revenue can be recorded before the point of sale, e.g. at the end of the production process (where demand is assured and production rather than sale is the critical event).

Section "Revenue measurement".

© John Wiley & Sons Australia, Ltd

9.2

Chapter 9: Revenue

5. In determining whether a sale has taken place consideration should only be given to the legal form of the contract of sale. a. True *b. False Feedback: The main consideration for whether a sale has taken place should be the economic substance of the transaction.

Section "Revenue measurement".

6. Where revenue is not recognised until cash is received it is possible that the revenue recognition criteria 'substantial completion' has not been met prior to this event. *a. True b. False Feedback: Where revenue is not recognised until cash is received it is possible that the revenue recognition criteria 'substantial completion' has not been met prior to this event.

Section "Revenue measurement".

7. Under the IAS standards accrued revenue cannot be recorded because there is no external transaction. a. True *b. False Feedback: Under the IAS standards accrued revenue can be recorded even though there is no external transaction. For example interest can be accrued at the end of an accounting period as the passing of time signifies that interest has been earned even though there is no external transaction.

Section "Revenue measurement".

8. Revenue recognition policies of US companies have been the subject of the majority of the SEC's requests for restatement of financial statements. *a. True b. False Feedback: Revenue recognition policies of US companies have been the subject of the majority of the SEC's requests for restatement of financial statements.

Section "Challenges for standard setters".

© John Wiley & Sons Australia, Ltd

9.3

Testbank to accompany Accounting Theory 7e by Godfrey et al

9. The IASB and the FASB's joint project on revenue recognition and measurement gives more emphasis to the substantial completion of the earning process than previous guidance and less on the change in value of assets and liabilities. a. True *b. False Feedback: It is the other way around. The IASB and the FASB's joint project on revenue recognition and measurement gives less emphasis on the substantial completion of the earning process than previous guidance and a greater emphasis on the change in value of assets and liabilities.

Section "Challenges for standard setters".

10. Understatement of revenue is regarded as a greater problem by auditors than overstatement of revenue. a. True *b. False Feedback: It is the other way around. Overstatement of revenue is regarded as a greater problem by auditors than understatement of revenue. This is because overstatement is more likely to be driven by managers' attempts to deceive financial statement users.

Section "Issues for auditors".

© John Wiley & Sons Australia, Ltd

9.4

Chapter 9: Revenue

Multiple choice

11. Under the Framework the statement concerning gains that is incorrect is: a. Income is defined to include both revenue and gains *b. Gains that meet the definition of income always arise outside the course of ordinary operations c. The definition of income includes unrealised gains d. None of the statements is incorrect Feedback: Gains that meet the definition of income may or may not arise in the course of ordinary operations. A and C are correct statements.

Section "Revenue defined".

12. The criteria that is not included in the Framework's definition of income is: a. An increase in economic benefits b. The economic benefits are in the form of increases in assets or reductions in liabilities of the entity (not resulting from equity contributions) *c. The economic benefit results from transactions or events that constitute the entities ongoing major or central operations d. The benefits result in an increase in equity during the period Feedback: The Framework's definition of income includes both revenue and gains and thus includes inflows or other asset enhancements arising from transactions or events that do not constitute major or central operations.

Section "Revenue defined".

13. According to Myers, Paton and Littleton when do revenue and profit accrue in the earnings process for a clothing manufacturer? a. Purchase of the raw materials (cloth, thread etc.) b. Completion of the piece of clothing for sale c. Sale of the clothing to a retail store on credit *d. All of the above Feedback: They argue that revenue and profit accrue throughout the earnings process.

Section "Revenue defined".

© John Wiley & Sons Australia, Ltd

9.5

Testbank to accompany Accounting Theory 7e by Godfrey et al

14. According to Coombs and Martin when is revenue most likely to be recognised in the earning cycle? *a. Delivery of goods to customers b. Receipt of orders after completing production c. Receipt of cash d. Completion of production Feedback: According to Coombs and Martin, the delivery of goods to the customer is the most likely point of revenue recognition in the earning cycle.

Section "Revenue recognition".

15. The statement regarding recognition versus realisation of revenue that is true is: a. For an asset to be "realised' there must be an inflow of assets or a measurable change in the value of an asset b. 'Recognition of revenue' means an inflow of liquid assets *c. 'Realisable' means the asset received is readily convertible to known amounts of cash d. All of the above are true Feedback: C is correct as to be realisable it must be possible to convert the asset received to a known amount of cash. A is incorrect as realised means the asset received must be cash or a claim to cash. B is incorrect as recognition of revenue means that the item is included on the face of the accounting reports.

Section "Revenue recognition".

16. Which standard provides specific guidance about revenue recognition in relation to the sale of goods and the rendering of service? *a. IAS 18/AASB 118 b. IAS 39/AASB 139 c. IAS 19/AASB 119 d. None of the above Feedback: IAS 18/AASB 118 Revenue provides specific guidance about revenue recognition in relation to the sale of goods and the rendering of service.

Section "Revenue measurement".

© John Wiley & Sons Australia, Ltd

9.6

Chapter 9: Revenue

17. The statement regarding IAS 11/AASB 111 'Construction Contracts 'that is not true with respect to revenue recognition is: a. The standard adopts the 'stage of completion' method *b. It is recommended that revenues and associated costs be recognised only when they can be 'clearly estimated' c. Revenues and expenses are recognised in the financial years in which the construction activities are performed d. None of the above, i.e. all are true statements Feedback: Revenues and costs are recommended to be recognised when they can be reliably estimated, not clearly estimated - the concept of reliability.

Section "Revenue measurement".

18. In which of these cases would the criteria for recognising revenue definitely not be met? *a. A wholly executory contract b. A credit sale c. The signing of a lease d. The collection of instalments on a higher purchase contract.

Feedback: For a wholly executory contract there is no substantial completion of the earning process.

Section "Revenue measurement".

19. Which of these is not an accepted exception to the recorded revenue at the time of sale? *a. Revenue recognised upon receipt of an order b. Revenue recognised at the end of production c. Revenue recognised when cash is received after the sale is made d. Revenue recognised during production Feedback: The three accepted exceptions to the sales recognition principle are at the end of production, when cash is received after the sale is made and during production.

Section "Revenue measurement".

© John Wiley & Sons Australia, Ltd

9.7

Testbank to accompany Accounting Theory 7e by Godfrey et al

20. The main consideration to determine whether a sale has occurred is: *a. The economic substance of the transaction b. Whether title to the goods has passed c. The provisions of the legal contract d. Whether the sale is for goods or services Feedback: The main consideration to determine whether a sale has occurred is the economic substance of the transaction.

Section "Revenue measurement".

21. For a cash sale, when possession of the goods passes at the time of sale, revenue will be recognised: a. At the point of sale b. When the goods are delivered c. When the cash is received *d. All of the above Feedback: For a cash sale, when possession of the goods passes at the time of sale, all three points will occur at the same time.

Section "Revenue measurement".

22. Which of the principles proposed by the FASB and the IASB's joint project on the recognition and measurement of revenue represent a change of emphasis from the current IASB treatment? a. Measurement should be reliable b. The focus is on changes in the value of assets and liabilities c. The fair value approach has been adopted as a working principle *d. B and C represent a change of emphasis from the current IASB treatment Feedback: The focus on changes in the value of assets and liabilities is a development which will mean there is less emphasis on substantial completion of the earnings process. Likewise the fair value approach is controversial and is a change from the current IASB position. Option A, reliable measurement, is consistent with the qualitative characteristics of financial information included in the Framework.

Section "Challenges for standard setters".

© John Wiley & Sons Australia, Ltd

9.8

Chapter 9: Revenue

23. In which of these standards are gains and losses from remeasurement of assets included in either operating income or in 'comprehensive income'? a. IAS 16/AASB 116 b. IAS 19/AASB 119 c. IAS 41/AASB 141 *d. All of the above Feedback: In all three standards gains and losses from remeasurement of assets are included in either operating income or in 'comprehensive income'. IAS 16/AASB 116 is the standard on property, plant and equipment, IAS 19/AASB 119 is the standard on employee benefits and IAS 41/AASB 141is the standard on agriculture.

Section "Challenges for standard setters".

24. Which of these is not a suggestion of the IASB/FASB joint project on financial statement presentation? *a. Multiple income statements b. Separate disclosure of performance and remeasurement c. The fact that an item is not realised will not preclude it from being included in the income statement d. All are suggestions Feedback: The suggestion is for an all-inclusive, single income statement which is a change from past practice where multiple statements have been presented.

Section "Challenges for standard setters".

25. If revenue for 2010 is understated then: a. Profit for 2010 is understated and net assets are overstated b. Profit for 2010 is overstated and net assets are overstated *c. Profit for 2010 is understated and net assets are understated d. None of the above Feedback: If revenue for 2010 is understated then profit for 2010 is understated and net assets are understated.

Section "Issues for auditors".

© John Wiley & Sons Australia, Ltd

9.9

Testbank to accompany Accounting Theory 7e by Godfrey et al

26. Which of these overestimates of revenue can occur within the accounting standards? a. Shipping goods prematurely to buyers without a firm order and recognising revenue when the goods are shipped *b. Making estimates which later prove to be over-optimistic c. Backdating sales made during the early part of the new accounting period to the last part of the old accounting period d. A and B can occur within the accounting standards Feedback: Some discretion is allowed by the accounting standards when accountants make estimates, e.g. estimating revenue for construction contracts that take several years to complete.

Practices B, and C are fraudulent and are not permitted under the standards.

Section "Issues for auditors".

Essay Questions

27. Explain and comment on the behavioural view of revenue.

28. 'The increase in net worth view of income (held prior to the First World War) was gradually supplanted by the notion that income had to be realised'. ' J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.299.

Explain what this statement means and why the change in view point came about. Which view of income is currently gaining the ascendancy?

29. Explain why the point of sale '…is selected as being generally the most appropriate time to measure and record revenue… ' J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.306.

30. Explain the justification for using the percentage-of-completion method to recognise revenue for long-term construction contracts rather than the point of sale.

31. 'The primary risk for auditors surrounding revenue is the risk that recorded revenue is overstated by managers'. J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.315. Give three examples of ways in which revenue can be overstated and make some suggestions as to how auditors can improve their auditing techniques in this area.

© John Wiley & Sons Australia, Ltd

9.10

Test Bank to accompany

Accounting Theory 7th edition PREPARED BY

Barbara Burns CHAPTER 10 Expenses

© John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

Chapter 10: Expenses True/False 1. IAS1/AASB 101 distinguishes between expenses and losses by categorising items as abnormal or extraordinary in the income statement. a. True *b. False Feedback: This was a previous practice but is no longer permitted under IAS 1/AASB 101.

Section "Expenses defined"

2. The FASB, the US standard setter, unlike the IASB, distinguished between expenses and losses. *a. True b. False Feedback: The FASB's Concepts Statement No. 6 distinguished between expenses and losses.

Section "Expenses defined"

3. The Framework links the definition of expenses to their relationship to revenue. a. True *b. False Feedback: The Framework's definition of expenses makes no reference to the relationship of expenses to revenue.

Section "Expenses defined"

4. If an employee renders services to the firm, without pay, in order to gain experience, an expense must be recorded by the firm. a. True *b. False Feedback: If an employee renders services to the firm, without pay, in order to gain experience, an expense cannot be recorded by the firm as there has been no sacrifice of economic benefits.

Section "Expenses defined"

© John Wiley & Sons Australia, Ltd

10.2

Chapter 10: Expenses

5. For an outflow to be recognised as an expense it must be probable that the outflow of future economic benefits has occurred or the expense must be able to be measured with reliability. a. True *b. False Feedback: For an outflow to be recognised as an expense it must be probable that the outflow of future economic benefits has occurred and the expense must be able to be measured with reliability. That is, both criteria must be met.

Section "Expenses recognition"

6. The cause and effect method of matching is based upon the costs attach concept. *a. True b. False Feedback: The cause and effect method of matching is based upon the costs attach concept, however various writers admit that not all costs attach in a discernable manner.

Section "Expenses measurement"

7. The Framework specifically states that the matching concept should not be applied in such a way as to allow the recognition of items in the balance sheet which do not meet the definition of assets or liabilities. *a. True b. False Feedback: The Framework specifically states that the matching concept should not be applied in such a way as to allow the recognition of items in the balance sheet which do not meet the definition of assets or liabilities.

Section "Challenges for accounting standard setters"

8. Accountants demand objective strong evidence for the recognition of expenses in the same way that they demand objective strong evidence for the recognition of revenue. a. True *b. False Feedback: It is notable that accountants demand objective evidence for the recognition of revenue, but there has been limited discussion of objective evidence in relation to recognising expenses. Instead the plea is for reasonableness or appropriateness.

Section "Challenges for accounting standard setters"

© John Wiley & Sons Australia, Ltd

10.3

Testbank to accompany Accounting Theory 7e by Godfrey et al

9. Under the IAS accounting standards a provision for maintenance cannot be recognised unless there is an obligation to an external party and it meets the recognition criteria. *a. True b. False Feedback: Under the IAS accounting standards a provision for maintenance cannot be recognised unless there is an obligation to an external party and it meets the recognition criteria.

Section "Challenges for accounting standard setters"

10. Treating assets as expenses is a way to overstate profits for a period. a. True *b. False Feedback: It is the other way around. Treating expenses as assets is a way to overstate profits for a period. (Or treating assets as expenses is a way to understate profits for a period.)

Section "Challenges for accounting standard setters"

11. Under the FASB's Concept Statement No 6, the statement that is correct is: a. There is no distinction between expenses and losses *b. Losses are regarded as always arising outside the course of the ordinary activities of the entity c. The treatment of losses is similar to that of the Framework d. All of the statements are correct Feedback: B is correct as, under the FASB's view, losses are regarded as always arising outside the course of the ordinary activities of the entity. It is incorrect that there is no distinction between expenses and losses or that the treatment of losses is similar to that of the Framework.

Section "Expense defined"

© John Wiley & Sons Australia, Ltd

10.4

Chapter 10: Expenses

Multiple Choice

12. The criterion that is not true regarding the Framework's definition of expenses is: *a. The definition makes clear the distinction between monetary and physical events b. The definition clearly defines expenses as outflows to indicate the concept of value c. Expenses do not include reductions in assets or increases in liabilities relating to distributions to owners d. The definition remains independent of assumptions regarding measurement Feedback: A is the correct answer as no distinction is made between monetary and physical events. B and C are incorrect answers as the Framework's definition it clearly defines expenses as outflows and the definition remains independent of assumptions regarding measurement.

Section "Expenses defined".

13. Under the Framework which of the following is not explicitly part of the definition of expenses? a. Expenses are decreases in economic benefits b. The decreases in economic benefits can be in the form of outflows or depletions of assets c. The decreases in economic benefits can be in the form of incurrences of liabilities *d. The decrease in economic benefits must be from the occurrence of a past transaction Feedback: Under the Framework it is not explicitly part of the definition of expenses that there must be a past transaction.

Section "Expenses defined"

14. Which of these is considered to be the 'ideal' way to match expenses? a. Allocation of costs *b. Cause and effect c. Immediate recognition d. All of the above are equally 'ideal' depending upon the circumstances Feedback: 'Cause and effect' is considered to be the 'ideal' way to match expenses. For example, certain goods and services used up must have helped to create the revenue in a period.

Section "Expense measurement"

© John Wiley & Sons Australia, Ltd

10.5

Testbank to accompany Accounting Theory 7e by Godfrey et al

15. An example where accountants normally decide that a cause and effect relationship exist between revenue and expenses is: a. Sales revenue and sales commissions b. Sales revenue and cost of sales c. Sales and sales manager's salary *d. All of the above Feedback: Section "Expense measurement"

16. The correct statement is: *a. The recognition criterion for expenses are consistent with those of other elements in the Framework b. The recognition criterion for expenses are not consistent with those of other elements in the Framework c. There are no recognition criteria for expenses in the Framework d. The recognition criterion for expenses are only partially consistent with those of other elements in the Framework Feedback: The recognition criterion for expenses are consistent with those of other elements in the Framework.

Section "Expense recognition"

17. Which of these is not one of the three basic methods of matching costs and revenue that are commonly relied on? a. The reducing-balance method b. The straight-line method c. A and B *d. None of the above is one the three basic methods of matching costs and revenue that are commonly relied on.

Feedback: The reducing-balance method and the straight-line method are methods of cost allocation relating specifically to the allocation of the cost of depreciable assets and are not the three basic methods of matching costs and revenue that are commonly relied on. The three methods are associating cause and effect, systematic and rational allocation and immediate recognition.

Section "Expense measurement"

© John Wiley & Sons Australia, Ltd

10.6

Chapter 10: Expenses

18. The statements concerning the matching concept that is correct is: i) The matching concept forms the basis of historical cost accounting ii) The matching concept forms the basis of accrual accounting iii) In practice proper matching is a relatively easy task iv) In practice proper matching is a relatively difficult task a. i. iii b. ii. iii c. i. iv *d. ii. iv Feedback: It is correct that the matching concept forms the basis of accrual accounting and, in practice, proper matching is a relatively difficult task.

Section "Expense measurement"

19. When the 'percentage-of-completion' method is used for construction contracts, how are expenses recorded? a. The liability account deferred gross profit is proportionately allocated b. The total accumulated costs of construction are expensed when the project is completed *c. For a given period the actual construction costs for that period are expensed d. None of the above Feedback: This method uses the 'cause and effect' method to match expenses.

Section "Expense measurement"

20. When depreciating assets using the allocation of costs method which of the following methods is best? a. Straight-line b. Unit-of-production c. Reducing-balance *d. It is not possible to say which is the best method from the information given in the question Feedback: A method should be chosen that coincides with the pattern of services or benefits that are provided by the asset.

Section "Expense measurement"

© John Wiley & Sons Australia, Ltd

10.7

Testbank to accompany Accounting Theory 7e by Godfrey et al

21. The statement that is correct concerning depreciation is: a. Depreciation means that the market price of the depreciable asset is declining b. The straight-line method is the preferred method of depreciation *c. Depreciation expense as recorded by accountants is a monetary effect of a physical event d. Depreciation is mainly caused by physical wear and tear Feedback: Section "Expense measurement"

22. Which of these is an expense that will normally be recognised using the 'immediate recognition' principle? a. Wages expense b. Sales commission *c. Advertising expense d. All of the above Feedback: Advertising is recognised immediately because its effects may be long lasting but can be difficult to determine. A and B would normally be recognised by the cause and effect principle.

Section "Expense measurement"

23. A criticism of the 'cause and effect' matching method is: a. Not all costs attach in a discernable manner b. The method is based upon estimates and assumptions c. It implies that a certain amount of revenue can be attributed to a certain amount of expense *d. All of the above are criticisms Feedback: Section "Expense measurement"

24. Which item is usually not given immediate recognition as an expense? a. Research expenditure *b. The cost of the goods sold c. Advertising expenses d. Impairment expenses Feedback: The cost of the goods sold is usually not immediately recognised as an expense but is matched with the sales revenue that it relates to. The other three items mentioned are normally

© John Wiley & Sons Australia, Ltd

10.8

Chapter 10: Expenses

written off as expenses immediately when incurred.

Section "Expense measurement"

25. The Framework in relation to conservatism: a. Explicitly states that conservatism is a bias to be avoided b. Requires that no profits be anticipated but all losses must be anticipated *c. Is not explicit about the application of conservatism d. Because of conservatism requires a higher standard of evidence for the recognition of expenses than for revenue Feedback: Section "Challenges for accounting standard setters"

26. Treating expenses as assets: a. Overstates profit and understates equity *b. Overstates profits and overstates equity c. Understates profits and understates equity d. Understates profits and overstates equity Feedback: Treating expenses as assets overstates profit and overstates equity.

Section "Challenges for accounting standard setters"

27. Which of these expenses normally requires a significant degree of estimation? a. Wages and salaries b. Light and power *c. Cost of sales d. None of the above requires a significant degree of estimation Feedback: Cost of sales requires a significant degree of estimation, e.g. a decision must be made as to which inventory flow method to choose, i.e. FIFO, weighted average.

Section "Challenges for accounting standard setters"

© John Wiley & Sons Australia, Ltd

10.9

Testbank to accompany Accounting Theory 7e by Godfrey et al

Essay Questions

28. The treatment of the relationship of losses to expenses in the IASB Framework differs from the treatment by the FASB. Explain the different treatments and discuss whether it is useful in terms of decision-making to distinguish between expenses and losses in financial reports.

29. Explain the essence of each of the three basic methods of matching commonly relied on; associated cause and effect, systematic and rational allocation and immediate recognition.

30. 'The matching process has become an essential part of accounting practice. However, there are many criticisms of this approach.' J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.353.

Outline and discuss the criticisms of matching and briefly explain how standard setters have sought to address these criticisms.

31. 'The interpretation of the matching concept in practice, therefore, is biased by the effect of the convention of conservatism.' J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.348.

Explain and discuss the above statement. Do you agree or disagree with the statement?

© John Wiley & Sons Australia, Ltd

10.10

Test Bank to accompany

Accounting Theory 7th edition PREPARED BY

Barbara Burns CHAPTER 11 Positive theory of accounting policy and disclosure

© John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

Chapter 11: Positive theory of accounting policy and disclosure True/False

1. Initially monitoring costs are incurred by the principal, however, ultimately agents will bear the monitoring costs. *a. True b. False Feedback: This is because the principal protects against bearing costs by paying according to the level of expected monitoring costs. This is known as price protection.

Section "Agency theory".

2. A price-protected owner will remunerate their manager according to the owner's expectations of how much the manager's behaviour is likely to be contrary to the owner's interests. *a. True b. False Feedback: A price-protected owner will remunerate their manager according to the owner's expectations of how much the manager's behaviour is likely to be contrary to the owner's interests.

Section "Contracting theory".

3. Covenants that restrict production-investment opportunities aim to reduce claim dilution problem. a. True *b. False Feedback: Covenants that restrict production-investment opportunities are designed to reduce asset substitution and under-investment problems.

Section "Shareholder-debtholder agency problems".

© John Wiley & Sons Australia, Ltd

11.2

Chapter 11: Positive theory of accounting policy and disclosure

4. The bonus plan hypothesis and the debt hypothesis are predictions developed under the efficient contracting approach. a. True *b. False Feedback: These hypotheses were developed under the opportunistic perspective.

Section "Ex post opportunism versus ex ante efficient contracting".

5. Under signalling theory it is predicted that firms will disclose less information than is demanded. a. True *b. False Feedback: Under signalling theory it is predicted that firms will disclose more information than is demanded.

Section "Signalling theory".

6. The more politically sensitive a firm, the more likely it is that the firm will understate its profits to prevent negative wealth transfers *a. True b. False Feedback: The more politically sensitive a firm, the more likely it is that the firm will understate its profits to prevent negative wealth transfers.

Section "Political processes".

7. The size hypothesis predicts that the larger the firm, the more likely that managers will choose accounting methods that will move reported profits from future periods to current periods. a. True *b. False Feedback: It is more likely that managers will adopt accounting methods that will defer profits from current periods to future periods to reduce the political visibility of the firm.

Section "Political processes".

© John Wiley & Sons Australia, Ltd

11.3

Testbank to accompany Accounting Theory 7e by Godfrey et al

8. In the oil and gas industry the full costing method would be preferred under the size hypothesis. a. True *b. False Feedback: The Full Costing (FC) method would be preferred under the bonus plan and debt to equity hypotheses because FC has the effect of shifting profits to current period and produces lower variance in profits.

Section "Additional empirical tests of the theory".

9. Ball and Foster were among the researchers who supported the use of firm size as a measure of political costs. a. True *b. False Feedback: Ball and Foster in fact criticised the use of firm size as a measure of political costs and suggested more direct measures such as industry membership.

Section "Additional empirical tests of the theory".

10. DeAngelo argues that larger auditors, such as those commonly referred to as the 'Big 4', are of lower quality than other auditors because larger auditors have 'more to lose' by failing to report a discovered breach in a particular client's record. a. True *b. False Feedback: DeAngelo argues that larger auditors, such as those commonly referred to as the 'Big 4', are of higher quality than other auditors because larger auditors have 'more to lose' by failing to report a discovered breach in a particular client's record.

Section "Additional empirical tests of the theory".

11. The demand for auditing can be explained by agency theory as part of monitoring and bonding activities and costs. *a. True b. False Feedback: The demand for auditing can be explained by agency theory as part of monitoring and bonding activities and costs.

Section "Additional empirical tests of the theory".

© John Wiley & Sons Australia, Ltd

11.4

Chapter 11: Positive theory of accounting policy and disclosure

Multiple Choice

12. Which of these is not an assumption of the efficient markets hypothesis (EMH)? a. All market participants are price takers b. No taxes *c. There are costs of doing transactions in the market d. Information is available freely Feedback: EMH holds the assumption of zero transaction costs.

Section "Background"

13. Which of these is not an underlying assumption of positive accounting theory? a. Individuals attempt to maximise their own wealth b. Accounting numbers play a central role in the distribution of wealth c. People are self-interested and rational *d. Non-financial aspects of individuals' utility functions are important in the distribution of wealth.

Feedback: Section "Background"

14. Who were generally regarded as the pioneers in developing the agency theory? a. Alchian and Demsetz *b. Jensen and Meckling c. Smith and Warner d. Whittred and Zimmer Feedback: Although there were antecedents in the work of Alchian and Demsetz, Jensen and Meckling were generally regarded as the pioneers in developing the agency theory.

Section "Agency theory"

© John Wiley & Sons Australia, Ltd

11.5

Testbank to accompany Accounting Theory 7e by Godfrey et al

15. The situation where a manager protects against bearing agency costs by paying the agent according to the level of costs expected is called: a. Residual loss b. Monitoring costs *c. Price protection d. Bonding costs Feedback: The situation where a manager protects against bearing agency costs by paying the agent according to the level of costs expected is called price protection.

Section "Agency theory"

16. An example of a bonding cost is: *a. Income lost due to the manager being unable to share trade secrets with a competing firm b. The costs of the provision of quarterly financial statements c. The cost of an audit d. Costs to establish management compensation plans Feedback: Answer B, C and D are monitoring costs.

Section "Agency theory"

17. Managers and shareholders have differing incentives regarding the firm. The statement regarding incentives that is true is: a. Because shareholders' investment portfolios can be widely diversified they are less likely to want to undertake risky projects than managers b. A manager can fully diversify his/her risk by investing in other firms *c. Managers may hold off paying dividends to owners in order to 'empire build' d. We would expect the horizon problem to lessen as a manager's age increases Feedback: Section "Price protection and shareholder/manager agency problems"

© John Wiley & Sons Australia, Ltd

11.6

Chapter 11: Positive theory of accounting policy and disclosure

18. It may be appropriate to remunerate a manger using reported profits under which of these circumstances? a. When the firm's market value is non-observable because of thin-trading b. When the level of management being remunerated is lower than the CEO *c. A and B d. None of the above Feedback: Section "Price protection and shareholder/manager agency problems"

19. Which statement is not true in relation to asset substitution as described in the shareholdersdebtholders agency relationship? a. Managers have incentives to accept debt finance and invest in higher risk assets to increase the potential returns to shareholders *b. Lenders are generally risk preferers c. When investments in high-risk assets cause financial distress, shareholders are liable only for the amounts unpaid on their shares d. Lenders' price debt is based on the expectations that firms will not invest in assets that have higher risk than that which is acceptable to the lenders Feedback: Asset substitution is based on the premise that lenders are risk averse, because they do not share in the increased returns that high-risk projects provide but they do share the potential losses when the high-risk investments fail to the extent that the losses reduce the security available to meet their claims.

Section "Shareholder-debtholder agency problems"

20. Which of these management actions might be considered under the efficient contracting perspective? a. A manger chooses to use FIFO instead of the weighted average cost of inventory because she believes that FIFO better reflects the value of the inventory on hand b. A manager depreciates an asset using the reducing balance method rather than the straight-line method because he believes that the method better reflects the economic consumption of the asset. c. A manager uses the straight-line method of depreciation rather than reducing balance to prevent a temporary breach of a debt covenant, even though the chosen method does not best reflect the asset's underlying economic consumption. *d. All of the above might be considered Feedback: Under the efficient contracting approach the aim is to align the interests of agents and principals so that actions that benefit the agent also benefit the principal.

Section "Ex post opportunism versus ex ante efficient contracting"

© John Wiley & Sons Australia, Ltd

11.7

Testbank to accompany Accounting Theory 7e by Godfrey et al

21. The statement that is correct concerning Australia is: a. As a firm's leverage increases the manager selects accounting procedures that decrease assets and decrease liabilities b. Most debt covenants have constraints on the proportion of debt to profit *c. Most debt covenants constrain liabilities as a proportion of assets d. All the statements are correct Feedback: Option A is incorrect as, as a firm's leverage increases the manager selects accounting procedures that increase assets and decrease liabilities. Option C is also incorrect.

Section "Shareholder-debtholder agency problems"

22. The statement that does not relate to the information perspective on accounting policy choice is: a. Manager use the accounts to signal expectations and intentions regarding the future *b. The information perspective is aligned with contracting theory c. The accounting information produced under this perspective is used to indicate how the value of the firm and claims against it will change d. Managers of firms with neutral news have an incentive to report positive news so they will not be suspected of having poor results Feedback: The information perspective on accounting policy choice is not aligned with contracting theory.

Section "Signalling theory"

23. Which of these is not the reason why there is generally less demand and incentive for the production of information in political markets than in capital markets? *a. There is high probability that one individual's actions will affect that person's wealth b. Heterogeneity of interests within groups c. High information and transaction costs d. In political markets it is harder for individuals or groups to capture benefits from the information Feedback: In political markets the probability that one individual's actions will affect that person's wealth is small.

Section "Political processes"

© John Wiley & Sons Australia, Ltd

11.8

Chapter 11: Positive theory of accounting policy and disclosure

24. The statement that is true is: a. Politically sensitive firms are likely to overstate profits *b. Politically sensitive firms are likely to understate profits c. It is more difficult to criticise a firm with higher profits for having an unfair level of government support d. Smaller firms are expected to be more politically sensitive Feedback: B is correct as politically sensitive firms are likely to understate profits. C is incorrect as it is more difficult to criticise a firm with lower profits for having an unfair level of government support and D is incorrect as larger firms are expected to be more politically sensitive.

Section "Political processes"

25. Traditional conservatism in accounting means: a. Accelerating revenue recognition b. Delaying expenses c. A higher degree of verification required for expenses compared to revenues *d. Anticipating losses but not gains Feedback: Traditional conservatism in accounting means anticipating losses (but not gains). A, B and C are incorrect because they are the wrong way round, e.g. conservatism means delaying revenue recognition.

Section "Conservatism, accounting standards and agency costs"

26. The change that will increase reported profit (assuming inflation) is: *a. A switch from the LIFO to the FIFO method of inventory valuation b. A switch from the straight-line to the reducing balance method of depreciation assuming new assets are being purchased c. Reducing the estimated life of depreciable assets d. All of the above will increase reported profit (assuming inflation) Feedback: A switch from the LIFO to the FIFO method of inventory valuation will increase reported profit (assuming inflation) as the cost of sales will be higher as it will be assumed to include the more recently purchased goods with the higher prices. Options B and C will result in a decrease in reported profit.

Section "Additional empirical tests of the theory"

© John Wiley & Sons Australia, Ltd

11.9

Testbank to accompany Accounting Theory 7e by Godfrey et al

27. Which of these research findings is not true? a. Blacconiere and Patten found that despite general falls in Indian chemical firms' share price after the Bhopal disaster, firms with more extensive environmental disclosures had less fall reaction. b. In their study Watts and Zimmerman argue that managers of large firms have greater incentives to reduce reported profits because of political factors. *c. The results of DeFond and Jiambalvo's study of managers of firms that defaulted on their accounting-based debt covenants support the ex ante perspective of accounting policy choice. d. Godfrey and Jones found that managers of companies with highly unionised workforces attempted to affect the probability of wealth transfers by smoothing reported operating profit via the classification of recurring gains and losses.

Feedback: The results of DeFond and Jiambalvo's study support the ex post opportunistic perspective of accounting policy choice. Statement A, B and D are true. Section "Additional empirical tests of the theory"

28. The statement in relation to issues for auditors in relation to agency theory that is not true is: a. Auditors have a bonding and monitoring role in agency theory *b. Smaller auditing firms have more to lose by failing to report a breach in a clients accounts than larger audit firms c. Research in the US did not support the proposition that promoters of initial public sharer offerings using a higher quality auditors would have lower holdings of shares than promoters in companies using lower quality auditors d. Researchers have refined the concept of high quality auditors to include those who specialise in certain industries or contracts Feedback: Option B is incorrect. It is the other way around. Larger auditing firms have more to lose by failing to report a breach in a clients accounts than smaller audit firms. Options A, C and D are correct.

Section "Issues for auditors"

© John Wiley & Sons Australia, Ltd

11.10

Chapter 11: Positive theory of accounting policy and disclosure

29. The following arguments are philosophical criticisms of positive accounting theory, except: *a. Cross-sectional models are poorly specified b. Positive accounting theory is not an accounting theory, but only a sociology of accounting c. Contrary to its claim, positive accounting theory is in fact value-laden d. The methodology of positive accounting theory is inappropriate for the purpose it purports to serve Feedback: Argument A is the methodological criticism of positive accounting theory.

Section "Evaluating the theory"

© John Wiley & Sons Australia, Ltd

11.11

Testbank to accompany Accounting Theory 7e by Godfrey et al

Essay Questions

30. Explain and discuss why the firm can be described as a 'nexus of contracts.

31. 'Politically sensitive firms are likely to understate profits' ' J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.384. Explain why this may be so and which firms are likely to be 'politically sensitive'.

32. Outline how the demand for auditing can be explained by agency theory as part of monitoring and bonding activities and costs.

33. Distinguish between the ex ante efficient contracting approach and ex post opportunism.

34. Explain and discuss why, under signalling theory, it is predicted that firms will disclose more information than is demanded.

© John Wiley & Sons Australia, Ltd

11.12

Test Bank to accompany

Accounting Theory 7th edition PREPARED BY

Barbara Burns CHAPTER 12 Capital market research

© John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

Chapter 12: Capital market research True/False 1. Jensen argues that positive accounting theory precedes normative accounting theory. a. True *b. False Feedback: It is the other way around; Jensen argues that normative accounting theory precedes positive accounting theory. He believes that in order to prescribe an appropriate accounting policy it is necessary to know how the world actually operates.

Section "Strengths of positive theory"

2. Positive accounting theory is aimed at prescribing how the world should work rather than providing an understanding of how the world does work. a. True *b. False Feedback: It is the other way around. Positive accounting theory is aimed at providing an understanding of how the world does work rather than prescribing how the world should work.

Section "Strengths of positive theory"

3. The development of positive accounting theory can be broken down into two stages, the first stage being literature that sought to explain and predict accounting behaviour. a. True *b. False Feedback: The first stage in the development of positive accounting theory involved research into accounting and the behaviour of the capital markets. The stage described is the second stage.

Section "Scope of positive accounting theory"

© John Wiley & Sons Australia, Ltd

12.2

Chapter 12: Capital market research

4. One focus of the second stage of positive accounting theory development is known as ex-ante, that is, trying to explain whether managers choose certain accounting methods for opportunistic reasons. a. True *b. False Feedback: The above statement describes the ex-post perspective. The ex-ante perspective assumes that firms select accounting practices for efficiency reasons.

Section "Scope of positive accounting theory"

5. If the 'sufficient conditions' outlined by Fama are met for an efficient market then it is impossible, on average, to earn economic profits by trading on security information. *a. True b. False Feedback: Section "Capital market research and the efficient markets hypothesis"

6. The first published study to investigate the magnitude of unexpected profits and abnormal returns was conducted by Beaver, Clarke and Wright, who found a positive correlation between the mean percentage of unexpected profits and the mean annual abnormal rate of return. *a. True b. False Feedback: Section "Impact of accounting profits announcements on share prices"

7. One explanation for differences in the earnings response coefficient across firms is that earnings announcements by large firms have more information content than earnings announcements by small firms. a. True *b. False Feedback: In fact, research would suggest that earnings announcements by small firms have more information content than earnings announcements by large firms.

Section "Impact of accounting profits announcements on share prices"

© John Wiley & Sons Australia, Ltd

12.3

Testbank to accompany Accounting Theory 7e by Godfrey et al

8. The 'mechanistic' hypothesis states that the market will ignore accounting changes which have no cash flow consequences. a. True *b. False Feedback: This is a descriptive of the 'no-effects' hypothesis.

Section "Trading strategies"

9. The maximum debt theorem of financial leverage suggests that as financial leverage steadily increases, the value of firms fall in response. a. True *b. False Feedback: The above statement describes the default theorem. The maximum theorem suggests that when financial leverage increases, shares concurrently increase (i.e. value of firms change in the same direction as changes in financial leverage).

Section "Impact of accounting profits announcements on share prices"

10. DeBondt and Thaler found that the winner/loser effect is attributable to investor overconfidence and biased self-attribution. *a. True b. False Feedback: Section "Trading strategies"

11. Blackwell, Noland and Winters found for small private companies that are not required to be audited, it was those that purchased audits who were charged lower interest rates. *a. True b. False Feedback: Section "Issues for auditors"

© John Wiley & Sons Australia, Ltd

12.4

Chapter 12: Capital market research

Multiple choice

12. Which research questions would you not expect to be addressed using a positive accounting theory philosophy? a. What costs and benefits will the adoption of IASs have for Australian companies? *b. Should the adoption of IASs be compulsory for listed Australian companies? c. What will be the effect of IAS adoption on share prices? d. Why are firms continuing to use historical cost accounting?

Feedback: This question is more normative in nature in that it is prescribing a course of action rather than seeking to explain and predict accounting practice.

Section "The philosophy of positive accounting theory".

13. Which of these would not be considered to be a criticism of normative accounting theories? a. They are not based on identified, empirical observations or methods b. Normative theories do not specify an objective nor an objective function independently of subjective preferences *c. The prescriptions made by normative theories are falsifiable d. Normative theories cannot be ranked objectively because it is impossible to prove or refute claims that one objective is more important than another Feedback: The criticism is actually that normative theories are not falsifiable.

Section "Strengths of positive theory".

14. The form of market efficiency in which the security's price at any particular time fully reflects the information contained in its sequence of past prices, is called: *a. Weak form b. Semi-weak form c. Semi-strong form d. Strong form Feedback: The form of market efficiency in which the security's price at any particular time fully reflects the information contained in its sequence of past prices, is called the weak form of market efficiency, i.e. investors cannot profit from extracting information based on cycles in prices, price patterns, or other rules.

Section "Capital market research and the efficient markets hypothesis"

© John Wiley & Sons Australia, Ltd

12.5

Testbank to accompany Accounting Theory 7e by Godfrey et al

15. Which of these is true with respect to the efficient market hypothesis? *a. The semi-strong form of market efficiency is the most directly related to the accounting profession b. Market efficiency means that all information has been correctly presented by a firm and properly interpreted by decision makers c. Market efficiency implies that investors can predict future events with absolute precision d. All of the above are true Feedback: Section "Capital market research and the efficient markets hypothesis"

16. When the market is described, in the context of the EMH, as being efficient this means: a. Every investor has knowledge of all information b. All financial information has been 'correctly' presented by a firm *c. Security prices reflect the aggregate impact of all relevant information in an unbiased and rapid manner d. All of the above Feedback: When the market is described, in the context of the EMH, as being efficient this means security prices reflect the aggregate impact of all relevant information in an unbiased and rapid manner, that is market prices are 'fair game' and are close to 'fundamental value'. It does not mean option A, or B. Section "Capital market research and the efficient markets hypothesis"

17. You have been given the following one period market model for Acme Ltd for the calendar quarter ending June 2010: αAcme = 3.0% RAcme = 10 % βAcme = 0.6 Rm = 7% What is the error during this period of time? a. 3% *b. 2.8% c. 0% d. 1.8% Feedback: The market return was 7%; therefore, return expected to Acme Ltd was 0.6 7 = 4.2% above the constant 3%. Therefore, the expected return to Acme Ltd is 4.2 + 3 = 7.2%. Acme's actual return was 10%, meaning that the error during this time period is 10 - 7.2 = 2.8%.

Section "Capital market research and the efficient markets hypothesis"

© John Wiley & Sons Australia, Ltd

12.6

Chapter 12: Capital market research

18. A conclusion drawn from Ball and Brown's information content studies is: a. 85-90% of the price adjustments to the change in profit of firms occur before the announcement month b. There is significant information content in the profit figure, however accounting is not the only source of information about firms c. Quarterly accounting profits are a timely source of information for the capital market *d. A and B Feedback: Statement (c) relates to research undertaken by Foster, not Ball and Brown.

Section "Impact of accounting profits announcements on share prices"

19. The factor that has not been found to affect the earnings response coefficient is: a. Risk and uncertainty b. Industry c. Firm growth *d. None of the above, i.e. all of the factors have been found to affect the earnings response coefficient Feedback: All of these factors have been found to affect the ERC of firms.

Section "Impact of accounting profits announcements on share prices"

20. The studies that followed Ball and Brown's 1968 foundation study: *a. Mostly supported their conclusions b. Mostly did not support their conclusions c. About half the studies supported their conclusions and half did not d. There have been no follow-up studies Feedback: The studies that followed Ball and Brown's 1968 foundation study, mostly supported their conclusions, e.g. Brown replicated the study for Australian companies. Section "Impact of accounting profits announcements on share prices"

© John Wiley & Sons Australia, Ltd

12.7

Testbank to accompany Accounting Theory 7e by Godfrey et al

21. It is true of the Australian study by Brown which replicated Ball and Brown's original 1968 study that: i) There was more of a price adjustment in the announcement month than in the original study ii) There was less of a price adjustment in the announcement month than in the original study iii) In Australia annual reports are a more important source of information about companies than they are in the United States iv) In Australia annual reports are a less important source of information about companies than they are in the United States a. ii, iii b. ii, iv *c. i, iii d. i, iv

Feedback: In the Australian study by Brown the findings were that there was more of a price adjustment in the announcement month than in the original study and in Australia annual reports are a more important source of information about companies than they are in the United States.

Section "Impact of accounting profits announcements on share prices"

22. Which of these does not describe the differential information hypothesis? a. Amount of information available from sources other than accounting reports is an increasing function of firm size *b. The larger the firm, the more information is contained in profits c. The differential information hypothesis is developed from the theory of transaction costs and different incentives for information search d. Incentive to undertake research for mispricing is greater for larger firms, given the costs of information search are fixed and constant across firms Feedback: Under the differential information hypothesis, the information content of unexpected profit announcements may be inversely related to firm size, that is the smaller the firm, the more information is contained in profits.

Section "Impact of accounting profits announcements on share prices"

© John Wiley & Sons Australia, Ltd

12.8

Chapter 12: Capital market research

23. Which of these is true with respect to information transfer research? a. The research is based on the premise that positive profits for one firm in an industry reflects improved conditions in that industry b. The variance of abnormal returns for competing firms decreases when another firm in the same industry makes a profit announcement *c. There are significant price reactions by non-announcing firms to early announcers sales and profit changes d. B and C only Feedback: Section "Impact of accounting profits announcements on share prices"

24. Ball and Brown's study 'An empirical evaluation of accounting income numbers', found that competing information pre-empted the information in annual reports by about: a. 35% b. 65% *c. 85% d. 90% Feedback: Section "Impact of accounting profits announcements on share prices"

25. Who first used the variance of abnormal return as an index of information content of profit announcements? a. Ball b. Brown *c. Beaver d. Fama Feedback: Section "Impact of accounting profits announcements on share prices"

© John Wiley & Sons Australia, Ltd

12.9

Testbank to accompany Accounting Theory 7e by Godfrey et al

26. The factor that has an incorrect association or relation with the earning response coefficients (ERC) is: a. There is a negative association between financial leverage and the ERC *b. Industries with the greatest perceived outcome uncertainty would have the smallest ERCs c. High-growth firms will have higher ERCs compared to low-growth firms d. Risk negatively affects the ERC Feedback: Industries with the greatest perceived outcome uncertainty would have the greatest ERCs. Statement A, C and D are true. Section "Impact of accounting profits announcements on share prices"

27. Which of these describes the principle based on the optimal leverage approach of financial leverage? *a. There is an ideal financial leverage position for each firm b. As financial leverage steadily increases, the value of firms falls in response c. When financial leverage increases, share price concurrently increases d. The ERC is positively related to profit persistence factor Feedback: B and D describe the default theorem of financial leverage; C describes the maximum debt theorem.

Section "Impact of accounting profits announcements on share prices"

28. Which of these is not the theoretical argument set out by Bowen, Burgstahler and Daley with respect to profits and cash flow as explanatory variables for price? a. Both profits and cash flow are individually and incrementally important b. Both profits and cash flow are individually important, but profits are more incrementally important *c. Both profits and cash flow are individually important, but cash flow is more incrementally important d. Both profits and cash flow are individually important, but neither is incrementally important Feedback: Refer to Figure 12.5 Section "Impact of accounting profits announcements on share prices"

© John Wiley & Sons Australia, Ltd

12.10

Chapter 12: Capital market research

29. The research finding that does not undermine the assumption of capital markets efficiency is: *a. Abnormal returns can be earned by trading on accounting information that is private b. Financial analysts are fooled by profit figures and are optimistic in their forecasts c. The presence of post-announcement drift d. Failure of the market to recognise profit manipulation Feedback: The research findings relate to publicly held information as per the semi-strong efficiency assumed for positive accounting research.

Section "Trading strategies"

30. The item that is not a variant of earnings management under the opportunistic perspective is: a. Debt covenant b. Equity offerings c. Fraud *d. Signalling Feedback: Signalling is a variant of earnings management under the informational perspective.

Section "Trading strategies"

31. The hypothesis that assumes that the capital market only reacts to accounting changes that have cash-flow consequences is the: a. Differential information hypothesis *b. No-effects hypothesis c. Mechanistic hypothesis d. Efficient market hypothesis Feedback: The hypothesis that assumes that the capital market only reacts to accounting changes that have cash-flow consequences is the no-effects hypothesis Section "Trading strategies"

© John Wiley & Sons Australia, Ltd

12.11

Testbank to accompany Accounting Theory 7e by Godfrey et al

Essay Questions

32. 'There is increasing evidence that markets can be fooled by accounting numbers'. ' J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.442. Discuss.

33. Outline the research that has been undertaken on post-announcement drift and the implications of this research.

34. Outline the arguments that have been raised to explain why a firm's size is a factor in the responsiveness of share price and the volume of trade to profit announcements.

35. Explain what accounting researchers mean by the market 'being efficient'.

36. 'The empirical research provides evidence of benefits to companies through lower cost of equity and debt capital when they voluntarily purchase an audit or purchase a high quality audit. ' J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.442.

Outline the details of a study undertaken on the above question and explain reasons that have put forward for the finding. What do researchers see as a 'high quality audit'?

© John Wiley & Sons Australia, Ltd

12.12

Test Bank to accompany

Accounting Theory 7th edition PREPARED BY

Barbara Burns CHAPTER 13 Behavioural research

© John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

Chapter 13: Behavioural research True/False 1. Behavioural accounting research is similar to research using agency theory in that it focuses on individual managers and firms and is derived from the discipline of economics. a. True *b. False Feedback: While it is true that both types of research focus on the individual managers and firm's behavioural accounting research is derived from other disciplines such as psychology.

Section "Behavioural accounting research: definition and scope"

2. The higher the beta in the Brunswik lens regression model, the more important the information cues will be to a person in making decisions. *a. True b. False Feedback: The betas in the Brunswik lens regression model represent the relative importance of the information cues to the decision makers.

Section "Why is BAR important?"

3. One of the limitations of the Brunswick lens model is that decision makers often have difficulty explaining all the steps they go through. a. True *b. False Feedback: This is a limitation of process tracing.

Section "Why is BAR important?"

4. One of the limitations of using CART models is that when there is lot of data available for analysis it becomes difficult to derive simple rules to train other analysts. *a. True b. False Feedback: Section "Why is BAR important?"

© John Wiley & Sons Australia, Ltd

13.2

Chapter 13: Behavioural research

5. Libby and Zimmer found a negative correlation between accuracy of judgement and confidence. a. True *b. False Feedback: Libby and Zimmer found a positive correlation between accuracy of judgement and confidence, that is, the accuracy of judgement increased with increasing confidence.

Section "Why is BAR important?"

6. The Brunswik lens model always outperforms the process tracing model in any decisionmaking scenario. a. True *b. False Feedback: The Brunswik lens model outperforms the process tracing model in some business contexts, however the process tracing model could be more advantageous in different contexts.

For instance, Selling and Shank found that the Brunswik model outperformed the process tracing model in the prediction of bankruptcy, but Larcker and Lessig found the opposite when the two models were used in a share selection scenario.

Section "Why is BAR important?"

7. According to the literature it does not appear that accounting information presentation affects decision-making. a. True *b. False Feedback: While the results are conflicting, the evidence does suggest that presentation in the accounting context does influence decision-making.

Section "Why is BAR important?"

8. The consequence of anchoring and adjustment is that there is a possibility of insufficient adjustment when a circumstance changes. *a. True b. False Feedback: Section "Representativeness: the evidence"

© John Wiley & Sons Australia, Ltd

13.3

Testbank to accompany Accounting Theory 7e by Godfrey et al

9. Research has found that the use of rules of thumb such as representativeness, availability, and anchoring and adjustment have improved the quality of decision making for auditors and accountants." a. True *b. False Feedback: It is still in dispute whether the use of rules of thumb such as representativeness, availability, and anchoring and adjustment have improved the quality of decision making for auditors and accountants.

Section "Representativeness: the evidence"

10. One of the limitations of BAR is that it is not useful for revealing the systematic errors made by all decision makers in specific contexts. a. True *b. False Feedback: This is one of BAR's strengths.

Section "Limitations of BAR"

11. Research shows that investors react as though they perceive auditor independence as impaired when auditors receive non-audit service revenue from their audit clients even if actual auditor independence is not affected. *a. True b. False Feedback: Section "Issues for auditors"

© John Wiley & Sons Australia, Ltd

13.4

Chapter 13: Behavioural research

Multiple choice

12. Which of these accounting research types can be called 'normative' research? a. Behavioural research b. Capital market research c. Agency theory *d. None can be called normative research Feedback: All three types of research are 'positive' research not normative research as they are all concerned with discovering the facts.

Section "Behavioural accounting research: definition and scope"

13. Which of these is not a model relied heavily on in applying human judgement theory to accounting issues? a. The Brunswik lens model b. The process tracing model *c. The efficient market model d. The probabilistic judgement model Feedback: Section "Behavioural accounting research: definition and scope"

14. Which research question would not be answered using behavioural accounting research? *a. How does the stock market react to the disclosure of upward asset revaluations? b. How does a bank loan officer decide whether to grant a loan to a client? c. How does an auditor judge the riskiness of an audit client? d. What are the most useful accounting disclosures for users of financial reports?

Feedback: This research question would be the domain of capital markets research as it looks at the macro level of the securities market rather than at individual investors.

Section "Behavioural accounting research: definition and scope"

© John Wiley & Sons Australia, Ltd

13.5

Testbank to accompany Accounting Theory 7e by Godfrey et al

15. The statement that is true is: *a. The objective of behavioural accounting research (BAR) is to explain why people behave as they do b. Capital market research investigates how information is actually processed by market participants c. BAR, capital market research, and agency theory are normative accounting theories d. Agency theory makes no assumptions about people's behaviours Feedback: B is incorrect because capital market research does not investigate how information is actually processed by market participants; it only concentrates on the release of information and the capital market's reaction. C is incorrect because BAR, capital market research, and agency theory are regarded as positive accounting theories. D is incorrect because agency theory assumes that all individual are wealth maximisers.

Section "Behavioural accounting research: definition and scope"

16. The statement that is correct is: *a. Human judgement theory is particularly relevant to auditing b. Contracting theory in accounting has been eclipsed in recent years by behavioural research c. The Brunswik lens model was first developed by accounting researchers and then was later used by other disciplines d. All of the statements are correct Feedback: A is a correct statement because of the importance of judgement to the audit process.

B is incorrect because it is the other way around; behavioural research in accounting has been eclipsed in recent years by contractual research. C is incorrect as the Brunswik lens model was already well used in the psychology literature before it was adapted for accounting research.

Section "Why is BAR important?"

© John Wiley & Sons Australia, Ltd

13.6

Chapter 13: Behavioural research

17. Behavioural accounting research is considered important to economic practitioners for the following reasons, except: a. The findings of BAR can lead to efficiencies in the work practices of accountants and other professionals b. BAR can provide valuable insights into the ways different types of decision makers react to particular items of accounting information c. BAR can potentially provide useful information to accounting regulators *d. Other accounting research schools such as capital market and agency theory are not useful for accounting information research Feedback: Capital market and agency theory are useful for accounting information research, however they are not equipped to answer questions about how people use and process accounting information.

Section "Why is BAR important?"

18. In behavioural research a model used in situations where initial predictions need to be adjusted in light of additional information is: a. The Brunswik lens model b. Process tracing *c. The probabilistic judgement paradigm d. None of the above Feedback: In behavioural research a model used in situations where initial predictions need to be adjusted in light of additional information is the probabilistic judgement paradigm. The initial likelihood estimation is adjusted by a likelihood ratio which is the amount by which prior expectations should be revised.

Section "Why is BAR important?"

19. The statement that is true with respect to the Brunswik lens model is: a. The results of research using this model can be used to train decision makers to change the weightings they give to different information cues b. It has provided insights into the stability of human judgement over time c. It is not as good as process tracing methods at predicting the event of interest *d. A and B Feedback: Section "Why is BAR important?"

© John Wiley & Sons Australia, Ltd

13.7

Testbank to accompany Accounting Theory 7e by Godfrey et al

20. Consider the following linear equation model regarding an accountant's judgements regarding the likelihood of business failure: Likelihood of Insolvency/Solvency= constant + 0.1 Net profit + 0.3 Cash flow + 0.15 Acid test ratio + 0.25 Debt to Equity ratio + other information cues + error According to the model which of the following statements is correct? a. The accountant considers the debt to equity ratio to be a relatively more important information cue regarding insolvency than the cash flow *b. The Acid test ratio has a higher beta weight than net profit c. The accountant will only consider net profit, cash flow, acid test ratios and debt to equity ratios when making judgements on business solvency d. The acid test ratio is the least important information cue for the accountant in making his solvency judgement Feedback: Section "Why is BAR important?"

21. The use of the Brunswik lens model has led to the discovery of the following insights, except: a. The stability of human judgement over time b. The circumstances under which a model of human behaviour outperforms humans *c. The step-by-step process of decision-making d. Patterns of cue use evident in various tasks Feedback: The step-by-step process of decision-making is discovered under the process tracing model.

Section "Why is BAR important?"

22. It is not true regarding research conducted using the Brunswik lens model that: *a. Replacing people with predictive models does not increase predictive accuracy b. It is the subject's choice of information, not his or her processing of the cues, that limits accuracy c. Expert and non-expert subjects are over-confident of their ability in specific judgement tasks d. All of the above are not true Feedback: Section "Why is BAR important?"

© John Wiley & Sons Australia, Ltd

13.8

Chapter 13: Behavioural research

23. The term 'posterior odds' in Bayes' theorem represents: a. Initial probability b. The amount by which prior expectations should be revised c. Base rate *d. Revised probability Feedback: Section "Why is BAR important?"

24. With respect to the probabilistic judgement model the true statement is: a. Research suggests that while the model is logical, humans do not appear to apply statistics intuitively b. The revised probability in light of additional evidence = the original belief multiplied by the amount by which prior expectations should be revised c. It is normatively correct to revise your initial beliefs by applying Bayes's theorem *d. All of the above are true Feedback: Section "Why is BAR important?"

25. According to the judgement confidence literature which of the following is not the factor that causes overconfidence? a. The limited nature of feedback in many instances *b. The tendency for people not to admit that they make mistakes c. The interdependency of actions and outcomes d. The tendency of humans to seek out and overweigh positive feedback Feedback: Section "Why is BAR important?"

26. Which of these is not an option suggested by Libby for improving decision making? a. Replacing decision makers with a model of themselves *b. Prescribing normative decision rules for repetitive decision making tasks c. Educating decision makers d. Changing the presentation and amount of information Feedback: Section "Why is BAR important?"

© John Wiley & Sons Australia, Ltd

13.9

Testbank to accompany Accounting Theory 7e by Godfrey et al

27. Which of these is true of the research evidence obtained in the literature regarding the presentation of financial information? a. Decision makers are readily able to use information presented in a graphical format b. On the whole, research evidence does not suggest that accounting report formats influence decision-making *c. The question the decision maker is answering and the form of presentation interactively affect performance d. The theory regarding which forms of information presentation are most appropriate is well developed Feedback: Section "Why is BAR important?"

28. The rule of thumb that refers to a general judgement process in which an initially generated or given response serves as an anchor and other information is used to adjust that response is: a. Representativeness *b. Anchoring and adjustment c. Availability anchoring and adjustment d. User friendliness Feedback: The rule of thumb that refers to a general judgement process in which an initially generated or given response serves as an anchor and other information is used to adjust that response is anchoring and adjustment. Section "Representativeness: the evidence"

29. The heuristic (rule of thumb) 'availability' can be described as: a. A general judgement process in which an initially generated or given response serves as an anchor, and other information is used to adjust that response b. Judging the probability that a particular item comes from a particular population by determining the extent to which the item is representative of the population *c. The assessment of the probability of an event based on the ease with which instances of that event come to mind d. None of the above Feedback: Section "Representativeness: the evidence"

© John Wiley & Sons Australia, Ltd

13.10

Chapter 13: Behavioural research

30. The statement concerning research on expert judgement that is correct is: *a. Audit experts have better recall, integrative abilities and error frequency learning ability than do novices b. Human's both short and long term memories have very limited capacity c. Auditors do not exhibit evidence of the use of rules of thumb d. All of the statements are correct Feedback: A is correct. B is incorrect as it has been found that while humans possess a shortterm memory with very limited capacity they have a virtually unlimited long-term memory. C is untrue as research has found that auditors do exhibit evidence of all three rules of thumb.

Section "Representativeness: the evidence"

31. Behavioural accounting research does have limitations, which of the following is not a limitation of this research? *a. It lacks application in the real world b. It has resulted in many conflicting results c. The research settings used are often unrealistic d. It lacks a unified underlying theory Feedback: Section "Limitations of BAR"

© John Wiley & Sons Australia, Ltd

13.11

Testbank to accompany Accounting Theory 7e by Godfrey et al

Essay Questions

32. Accounting is a function of human behaviour and activity. J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.471. Discuss.

33. Briefly explain the Brunswik lens model and what factors make it a better predictor of the event of interest than the person from whom the model was derived.

34. Discuss the limitations of behavioural accounting research.

35. Explain and discuss some of the findings concerning behavioural research in the field of auditing.

36. 'Findings reveal that auditors and others use the same rules of thumb as have been prevalent in research in psychology, although often to a lesser extent. The rules of thumb of representativeness, availability, and anchoring and adjustment seem to be adopted in auditing and other business contexts in order to simplify complex judgement tasks and alleviate limitations in the cognitive processes of humans.' J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.476.

Explain the meaning of each of the three rules of thumb referred to in the quotation and describe and summarise the findings of one accounting or auditing research study that has been carried out in relation to one of the rules of thumb referred to above.

© John Wiley & Sons Australia, Ltd

13.12

Test Bank to accompany

Accounting Theory 7th edition PREPARED BY

Barbara Burns CHAPTER 14 Emerging issues in accounting and auditing

© John Wiley & Sons Australia, Ltd

Testbank to accompany Accounting Theory 7e by Godfrey et al

Chapter 14: Emerging issues in accounting and auditing True/False

1. In 2008 the IASB voted to require the 500 largest companies of each member to file their 2009 financial reports using Extensible Business Reporting Language (XBRL). a. True *b. False Feedback: In 2008 the SEC in the USA voted to require the 500 largest companies in the United States to file their 2009 financial reports using Extensible Business Reporting Language (XBRL).

Section "Current factors influencing accounting and auditing research, regulation and practice"

2. It is agreed among accountants that a big contributor of the 2008 global financial crisis was the practice of requiring firms to mark their assets to fair value. a. True *b. False Feedback: There is no agreement on the causes of the global financial crisis though some observers have expressed the opinion that the requirement for firms to mark their assets to fair value (particularly in the case of banks) may have exacerbated the crisis.

Section "Issues surrounding the application of fair value accounting during the global financial crisis"

3. The Sarbanes-Oxley Act in the United States decided not to restrict auditors' provision of nonaudit consulting services to their clients as the evidence that the practice comprised auditor's independence was mixed. a. True *b. False Feedback: The Sarbanes-Oxley Act in the United States decided to restrict auditors' provision of non-audit consulting services to their clients even though the evidence that the practice comprised auditor's independence is mixed.

Section "Current factors influencing accounting and auditing research, regulation and practice"

© John Wiley & Sons Australia, Ltd

14.2

Chapter 14: Emerging issues in accounting and auditing

4. SFAS 157 explicitly uses exit price as a definition of fair value but IFRS fair value is neither explicitly an exit nor an entry price. *a. True b. False Feedback: SFAS 157 explicitly uses exit price as a definition of fair value but IFRS fair value is neither explicitly an exit nor an entry price.

Section "Issues surrounding the application of fair value accounting during the global financial crisis"

5. In October 2008 the IASB changed the rules for financial assets so that, under certain circumstances, the assets could be reclassified to avoid charging mark-to-market losses to the income statement. *a. True b. False Feedback: In October 2008 the IASB changed the rules for financial assets so that, under certain circumstances, the assets could be reclassified to avoid charging mark-to-market losses to the income statement.

Section "Issues surrounding the application of fair value accounting during the global financial crisis"

6. It is usually considered that IFRS standards are more principles-based and US standards are more rule-based. *a. True b. False Feedback: Section "Possible directions in future international accounting standard setting arrangements"

7. Despite the existence of 'the Roadmap', it is not certain that the United States will adopt IFRS. *a. True b. False Feedback: Despite the existence of 'the Roadmap', it is not certain that the United States will adopt IFRS. Section "Possible directions in future international accounting standard setting arrangements"

© John Wiley & Sons Australia, Ltd

14.3

Testbank to accompany Accounting Theory 7e by Godfrey et al

8. International auditing standards are issued by the International Accounting Standards Board. a. True *b. False Feedback: International auditing standards are issued by the International Auditing and Assurance Standards Board (IAASB) under the auspices of the International Federation of Accountants (IFAC).

Section "Possible directions in future international accounting standard setting arrangements"

9. Social accounting and reporting aims at observing and assimilating issues not necessarily covered by traditional accounting functions into a form that can be used for decision making by individuals not necessarily directly or only concerned with the financial success of the entity. *a. True b. False Feedback: Social accounting and reporting aims at observing and assimilating issues not necessarily covered by traditional accounting functions into a form that can be used for decision making by individuals not necessarily directly or only concerned with the financial success of the entity.

Section "Sustainability accounting, reporting and assurance"

10. The water standards currently under development in Australia will essentially require qualitative rather than quantitative reports. a. True *b. False Feedback: The water standards currently under development in Australia are based on the financial accounting standard model and will include a Statement of Physical Water Flows, a Statement of Water Assets and Water Liabilities a Statement of Changes in Water Assets and Water Liabilities.

Section "Other non-financial accounting and reporting issues'

© John Wiley & Sons Australia, Ltd

14.4

Chapter 14: Emerging issues in accounting and auditing

Multiple choice 11. The statement concerning the XBRL system of reporting that is not true is: *a. It was developed by the IASB b. It is required to be used by the largest companies to file their reports c. It is hoped that it will allow much faster analysis of company financial data by a wider group of users, with less error. d. None of the statements is untrue, i.e. all are true statements Feedback: The Extensible Business Reporting Language (XBRL) system was developed by the US Securities and Exchange Commission (SEC), not the IASB. Section "Current factors influencing accounting and auditing research, regulation and practice"

12. A criticism of the XBRL system is: a. Haka suggests that it could mean less interest in small companies b. It will make auditing redundant *c. CFO's will lose their ability to choose the level of disaggregation of accounting information d. All of the above are criticisms Feedback: A is not a criticism of XBRL. In fact Haka suggested that it could mean an increase in the data available for small companies making them more attractive to analysts. B is not a criticism. In fact the criticism is that auditing will be more difficult.

Section "Current factors influencing accounting and auditing research, regulation and practice"

13. The statement that is most correct regarding the application of fair value accounting and the global financial crisis (GFC) is: a. There is no connection between the application of fair value accounting and the GFC *b. Some regard the practice of fair value accounting as a contributing factor in the rapid spread of the GFC from its origins in the US sub-prime mortgage market to the rest of the world c. Fair value accounting was one of the primary causes of the GFC d. There were no changes in international accounting standards relating to fair value as a result of the GFC Feedback: It is correct that some regard the practice of fair value accounting as a contributing factor in the rapid spread of the GFC from its origins in the US sub-prime mortgage market to the rest of the world. D is incorrect as in October 2008 the IASB changed the rules for financial assets so that, under certain circumstances, the assets could be reclassified to avoid charging mark-to-market losses to the income statement.

© John Wiley & Sons Australia, Ltd

14.5

Testbank to accompany Accounting Theory 7e by Godfrey et al

Section "Issues surrounding the application of fair value accounting during the global financial crisis "

14. The statement that is correct concerning the convergence of IASB and US accounting standards is: *a. The Securities and Exchange Commission released a 'Roadmap' for the potential use of International Financial Reporting Standards by US companies by 2014 b. The Securities and Exchange Commission has agreed to adopt international accounting standards in 2014 c. The Securities and Exchange Commission has agreed to adopt international accounting standards by 2014 d. None of the statements are correct Feedback: The Securities and Exchange Commission released a 'Roadmap' for the potential use of International Financial Reporting Standards by US companies by 2014.

Section "Possible directions in future international accounting standard setting arrangements"

15. It is not true that: *a. The IASB does not report to any higher body b. The FASB reports to the US Congress c. The Australian Accounting Standards Board ultimately reports to the Australian government d. No statement is untrue. i.e. all are true statements Feedback: Option A is correct. It is not true that IASB does not report to any higher body, it reports to the International Accounting Standards Committee Foundation (IASCF). The IASCF is a non-profit, non-government organisation. It is true the IASB does not report to any sovereign government.

Section "Possible directions in future international accounting standard setting arrangements"

16. The body that has been formed to oversee the International Auditing and Assurance Standards Board is: a. PCAOB *b. The PIOB c. The IASB d. XBRL Feedback: The Public Interest Oversight Board (PIOB) was formed in 2005 to oversee the operations of the International Auditing and Assurance Standards Board. Part of the reason for

© John Wiley & Sons Australia, Ltd

14.6

Chapter 14: Emerging issues in accounting and auditing

its establishment was to counter suggestions of lack of independence of the IAASB. Section "Possible directions in future international accounting standard setting arrangements"

17. The statement that is not true in relation to the internationalisation of auditing standards is: a. Many multinational firms voluntarily choose to have their financial statements audited according to international accounting standards b. Auditing standards are being internationalised for the same reasons as accounting standards were internationalised *c. In the past the International Auditing and Assurance Standards Board (IAASB) has been praised for its independence from the auditing profession d. None of the statements are untrue, i.e. all are true statements Feedback: In the past the International Auditing and Assurance Standards Board (IAASB) has been criticised for its lack of independence from the auditing profession.

Section "Possible directions in future international accounting standard setting arrangements"

18. With respect to the concept of sustainability which of these statements is not true? a. Sustainability is about eco-efficiency and eco-justice b. A sustainable entity needs to consider objectives relating to economic, social and environmental performance c. Recently the focus in the sustainability debate has been on eco-efficiency *d. None of the statements are untrue, i.e. all are true statements Feedback: All of these statements are true.

Section "Sustainability accounting, reporting and assurance"

19. The most widely used set of guidelines for sustainability reporting are published by: a. The IASB b. The United Nations c. The FASB *d. The Global Reporting Initiative Feedback: The most widely used set of guidelines for sustainability reporting is published by the Global Reporting Initiative (GRI).

Section "Sustainability accounting, reporting and assurance"

© John Wiley & Sons Australia, Ltd

14.7

Testbank to accompany Accounting Theory 7e by Godfrey et al

20. In a recent survey KPMG reported that what percentage of the reporting companies worldwide use the Global Reporting Initiative guidelines? a. 30% b. 50% c. 60% *d. 70% Feedback: Section "Sustainability accounting, reporting and assurance"

21. Meeting the needs of the present without compromising the ability of future generations to meet their own needs, is a definition of: a. Environmental accounting b. Green accounting *c. Sustainability d. All of the above Feedback: Meeting the needs of the present without compromising the ability of future generations to meet their own needs, is a definition of sustainability.

Section "Sustainability accounting, reporting and assurance"

22. In a recent survey KPMG reported which group of countries as having the highest level of formal assurance for their sustainability reports? a. The North American countries *b. The European countries c. The Australasian countries d. The African countries Feedback: The higher level of assurance in the European countries compared to the North American countries could be reflective of the different regulatory environments, particularly with respect to emissions trading schemes.

Section "Sustainability accounting, reporting and assurance"

© John Wiley & Sons Australia, Ltd

14.8

Chapter 14: Emerging issues in accounting and auditing

23. Which of these is a future direction in accounting and auditing? a. The convergence of international accounting standards and the FASB standards b. An improvement in the quality of international auditing standards and their increased acceptance c. An increase is sustainability accounting and reporting *d. All of the above Feedback: Section "Possible directions in future international accounting standard setting arrangements"

24. The statement that is not true in relation to water accounting is: a. This is an area outside traditional financial accounting where the concepts and skills used in accounting and auditing could provide a contribution *b. Water accounting in Australia applies cash accounting concepts c. c. The Water Accounting Conceptual Framework is based on the financial accounting standards model d. None of the above, i.e. all are true statements Feedback: Water accounting in Australia applies accrual accounting concepts.

Section "Other non-financial accounting and reporting issues"

25. A difference between water accounting and greenhouse gas emissions accounting is: *a. The purpose of the Greenhouse Gas Protocol standards is to aid companies in their measuring and reporting decisions whereas the purpose of water accounting is to assist external decision makers in their decisions. b. Water accounting is evidence of the pressure on governments to obtain data on scarce resources other than those traditionally captured by financial accounting whereas green house gas standards has a different motivation c. Water accounting is based on generally accepted financial and accounting reporting principles whereas greenhouse gas accounting is not based on those principles d. All are differences between water accounting and greenhouse gas emissions accounting Feedback: A is a difference between water accounting and greenhouse gas emissions accounting.

For B. the motivation for both water accounting and greenhouse gas emissions accounting is to obtain data on scarce resources and for C. both water accounting and greenhouse gas emissions accounting are based on generally accepted financial and accounting reporting principles (though greenhouse gas accounting to a lesser extent).

Section "Other non-financial accounting and reporting issues "

© John Wiley & Sons Australia, Ltd

14.9

Testbank to accompany Accounting Theory 7e by Godfrey et al

Essay Questions

26. Explain how the Extensible Business Reporting Language ( XBRL) system works and discuss the effects that its use is likely to have on financial reporting.

27. 'Despite the existence of the Roadmap, it is not certain that the United States will adopt IFRS'. J. Godfrey, et el, 'Accounting Theory', 7th Ed. p.492. Discuss some advantages that adopting IFRS would have for the US and some of the problems that have yet to be resolved concerning the US adopting International Financial Reporting Standards.

28. Discuss some of the problems that auditors face in providing assurance for sustainability reports issued by companies.

29. What, in your opinion, was the role of fair value accounting in the Global Financial Crisis?

30. Discuss how social accounting differs from financial accounting.

© John Wiley & Sons Australia, Ltd

14.10