Mid semester Exam notes
Topic 1
Function of accounting
Decision Making * Investment – buy/sell shares, buy new shares offered by company * Lending – lend money to company in the form of bonds, loan conditions such as interest rates, security, other conditions
Contracting – legally binding obligation that gives party the right to demand the performance of whatever promised * management (agency problem) – information asymmetry, act in self interest * debt
Stewardship – compliance with delegated authority
Agency Cost of equity
Perquisite consumption – Manager give themselves more luxury than would seem reasonably from the principals point of view. E.g. corporate jets and huge officers with expensive art
Risk aversion – managers and shareholders may prefer different levels of risk when it comes to project selection. Shareholders would generally prefer more risky investment because they are well diversified and know that any loss will be offset by another investment. Managers however are generally not as diverse, if the firm suffers a substantial loss, their salaries may be at risk, or it would be extremely difficult to find another job. Hence managers are usually more reluctant to take risk than the shareholders.
Agency cost of debt
Claim dilution – The value of existing debtholders’ claims can be diluted by the issue of additional debt of the same or higher priority.
Asset substitution – If a firm sells debt for the stated purpose of investing in a low risk project, for example like a building, and subsequently invests in a high risk project, for example mineral exploration, the value of the debt falls while that of the equity rises.
Accounting Standards Harmonisation
Benefit – For users, consistency in interpretation of financials * For preparers, reduced costs in restating and reconciling reports
Disadvantages – culture differences,