Question 1

Explain how earnings management may arise.

Accepted Answer

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Question 2

Explain the difference between moral hazard and adverse selection.

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Question 3

For the situations described below, explain whether managers would be motivated to manage earnings, assets, and equity upward and liabilities downward, or alternatively, managers may be motivated to manage earnings, assets, and equity downward and liabilities upward.

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Question 4

Management motivation to increase the likelihood that the company will receive a $50,000 government rebate best illustrates which of the following?

Accepted Answer

A) Earnings management. 
B) Positive accounting theory. 
C) Information asymmetry. 
D) Efficient securities market.

Question 5

Which statement best explains "moral hazard"?

Accepted Answer

A) The term refers to a situation where one party has an information advantage over another. 
B) The term refers to the need external parties have for financial information. 
C) The term refers to the fact that some people have more information than others. 
D) The term refers to a situation where one party cannot observe the actions of another party.

Question 6

Which statement best explains "adverse selection"?

Accepted Answer

A) The term refers to a situation where one party has an information advantage over another. 
B) The term refers to the need external parties have for financial information. 
C) The term refers to the fact that some people have more information than others. 
D) The term refers to a situation where one party cannot observe the actions of another party.

Question 7

Explain the meaning of publicly accountable enterprises, efficient securities market (semi-strong form), and efficient securities market (strong form).

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Question 8

Which of the following statements is correct about financial information?

Accepted Answer

A) All users require the same kind of information. 
B) Forward looking information is useful for evaluating management stewardship. 
C) Trade offs are necessary in accounting. 
D) Historical cost information is useful for pricing the value of a company's shares.

Question 9

Why is the efficient securities market hypothesis important for accounting?

Accepted Answer

A) When providing financial information, management need only consider the specifically identifiable users who they know will rely on the information. 
B) Accounting standards can assume that the majority of market participants have a reasonable level of sophistication. 
C) Individuals with information that is not publicly available cannot make significant profits. 
D) Accounting information is the only source of financial information that markets use.

Question 10

Discuss two ways in which a shareholder can mitigate the problem of moral hazard when investing in a company.

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Question 11

Which statement is correct?

Accepted Answer

A) Financial reporting is the process of preparing information for internal parties. 
B) Financial reporting involves issuing financial statements to external parties. 
C) Financial reporting provides the same information as management accounting. 
D) Financial reporting is based on rules issued by the CICA or IASB.

Question 12

Discuss three reasons why it is important to understand accounting theory.

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Question 13

Which statement appropriately explains the meaning of "publicly accountable enterprise"?

Accepted Answer

A) Firms without equity, debt or other securities traded in public markets. 
B) Firms with equity, debt or other securities traded in public markets. 
C) Firms with assets and liabilities that provide goods and services in public markets. 
D) New firms entering the public markets to provide goods and services.

Exam 1: Fundamentals of Financial Accounting Theory