Accounting: Stock Market and Net Income Essay

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CGA-CANADA
ACCOUNTING THEORY & CONTEMPORARY ISSUES [AT1] EXAMINATION
March 2011
Time: 3 Hours

Marks

Note:
All references to the Handbook refer to the CICA Handbook.

30

Question 1
Select the best answer for each of the following unrelated items. Answer each of these items in your examination booklet by giving the number of your choice. For example, if the best answer for item (a) is (1), write (a)(1) in your examination booklet. If more than one answer is given for an item, that item will not be marked. Incorrect answers will be marked as zero. Marks will not be awarded for explanations.
Note:
2 marks each

a.

Which of the following statements describes the effects of accounting for financial assets at fair value through profit and loss under IAS 39?
1)
2)
3)
4)

Tends to increase the volatility of other comprehensive income
Tends to decrease the volatility of other comprehensive income
Tends to increase the volatility of net income
Tends to decrease the volatility of net income

b. Which of the following statements describes post-announcement drift?
1) Prices of good news firms tend to drift upwards and prices of bad news firms drift downwards for
60 days beyond the earnings announcement date.
2) Future earnings are more highly correlated with current cash flows than current accruals.
3) Noise traders are more active after good news announcements than after bad news announcements. 4) Stock prices of firms announcing good earnings news increase and those of firms announcing bad earnings news fall, surrounding the earnings announcement date.
c.

Which of the following statements describes the features of a first-best contract between a risk-averse manager and a risk-neutral owner of an enterprise under direct monitoring?
1)
2)
3)
4)

The owner does not bear any risk and the manager bears all the risk.
The manager is never able to meet his or her reservation utility.
The owner bears all the risk and the manager does not bear any risk.
The manager is easily able to shirk.

d. Which of the following statements explains why firms with high levels of research and development
(R&D-intensive firms) exhibit a low level of association between net income and stock prices?
1) Net incomes of R&D-intensive firms are low, while stock prices react positively to the firms’
R&D activities.
2) R&D-intensive firms are low-risk firms.
3) R&D-intensive firms are high-growth firms.
4) R&D-intensive firms exhibit low recognition lags.

Continued...
EAT1M11

©CGA-Canada, 2011

Page 1 of 7

e.

Which of the following statements explains why accounting policy changes required by accounting standards matter to management?
1)
2)
3)
4)

f.

New accounting policy rules affect net income.
New accounting rules lead to lower reliability of accounting numbers.
Managers do not believe markets are efficient.
New accounting rules interfere with existing contracts.

Hanna (1999) asserted that managers’ bonuses are often based on core earnings. Which of the following statements reflects one implication of this assertion?
1) Managers have a tendency to reduce core earnings.
2) Managers have a tendency to delay recognizing revenue.
3) Managers have a tendency to incur excessive amounts of non-recurring charges in the current period. 4) Managers have a tendency to increase operating earnings.

g. Which of the following statements describes what is meant by Positive Accounting Theory (PAT)?
1) PAT attempts to predict and explain the reasons why firms make income-increasing accounting policy choices.
2) PAT attempts to predict and explain the reasons why firms make income-decreasing accounting policy choices.
3) PAT attempts to predict and explain the reasons why firms make income-increasing as well as income-decreasing accounting policy choices.
4) PAT attempts to predict and explain the effects of accounting policy choices on debt covenants and managerial bonus
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