ch05 - Chapter 5 Solutions Overview Problem Length{S{M{L...

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Chapter 5 - Solutions Overview: Problem Length Problem #’s {S} 1,4,5,6,12-15 {M} 2,3,7,8,10,11 {L} 9 NOTE: The problems in this chapter are designed primarily as a basis for discussion of the issues covered in this chapter. There are no absolutely right/wrong answers. The solutions that follow should be viewed in that spirit. 1.{S}The FASB view of neutrality is consistent with the classical approach, that takes the position that an "ideal" accounting paradigm can and should be designed disregarding potentially adverse impacts. Market-based researchers, however, argue that the costs and benefits of accounting policy setting should be subject to economic analysis. Neutrality as defined in the quotation is therefore not a desirable objective . The fact that certain firms would be adversely affected by accounting standards renders the standard non (pareto 1 ) optimal. Thus, although the efficacy of an accounting system is measurable by its market impact (information content), that same impact means that it is not possible to use information content to determine accounting policy. The "positive" approach argues that de facto neutrality is not a feasible objective . The accounting standard setting process is influenced by the impact, favorable or unfavorable, that standards have on firms. Firms lobby (in many cases successfully) for or against certain standards precisely for that reason. This is not necessarily bad. Rather it is a "fact of life" and in this view, accounting standards and the standard setting process cannot be determined exogenously of firms' production-investment decisions. 1 Pareto optimality is defined as the condition where a change to a new equilibrium leaves nobody worse off and at least one participant is better off. 5-1
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2.{M}a. This question is difficult to answer without knowing the total information set provided by each system in its first report. However, assuming that in other respects they are identical, information system Alpha is a superior system insofar as it provides a better prediction of the second report. b. Since, under the Alpha system, the second report could be forecasted better, at the time of its issuance it would contain fewer "surprises" and show less information content. The Gamma system, however, would contain a greater degree of "surprise" and, therefore, show greater information content. c. The answers to parts a and b point out the problems of focusing only on the market reaction to one report at a specific point in time. Although market reaction may tell us something about the information content of that given report, it does not tell the whole story. Accounting reports may contain information that will only be known at a later point in time (outside the "window" examined). Similarly, nonreaction may be due to knowledge generated by previous information provided by the system (alone or in conjunction with external information sources); the better a system predicts, the less "information" content in subsequent reports.
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ch05 - Chapter 5 Solutions Overview Problem Length{S{M{L...

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