SOLUTION FAR660 - JAN 2018 (1) updated - 22 jan 18.docx - FAR660 – JAN 2018 SUGGESTED SOLUTION FAR660 JANUARY 2018 QUESTION 1 a Two(2 incentives for

SOLUTION FAR660 - JAN 2018 (1) updated - 22 jan 18.docx -...

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FAR660 – JAN 2018 SUGGESTED SOLUTION FAR660 JANUARY 2018 QUESTION 1 a. Two (2) incentives for organisations to produce optimal amounts of accounting information despite the absence of regulation. There are economics-based incentives for organisations to produce information. Many of the contracts entered into by the management will be based on accounting information√ (for example, paying the manager a bonus based on accounting profits Λ). Thus, organisations will be motivated to provide the information to align their interests with that of the other parties√ Organisations not producing information would be penalised by higher costs of capital√. This is because little or no information gives rise to greater uncertainty√ about the performance of the firm which is translated into higher costs for the entityΛ. There is also a view that organisations are best placed to determine what information should be produced√. The introduction of accounting standards creates inefficiencies√ by imposing a ‘one-size-fits-all’ approach on external reporting. Imposing regulations that restrict the available set of accounting methods decreases the efficiency of contracting (for example, the organisation might have developed what it considers is the best way to reflect managers’ performance, but an accounting standard may disallow the use of this accounting techniqueΛ). Underperforming organisations will ultimately be taken over by another entity with the existing management team subsequently being replaced√ (because ‘the market’ is deemed to be efficient, it will identify organisations that are underperforming because of poor managersΛ). Therefore, managers are motivated to maximise firm value√. Information is produced to minimise the cost of capital, thereby increasing firm value. (Any 2 points or other acceptable answers) 4√ x1 = 4 marks 2Λ x ½ = 1 mark (Total = 5 marks) b. Main characteristics of private interest theories of regulation. Private interest theorists believe that there is a market for regulation with supply and demand forces operating as in the capital market.√ Within this political market, while there are many bidders, only one group will be successful, and that is the group that makes the highest bid√ Theorists believe that regulation does not come into existence as a result of a government’s response to public demands√, but rather (as a rule), regulation is sought 1
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FAR660 – JAN 2018 by the producer private-interest group and is designed and operated primarily for its benefit.√ But even if a group has a strong incentive to organise, there must still be a mechanism by which the group acquires and uses its influence√. It also assumes that players are always seeking to maximise their wealth√.
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