Chapter 6_Notes

Chapter 6_Notes - Chapter 6 Notes 6.1 Overview Measurement...

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Chapter 6 Notes 6.1 Overview Measurement Approach – The measurement approach to decision usefulness is an approach to financial reporting under which accountants undertake a responsibility to incorporate current values into the financial statement proper, provided that this can be done with reasonable reliability, thereby recognizing an increased obligation to assist investors in predicting firm performance and value. The measurement approach does not invalidate the argument that it is the investor’s responsibility to make his/her own predictions of future firm performance. Rather, the intent is to enable better predictions of this performance by means of a more informative information system. 6.2 Are Securities Markets Fully Efficient? 6.2.1 Introduction In recent years, increasing questions have been raised about investor rationality and securities market efficiency. These questions are of considerable importance to accountants because (i) if these questions are valid, the practice of relying on supplementary information in notes and elsewhere to augment historical cost-based financial statements proper may not be completely effective in conveying useful information to investors; (ii) if shares are mispriced, improved financial reporting may be helpful in reducing inefficiencies, thereby improving the working of securities markets. The basic premise of these questions is that average investor behaviour may not correspond with the rational decision theory and investment models. Some of these behavioural characteristics are: Limited attention: Individuals may have limited attention. That is, they may not have the time or ability to process all available information. Then, they will concentrate on information that is readily available, such as the ‘bottom line”, and ignore information in notes and elsewhere in the annual report. Conservative: Individuals are conservative in their reactions to new information. Conservative individuals revise their beliefs less than Bayes’ theorem implies. Overconfidence: Individuals tend to overstate the precision of information they collect themselves. If we equate the individual’s self-collected information with prior probabilities in Bayes’ theorem, this implies that the overconfident individual will underreact to new information that is not self-collected relative to information that is. Representativeness is another individual psychological characteristic whereby the individual assigns too much weight to evidence that is consistent with the individual’s impressions of the population from which the evidence is drawn. Thus, an individual subject to representativeness overreacts to new information.
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Chapter 6 Notes Self-attribution bias: Individuals feel that good outcomes are due to their abilities, and bad outcomes are due to unfortunate events, and are hence not their fault.
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