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Unformatted text preview: To properly understand decision usefulness: • We need to consider other theories (that is, other than the present value model) from economics and finance • Know exactly what usefulness means- Decision theories and capital market theories assist in conceptualizing the meaning of useful financial statement information • Need a precise definition of information Theory of Investment: • A specialization of decision theory to model the decision processes of a rational investor • Helps us to understand the nature of risk in a portfolio investment context 3.2 THE DECISION USEFULNESS APPROACH In adopting the decision usefulness approach, two major questions must be addressed: 1. Who are the users of financial statements? There are many users It is helpful to categorize them into broad groups , such as investors, lenders, managers, unions, standard setters, and governments These groups are called c onstituencies of accounting 2. What are the decision problems of financial statement users? Understanding these decision problems will help accountants be better prepared to meet the information needs of the various constituencies FS is made more useful by tailoring financial statement information to the specific needs of the users of those statements 3.3 SINGLE-PERSON DECISION THEORY Characteristics: • Takes the viewpoint of an individual who must make a decision under conditions of uncertainty • Recognizes that state probabilities are no longer objective, as they are under ideal conditions Thus: SETS OUT A FORMAL PROCEDURE … 1) Whereby the individual can make the best decision by selecting from a set of alternatives 2) That allows additional information to be obtained to revise the decision maker’s subjective assessment of the probabilities of what might happen after the decision is made (i.e., the probabilities of states of nature) Decision theory is relevant to accounting because financial statements provide additional information that is useful for many decisions, as illustrated in Example 3.1. 3.3.1 DECISION THEORY APPLIED Example 3.1 – A Typical Investment Decision B ILL C AUTIOUS : • Is risk-averse The amount of utility, or satisfaction , he derives from a payoff = • Has $10,000 to invest for 1 period • He has narrowed down his choice to two investments 1) Shares of X Ltd – let ‘a1’ represent this act 2) Government bonds yielding 2.25% – let ‘a2’ represent this act We can think of X Ltd.’s future performance in terms of its : • future dividends • cash flows/earnings Generally all of which have an effect on the end-of-period market value of its shares S UPPOSE B ILL DECIDES ON A 1: • He faces risk because the future performance of X Ltd. is not known when Bill makes his decision • Consequently, he defines two states of nature: 1) State 1: X Ltd. future performance is high 2) State 2: X Ltd. future performance is low Suppose 1 : X Ltd. is in state 1 Then: Bill’s net return on the X shares...
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This note was uploaded on 03/27/2012 for the course ACC 706 taught by Professor Shadifarshad during the Spring '09 term at Ryerson.
- Spring '09