Chapter 4 - Solution Manual

C agency theory would predict that managers would

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c. Agency theory would predict that managers would choose accounting procedures that would increase assets, increase earnings, or decrease debt. The higher debt is to equity the more likely the company will breach existing debt covenants. Management is expected to act in a manner that would reduce associated agency costs. Lease capitalization would increase assets, but it would also increase debt. Hence, agency theory would predict that management would have a tendency to structure lease agreements so that the debt would not be reported on the balance sheet - i.e., management would not want to capitalize leases. FASB ASC 4-1 Employee Stock Options Information on stock compensation is contained in FASB ASC 718-10. It is accessed through the expense topic field. 10-1 The objective of accounting for transactions under share-based payment arrangements with employees is to recognize in the financial statements the employee services received in exchange for equity instruments issued or liabilities incurred and the related cost to the entity as those services are consumed. This Topic uses the terms compensation and payment in their broadest senses to refer to the consideration paid for employee services. 10-2 This Topic requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. This Topic establishes fair value as the measurement objective in
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71 accounting for share-based payment arrangements and requires all entities to apply a fair-value-based measurement method in accounting for share-based payment transactions with employees except for equity instruments held by employee stock ownership plans. Room for Debate Debate 4-1 The efficient market hypothesis and accounting information Team 1 Given the EMH, argue that accounting is relevant The three forms of the efficient market hypothesis (EMH) are the weak form, the semi-strong form, and the strong form. According to the weak form, the historical price of a stock provides an unbiased estimate of the future price of the stock. Hence, an investor cannot make excess gains by knowledge of prior prices. But, an investor could gain if he/she has other knowledge regarding expected future performance of a company, e.g., accounting information. Under this form of the EMH, accounting information is definitely relevant. According to the semi-strong form of the EMH, all publicly available information is instantaneously impounded into security prices. Hence, publicly available information, such as publicly released accounting information is already reflected in the price of a share of stock, and knowledge of this information would not provide an advantage to any potential investor. In this case only insider information, e.g., accounting information which is not released to the public, would benefit the potential investor. Yet there are restrictions on insider trading of stocks.
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