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Chapter 4 - Solution Manual

Semi strong form available information includes past

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Semi-strong form - Available information includes past price history and all other publicly available information. Strong form - Past price history, all publicly available information and insider information. Case 4-3 The deductive approach to the development of a theory begins with the establishment of certain objectives. Once the objectives have been identified, key definitions and assumptions are stated. the researcher then develops a logical structure for accomplishing the objectives, based on the definitions and assumptions. Political economy theory is an example of deductive theory formation in that it stresses that the objective of accounting should not be the benefit of one group over another and recommends viewing market and socio-economic forces in the development of accounting theory. Agency theory is also a normative theory in that it attempts to explain behavior. The inductive approach to the development of a theory emphasizes making observations and drawing conclusions from those observations. It is going from the specific to the general. Under this approach the researcher generalizes about the universe based upon a number of observations of specific situations. APB Statement No. 4 was an example of inductive research in that it described GAAP on the basis of observations about current practice. The pragmatic approach to theory development is based on the concept of utility or usefulness. That is, once a problem has been identified, the researcher attempts to find a utilitarian but not necessarily a optimum solution. A Statement of Accounting Theory by Sanders, Hatfield and Moore was an example of the pragmatic approach to theory development in that it essentially recommended to accountants "do what you think best." This study was used by some accountants as an authoritative source that justified current practice. Case 4-4 The basic assumption of agency theory is that individuals maximize their own expected utilities. It attempts to explain behavior in terms of the benefit to be derived from a particular course of action. Inherent in agency theory is the assumption that there is a conflict of interest between the owners of a firm (shareholders) and the managers because managers are maximizing their own utilities which does not result in a maximization of shareholder wealth. An agency is defined as a relationship by consent between two parties whereby one party (agent) agrees to act on behalf of the other party (principal). According to agency theory, the political process has an impact on agency relationships because political officials frequently believe that inefficient markets can only be remedied by government intervention. Agency theory may help to explain the absence of a comprehensive theory of accounting because of the diverse interests involved in financial reporting; however, it will not help to identify the correct accounting procedures because it only attempts to explain the state of current practice not the best methods of practice.
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