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PART A - Multiple Choice Questions

This section contains 10 multiple choke questions. Answer all questions.

1. Critical researchers accuse financial accounting of:

(A) Being open to manipulation by self-interested managers.

(B) Reinforcing unequal distributions of wealth and power.

(C) Being irrelevant to management decision-making.

(D) Giving inaccurate predictions of share price movements.

2. Critical researchers believe that accounting information:

(A) Is neutral and unbiased.

(B) Benefits neither the rich nor poor.

(C) Is used by the elite to maintain their power.

(D) Challenges existing social orders.

3. Critical researchers interpret the Australian accounting bodies' opposition to mandatory corporate social and environmental reporting as evidence that the accounting profession:

(A) Is legitimately concerned with introducing unnecessary regulation.

(B) Does not believe mandatory reporting would enhance corporate accountability.

(C) Does not believe shareholders and the public support mandatory reporting.

(D) Promotes the interests of business above the interests of other stakeholders.

4. Critical researchers interpret the post-Enron increase in mandatory corporate reporting as primarily benefiting:

(A) Society, as corporations are required to improve their level of disclosure.

(B) Corporations, as confidence will be restored to financial markets.

(C) Employees, as fewer companies will go bankrupt.

(D) Accountants, as demand for accounting services will increase.

5. Critical researchers believe that accountants are:

(A) Complicit in the exploitation of citizens.

(B) Resistant to the exploitation of citizens.

(C) Irrelevant to the exploitation of citizens.

(D) Exploited by citizens

6. Critical researchers believe that accounting standards:

(A) Create reality.

(B) Describe reality.

(C) Challenge reality.

(D) Obscure reality.

7. According to Karl Popper's Falsificationist perspective, a good theory is one:

(A) That is falsified.

(B) That is true.

(C) For which there is a conceivable means of testing its falsity and the theory withstands the test.

(D) For which there is no conceivable means of testing its falsity and the theory upholds.

8. In social sciences, such as accounting, the failure of a particular study to support a theory: (Note: select the most suitable answer)

(A) Provides the basis for rejecting the theory as useless or insignificant.

(B) Means that the particular study must have flaws in its design or execution in specifying and collecting the data.

(c) Threatens the theory, if repeated or more refined studies fail to support it with empirical evidence.

(D) Means that the hypothesis was too broad, and did not specify the particular circumstances and conditions in enough detail.

9. The free-market perspective of accounting regulation suggests that accounting information:

(A) Should be provided free of charge.

(B) Should be provided like any other good that is subject to demand and supply.

(C) Should be free of considerations and lobbying of the market.

(D) Will require regulation to avoid underproduction of information.

10. Which of the following statements is true in times of inflation?

(A) Holders of monetary liabilities will lose.

(B) Holders of monetary assets will gain.

(c) If the amount of non-monetary assets is the same as non-monetary liabilities, no gains or losses would occur.

(D) If the amount of monetary assets held is less than the amount of monetary liabilities held, a net gain will occur.

PART B - Essay Questions

QUESTION 1

Emotional investing ends in tears

It is noteworthy that the two stocks that contributed most to the rise in the Australian share market on Monday, National Australia Bank and QBE Insurance, were the subject of market moving media reports but no ASX announcements.

NAB shares got a kick along from a report in the Sunday Times in London that Spanish bank, Banco Santander was contemplating a bid for NAB's Clydesdale and Yorkshire banks.

QBE shares jumped 3.3 per cent on the back of a report in 'The Australian Financial Review' that relatively new chief executive John Neal was set to cut about 700 jobs in Australia as part of a bid to save $US200 million by 2014.

It is clear from the share market reaction that many investors took these two reports as signals to buy.

The NAB buyers must think it a positive for NAB to be rid of the UK business, while the QBE buyers must be reassured that promised cost cutting will eventuate through getting rid of at least 15 per cent of the local workforce.

Chanticleer reckons this is knee-jerk investing at its worst. It displays a lack of understanding of the main profit drivers of both companies. Before analysing these drivers, it is worth commenting on the proven dangers of impulsive share buying.

While the Financial Review and Sunday Times provided a valuable service to readers by putting the focus on key market developments surrounding NAB and QBE, any leap into the market based on these reports could well backfire.

Yet it is common for investors with low levels of emotional intelligence to get it wrong. This view is certainly supported by the findings of a study called Emotional Intelligence and Investor Behaviour, published several years ago by the Research Foundation of the CFA Institute.

Using data collected from a survey of 401(k) pension fund investors in the United States, the authors show that investors who score highly on tests of emotional intelligence tend to exhibit behaviours that correlate well with good investment performance.
The study, by John Ameriks from Vanguard Group, Tanja Wranik of University of Geneva, and Peter Salovey of Yale University, was careful to say that emotional intelligence was different to being emotional or being in touch with one's emotions. It is about understanding your emotions and using them productively.

Most investors have difficulty overcoming fear when prices are falling, so they buy too little; then they become subject to greed when prices are rising and sell too little or hold too long, according to a preface to the report, written by Laurence Siegel.

The study says there are many emotionally laden decisions in investing, including "how much active management to use, how frequently to trade, how concentrated one's portfolio should be, how extensively to use risky or novel strategies, and, perhaps most importantly, how much to save and invest (as opposed to consuming)."

(Source: Boyd, T (2013) 'Emotional investing end in tears', Australian Financial Review, https://www.afr.co m/m a rkets/eq uity-ma rkets/emotional-investi ng-ends-i n-tea rs¬20130121-j17zj#ixzz4N13rz3We)

REQUIRED:

After reading the above extract, answer the following questions

(a) Explain how a study using capital markets research methodology can be designed to determine whether the movement in the share prices of QBE and NAB was linked to the respective news announcements?

(b) How would the findings reported in the above extract be relevant to newspaper editors when determining which stories to publish? Explain.

(c) How would the findings reported in the above extract be relevant to the securities exchanges or corporate regulators? Explain.

QUESTION 2

SEC Charges Two Clinical Drug Trial Doctors with Insider Trading

Urologists Franklin M. Chu and Daniel J. Lama work at the San Bernardino Urological Associates Medical Group. The practice frequently does clinical studies on drugs that are under development, which includes research and tests on patients to see if the drugs work safely and efficiently.

The medical group was chosen to test a drug called Capesaris, a treatment for prostate cancer that was under development by GTx Inc., a Memphis-based biopharmaceutical company that specializes in developing cancer treatments. According to government filings, Chu, who founded the San Bernardino clinic in 1985, was the lead medical investigator in the clinical trials and Lama worked with him on the tests.

The SEC alleges that in February 2012, Chu and Lama learned from GTx that the U.S. Food and Drug Administration was placing a hold on the clinical tests because of concerns that Capesaris could cause blood clots in patients who were participating.

That information was confidential and not released to GTx stockholders. but Chu, upon hearing the news, sold 16,000 shares of the company stock at an average sales price of $5,82 per share, the SEC alleges. Lama sold 5,400 shares of GTx stock at the same price.

A few days later, GTx made a public announcement about the blood clot worries and the stock plummeted more than 36 percent and closed at $3.69 per share, according to the SEC filing. By using insider information, the government agency alleges Chu avoided stock market losses of more than $34,000, and Lama avoided $11,502 in trading losses.
(Source: https://www.sec.gov/litigation/litreleases/2014/1r22996.htm)

REQUIRED:

a) Do you think the fact that Dr. Chu and Mr. Lama could avoid losses by trading on insider information is an indication that the market is inefficient? Explain your answer demonstrating your understanding of the three market efficiency forms of strong form, semi-strong from and weak form efficiency?

b) Assume that there was no share price movement when GTx made a public announcement about the blood clot worries. Do you think this information is not relevant to the market? Explain.

QUESTION 3

India should customise its Accounting standards as per its prevailing legal environment: Chairman, NACAS

We should converge to the New Accounting Standards, which suits Indian legal environment and standards, and must not copy the west blindly, emphasised Mr Amarjit Chopra, Chairman, National Advisory Committee on Accounting Standards (NACAS) at a workshop on 'Adoption of Indian Accounting Standards (IndAS) - Key impacts and challenges' organised by Confederation of Indian Industry (CII) in association with Grant Thornton.

Mr Vishesh Chandiok, Chairman, CII NR Committee on Economic Affairs & Taxation & National Managing Partner, Grant Thornton India LLP said that the new IndAS will help India Inc. raise capital from more sources and do so cheaper than before, in the long term. However, in our experience, transition will be extremely challenging for companies, service providers and regulators as International Financial Reporting Standards (IFRS) brings with it much more judgment. Ironically there will be a lot more grey than black and white, as IndAS is principles based and not rules based. Companies will do well to immediately conduct a benchmarking study so that they have time to plan on how to minimise the impact on key financial ratios and operating parameters.

(Source:https://www.business-standard.com/article/news-cm/india-should-customise-its-accounting-standards-as-per-its-prevailing-legal-environment-chairman-nacas¬115061200225 1.html)

REQUIRED:

a) In the above article Mr. Amarjit Chopra is quoted as having said that India should adapt the new accounting standards (that would be based IFRSs) to suit the Indian legal environment and context. Do you agree with this statement? When discussing your answer explain whether India would benefit more by adapting 1FRSs to the local context or adopting them without any amendments.

b) Explain how Indian companies would be able to raise capital from more sources and at a lower cost than before by harmonising Indian accounting standards with IFRSs.

c) Explain possible challenges that might be experienced by companies, accounting firms and regulators when transitioning to IFRS.

QUESTION 4

T-Mobile's profit beat obscured by non-standard numbers

T-Mobile U.S. Inc. investors had to settle for a third-quarter earnings release on Monday that was full of non-standard metrics, crowding out a positive net income number that was almost three times as much as in the same period last year.

The U.S.-based wireless network operator also made readers do their own math to divine an earnings-per-share growth rate.

The Securities and Exchange Commission issued updated guidance to companies in May, reminding them that numbers prepared according to Generally Accepted Accounting Principles, the accounting standard, must be shown first and emphasized equally with the adjusted, or non-GAAP figures, that often make results look better.

That didn't stop T-Mobile whose advertising tag line is "Never Settle,"from emphasizing three non-GMP metrics- customer net adds, service revenue growth, and adjusted EBITDA - in the headline in bold print. The first four bullets on the page were all operating metrics, and the actual GAAP revenue number, up 17.8% year-over-year to $9.2 billion, did not appear until the fifth bullet.
(Sou rce:https://www. ma rketwatch.com/story/t-mobi les-profit-beat-obscu red-by-non-standard-numbers-2016-10-24)

REQUIRED:

a) Explain why companies provide non-financial information to shareholders when the provision of such information is not mandated. Your answer should be informed by theory and sound argument and focus on shareholders (instead of other stakeholders).

b) The above article highlights that the provision of non-standard metrics by T-Mobile obscured the key message in the earnings release. Based on efficient market hypothesis explain whether the capital market's ability to value T-Mobile's shares will be negatively affected by such voluntary information included in earnings releases.

c) Assume you are a behavioural accounting researcher; explain a studyyou would design to investigate whether the claim made in this paper that the non-GAAP metrics confuse investors is valid.

QUESTION 5

The Blackstone Group is a large U.S.-based investment company whose operations include investing in public companies and taking them private. A major component of its earnings from these investments derives from "carried interest." This is a management fee based on a preferential interest in the profits earned by unconsolidated companies in which it has invested. For example, a typical arrangement would be for Blackstone to receive an annual payment of 20% of a company's profits in excess of a hurdle rate of return on equity. These payments could continue for, say, five years, after which Blackstone would plan to sell its interest in the company.
Under historical cost accounting and the equity method of accounting for unconsolidated subsidiaries, carried interest fees would be recorded as revenue each period, if and as they are earned, with offsetting debit to the investment account. Note, however, that Blackstone's preferential right to receive future fees conditional on a hurdle rate of return on equity of a firm in which it has invested has option-like characteristics, expiring in five years in the above example.

In 2007, Blackstone planned an initial public offering of its stock. In its preliminary prospectus, date March 22, it revealed that for many of its unconsolidated investments it would use the fair value option to value future carried interest fees on a fair value basis, with the offsetting credit to current earnings. Presumably, an option pricing model, such as Black-Scholes, would be used to determine fair value. If this accounting had been applied in 2006, Blackstone indicated that its 2006 earnings would have increased by $595,205, relative to earnings reported using the equity method of accounting for its unconsolidated investments.

Note that fair value has to be re-evaluated each period. Blackstone pointed out that this could introduce considerable volatility into its reported earnings. It seems that Blackstone was willing to bear this volatility in order to secure earlier revenue recognition.

Concerns about reliability of Blackstone's proposed accounting soon appeared in the financial media, despite the greater relevance of this approach. A major source of concern was that since bought-out companies are typically taken private, the amount of public information about them is minimal. This makes it particularly difficult for the market to assess Blackstone's valuation, and puts considerable onus on Blackstone to fully disclose its assumptions in determining fair value. Concern was also expressed that Blackstone could bias its financial results by means of these assumptions.

(Source: Scott, W. R., 2012, Financial Accounting Theory, Pearson: Ontario)

REQUIRED:

a) As a rational investor who is considering investing in the shares of Blackstone's initial public offering, would you find fair value accounting more or less decision-useful than historical cost accounting for the value of Blackstone's carried interest? In your answer, consider issues of relevance, reliability and full disclosure of accounting information produced under historical cost and fair value approaches.

b) As an investor, would the increased volatility of Blackstone's earnings resulting from fair value accounting affect the amount you would be willing to pay for its shares? Explain your answer referring to an appropriate theory you have studied in this unit.

c) Using Positive Accounting Theory introduced by Watts and Zimmerman explain Blackstone's decision to adopt fair value accounting for carried interest fees in 2007.