Final Summer 2023 Accounting Theory Question 1: (20 points) Part 1: Explain

Final Summer 2023

Accounting Theory

Question 1: (20 points)

Part 1: Explain what the earnings response coefficient (ERC) is and how it is determined.  

Part 2: Discuss how the ERC can be used to evaluate the quality of earnings.

Part 3: What is meant by the term earnings persistence as it relates to earnings quality? 

Part 4:  Give an example of persistent and non-persistent components of earnings.  Only use examples of revenues/gains in your answer.  As part of your answer, explain why market participants would interpret the component as persistent or non-persistent.  

Question 2 (10 points)

Part 1: How did the work of Kahneman and Tversky inform market stakeholders about investor behavior?

Part 2: Explain why their work was paradigm changing.

Question 3 (20 points

Part 1: Briefly explain the methodology of the Ball and Brown (1968) study. 

Part 2: Explain the importance of the Ball and Brown (1968) study for the accounting profession.

Part 3: What is post earnings announcement drift (PEAD)?

Part 4: What does the existence of PEAD imply about market efficiency?

Question 4 (20 points)

Below are some terms frequently used when discussing earnings management.  Explain each term, describe under what circumstances management would likely use it, and given an example of how management might engage in this type of management.  In your example, explain what accounts would be used and how.  

A.  Big Bath

B.  Cookie jar reserves

C. Discretionary accruals.

D. Explain why researchers have to distinguish between discretionary and non-discretionary accruals when examining whether management uses accruals to manage earnings. 

Question 5 (15 points)

Part 1: Explain what real earnings management is. 

Part 2: Give an example of real earnings management.

Part 3: Give two reasons why management might prefer real earnings management over other methods of earnings management. 

Question 6 (15 points)

In executive compensation contracts today, managers are often paid a combination of (a) salary, (b) bonuses, and (c) stock options. From a contracting/agency theory perspective, explain why these three are likely to all be included in the executive compensation plan. Please label your discussion for each of the three.