Question 3

BKAF3083 2nd semester 2012/2013

NAME: MATRIC NUM:KARNAN A/L MUNIANDY 207381SAROJA A/P MANOHARAN 221690KU AZWA BINTI KU AZMI 221915LOOI SAIK WOEN 223882LECTURER NAME: PN. NORAZITA MARINA BINTI ABDUL AZIZQuestion 1 a)In trying to explain shareholders' subdued reaction to Affin's Research report on Malaysian Airline System Bhd (MAS), explain whether on how you could use the following approaches to accounting theory construction:1)Decision usefulnessDecision usefulness approach to financial reporting is an approach to the preparation of financial accounting information that emphasis on the theory of investor decision making in order to infer the nature and types of information that investors need. It focused on developing theories to ensure that accounting reports would provide the information most useful for making the decision that the theorists believe to be most important.2)Positive accounting theoryPositive accounting theory is concerned mainly with explaining the reason for current practice and predict the role of accounting and associated information in the economic decision of individuals, firms and other parties that contribute to the operation of the marketplace and the economy. Investor need higher yield that would be required from a comparable company paying fully franked dividends.

(continued)3)Scientific approachScientific approach observe the real world behavior that does not concur with the theory, it treated that anomaly as a research issue and express it as a research problem to be explained. It develop a theory to explain the observed behavior and use that theory to generate testable hypotheses that will be corroborated only if the theory holds and the follow precise and highly structured or predetermined procedures for data collection and after subjecting the data to mathematical or statistical techniques, we can validate or refuse the hypotheses testes. Scientific approach has an inherent assumption that the world to be researched in objective reality capable of examination in term of large scale or average statistics. This type of research is carried out by incremental hypotheses which are the combined to provide greater understanding or better predictions of accounting.

Question 1 b)Explain why principles-based standards require a conceptual framework.

It is because the conceptual framework provides a framework for the development of a body of coherent standards based on consistent principles. It presents the basic ideas which underpin the development of the standard and assist user in their interpretation of standardQuestion 1 c) Why is it important that the IASB and FASB share a common conceptual frameworkA common goal of the IASB and FASB is for their standards to be clearly based on consistent and appropriate principles. These principles must be rooted in fundamental economic concepts rather than based on a collection of arbitrary conventions. To provide the best foundation for developing principle based, common standards, the boards are undertaking a joint project to develop a common and improved conceptual framework. Such a framework is essential to fulfilling the Boards goal of developing standards that are principles based, internally consistent, and internationally converged.

Question 1d)Describe briefly FOUR (4) main differences between Islamic Accounting and Conventional Accounting.

Conventional AccountingDifferencesIslamic AccountingAccounting process aim to allow informed decisions whose ultimate propose is to efficient (profitable) uses by providing information efficiency in the market (without compliance to Islamic shari`ah)DefinitionAccounting process which provides appropriate information ( not only financial data only) to stakeholders of an entity that will enable them to ensure that the entity is continuously operating within the limit of Islamic shari`ah and delivering on its socioeconomic objectivesPerforms everything within the limit of Islamic shari`ah.

OperationAllow everything to maximize their profitConceptual based on the Islamic principlesNatureConceptual based on principles Of secularism and capitalism.

al-Quran and sunnah or Islamic syari`ah.GovernanceAccounting and commercial law and security ethicQuestion 2 (a)Conditions related to the measurement on the valuation of the assets and liabilities Historical cost is the price paid to acquire an asset or the amount received when a liability is incurred in an actual transaction. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Replacement cost is the price that would be paid to acquire an asset with equivalent service potential in an orderly market transaction at the measurement date. Settlement amount is the amount at which an asset could be realized or a liability could be liquidated with the counterparty, other than in an active market.

Question 2 (b)(i) Financial capital concepta profit is earned only if the amount of net assets at the end of a period exceeds the amount at the beginning of the period, excluding any inflows from or outflows to owners, such as contributions and distributions. It can be measured either in nominal monetary units or constant purchasing power units.

(ii) Physical capital concepta profit is earned only if the enterprise's productive or operating capacity at the end of a period exceeds the capacity at the beginning of the period, excluding any owners' contributions or distributions.

Question 2(c) Reasons why income concept is very important in accounting1. judgment of performance- efficiency- effectiveness2. description of economic processes- integrated- partial3. determination of the financial strengthQuestion 2 (d) (i) Why the management is prone to choose stable earnings trend?

To maintain investorsProvide good information for analyst to make decisionHigher share price-The stock become safer and potentially a better investmentQuestion 2(d)(ii) Two methods used to adjust earnings bay management1. Adjustment of Operating and Investing ActivitiesExample: Managing production, inventory, and sales

2. Adjustment of financing activitiesExample: Repurchasing outstanding stocks

Question 3(a)Identify the 5 theories or concept that contributes to conflicts between owners and managers.

A- Effort AdverseB- Cost of Shareholder Management ConflictC- Reservation UtilityD- Non- cooperative Game TheoryE- Self-interested Behavior

Question 3 (b) Discuss any 3 reasons of market failures of providing first-best information and how it is related to designing a contract between owners and managers1. First version of adverse selection problem, which states that if opportunities exist for industries to generate excessive profit by trading on basis of insider information, it causes outside investors to not perceive securities market as a level playing field. They will either reduce the amount they are willing to pay or withdraw from market. Information production is not first-best since useful information is held from market for insiders benefit.2. Second version of adverse selection problem, which arises when managers who know bad news regarding firm do not disclose the information to avoid or postpone negative firm consequences. This lacks timeliness and contributes to failure of producing first- best information.3. Net income does not completely provide information regarding effort. This is a reason why managers are able to disguise shirking, thus moral hazard problem will arise and earnings management problem which consequently leads to market failure.Question 3 (c) Criticize 4 options for owners in designing contract to control moral hazard.1. Direct monitoring. It is the method where owners costlessly monitor managers chosen act. But, first- best contract is frequently unattainable because it is unlikely for owners to monitor agents efforts in managerial setting as seen in owner-manager contact. This leads to information asymmetry.2. Indirect monitoring. It is when managerial effort is not directly observable, it is still possible to impute the efforts under some conditions. But, it cannot be relied on to ensure the attainment of a first-best contract.3. Owner rents to manager. Owner gives manager rights to 100% of payoff after paying a fixed rental price to owner. But this is not a common relationship. The owner is often worse off since contracting agreement has inefficient risk sharing.4.Profit sharing. It is widely used. This gives manage a share of profits and aligns managers incentives with owners and thus maximizes both. However, net income is not always informative. There is also a lag of management efforts.Question 3 (d) How accounting standards reduce moral hazard and promote high quality information- Provide guidelines for accountants to follow during the preparation of financial statements. By following accounting standards, financial statements would have higher quality information.- Accounting standards require full disclosure. Therefore, firm have to fully disclose the financial information to the users of financial statements. This would prevent information asymmetry from occurring and users could make better economic decisions.- Accounting standards serves as law to be followed and to be complied with. Those who do not comply with the accounting standard would cause violations. In short, it could help the detection of moral hazard in the company.

To show companies the relevance of sustainability and how to practice sustainability in a more meaningful manner. Source of reference for directors in assisting them to understand the growing relevance of sustainability and how companies can embed sustainability within the organization.

Question 4 (Part A)1)Why do some Malaysian companies issue sustainability reports ?2) What advantages do companies perceive in obtaining assurance for sustainability reports ?I) Improved board and CEO level engagement :With increased interest in sustainability disclosures and their importance for driving improvements in organizational strategy, performance and reputation, sustainability issues are moving up to the Board Room and C-Suite levels. Disclosures and data which are believed to be trustworthy and credible are more likely to be used for internal decision makingII) Strengthened internal reporting and management systems :Internal robust reporting systems and controls play an important role in stain ability performance and impacts. External assurance can help confirm that internal systems and controls are robust, and can recommend any necessary improvementiii) Improved stakeholder communication :Assurance processes may involve the review of a reporters stakeholder engagement processes. Some organizations use their reporting processes and/or sustainability reporting as the basis for on-going dialogue with stakeholders. Both of these can help promote mutual communication and understanding

3)Why has the practice of sustainability reporting varied around the world ?- A report containing disclosure of governance approach and of the environmental, social and economic performance and impacts of organizations

Question 4 Part BDiscuss any five (5) reasons why the sample companies might both believe in securities markets efficiency and engage in Earning Management.

-Taxation Motivations-Changes of CEO-IPO-To communicate information to investors-Political Motivations

Taxation authorities impose their own accounting rules for calculation of taxable income, reducing the firms ability to manoeuvre. Taxation should not play a major role in EM decisions in general. An exception occurs with respect to the choice of LIFO versus FIFO inventory method. During periods of rising prices, LIFO will usually result in lower reported profits and lower taxes, relative to FIFO. Much PAT research has tried to explain and predict firms inventory policy choices. Dopuch and Pincus (1988) reported evidence that tax savings are high for LIFO firms and that firms keep using FIFO do not suffer large tax consequences, for reasons including low amounts of inventory, high variability of inventory levels, high inventory turnover, and low effective tax rates.

Taxation Motivations

The bonus plan hypothesis predicts that CEOs approaching retirement would be particularly likely to engage in a strategy of income-maximization. CEOs of poorly performing firms may income-maximize to postpone termination. This motivation also applies to new CEOs, especially if large write-offs can be blamed on the previous CEO.Murphy and Zimmerman (1993) (MZ) examined the behaviour of four discretionary variables: research and development, advertising, capital expenditures, and accruals. MZ found that reducing R&D, advertising, and capital expenditures might be effective to increase current earnings but can potentially be quite costly. The accrual and accounting policy variables are less costly, since for the most part they are strictly paper devices. These studies face difficult methodological problems. (1) Could be difficult to tell whether lower discretionary variable values are due to EM or poor operation performance. (2) Could be difficult to tell whether any apparent EM is due to the new CEO or the old.

Changes of CEO

Firms making initial public offerings (IPOs) do not have an established market price, which raises the question of how to value the shares. Evidence found by Clarkson, Dontoh, Richardson, and Sefcik (1992) raises the possibility that managers of firms going public may manage the earnings reported in their prospectuses in the hope of receiving a higher price for their shares.Friedlan (1994) concluded that IPO firms did indeed make income-increasing discretionary accruals in the latest period prior to the IPO, relative to accruals in a comparable previous period. Accrual management seemed to be concentrated in the poorer-performing sample firms and in the smaller sample firms.

Initial Public Offerings

Earnings management used to communicate information to investors may seem questionable in view of efficient securities market theory. However, markets are only efficient in terms on publicly available information so if earnings management can reveal inside information, it can actually improve the informative nature of financial reporting.Management has the best (inside) information about future earnings prospects. So, responsible use of EM can increase the main diagonal probabilities of the information system.

To Communicate Information to Investors

Many companies are quite politically visible and may manage earnings to reduce their visibility, achieved through accounting practices and procedures to minimize reported net income, especially in highly prosperous periods. If they do not, public pressures may lead to increased government regulation or other means to lower profitability. This motivation underlies the size hypothesis of PAT.Jones (1991) found use of greater income-decreasing accruals during the year of ITC investigation than in years outside the investigation. Cahan (1992) found that firms under investigation for monopolistic practices used more income-decreasing accruals during investigation years relative to other years sampled.

Political MotivationsTHANK YOU