Chapter 03

Chapter 03 Key
20.
An empirically based theory could be described as being:

A. developed and supported on the basis of observations.
B. based on a set of accepted scales and measures.
C. based on a political approach developed in the early nation states.
D. related to a specific time period and not able to be generalised.
Chapter - Chapter 03 #20
Difficulty: Easy
Section: 3.02 Definition of theory
22.
The agency relationship:

A.
can lead to a loss of efficiency.
B.
can only work if principals are paid a bonus.
C.
involves delegating authority.
D. can lead to a loss of efficiency and involves delegating authority.
Difficulty: Easy
Section: 3.03 Positive Accounting Theory
23.
The efficiency perspective in PAT research considers:

A. the cost of risk capital ex antebefore the provision of additional accounting
information to reduce risk through monitoring.
B. what mechanisms are put in place 'up-front' with the objective of minimising
future agency costs
C. the interaction of many investors in the market for corporate shares to generate
efficient prices.
D. the lowest cost method of establishing which accounting methods are best for
particular enterprises.
Difficulty: Medium
25.
In the situation where a contractual arrangement has been negotiated that

provides managers with a bonus based on the profits generated by the entity:
A. The efficiency perspective identifies this as a way of minimising agency costs by
aligning the interests of the principal and the agent.
B. The opportunistic perspective predicts that managers will seek to adopt
accounting methods that best reflect the performance of the organisation.
C. The underlying premise of PAT is that agents (managers) aim to act in the best
interests of the organisation, so the bonus is recognition of those efforts.
D. The efficiency perspective identifies this as a way of minimising agency costs by
aligning the interests of the principal and the agent and the opportunistic
perspective predicts that managers will seek to adopt accounting methods that
best reflect the performance of the organisation.
Difficulty: Easy
26.
Positive Accounting Theory (PAT) assumes that principals are aware that agents
will act opportunistically, so principals stipulate in any bonus contract the
accounting methods to be applied. This means that:
A. A carefully worded contract is assumed by PAT to remove the potential for the
agent to overstate profits.
B. Agents will not be permitted to negotiate elements of the bonus contract
relating to the stipulation of accounting methods.
C. While the range of accounting treatments may be reduced, the cost of
stipulating all the methods for all circumstances is too high, so there will always
be scope for agents to opportunistically select accounting methods.
D. It is more efficient in terms of the assumptions of PAT not to use bonus plans for
agents.
Difficulty: Medium
27.
In a market where individuals are perfectly informed:

A. It could be assumed managers would ultimately bear costs associated with
bonding and monitoring.
B. There are no monitoring costs as managers will not risk acting in their own selfinterests.
C. Managers will receive a higher salary as principals will assume that managers
will act opportunistically.
D. Principals will bear the costs of bonding and monitoring so that they can remain
informed.
Difficulty: Easy
28.
The rational economic person assumption as it is used in PAT is that:

A. All action by all individuals is driven by multiple interests in achieving a wide
range of goals.
B. All individual action is driven by self-interest and individuals will act in an
opportunistic manner.
C. Individuals are governed by a desire to cooperate in organisations to achieve
the rational allocation of economic resources.
D. The rational person is concerned only with economic factors and so does not
assess the importance of non-economic impacts on their organisation.
Difficulty: Easy
29.
Within the principal/agent perspective of PAT, the price-protection approach is:

A. The principal pays the agent a lower salary on the basis that the agent is
expected to undertake opportunistic behaviour.
B. The contract between the principal and agent includes a clause that stipulates
the basis for pricing of goods so that the agent does not price the product too
highly in an effort to increase the agent's short-term rewards.
C. The contract between the principal and the agent specifies a period within
which the price paid for the services of the agent cannot be changed.
D. The contract between the principal and the agent includes an agreement
whereby the agent guarantees the price of the shares in the company will be
protected by the agent's actions.
Difficulty: Medium
30.
Using the PAT perspective of managers' behaviour, the effect of paying managers
a fixed income salary is that:
A. They will feel secure enough to accept risky projects for the organisation.
B. They will prefer not to have the organisation take on debt.
C. They will be free to consider the optimal investment options for the organisation
from the perspective of the principals.
D. They will feel secure enough to accept risky projects for the organisation and
they will be free to consider the optimal investment options for the organisation
from the perspective of the principals.
Difficulty: Medium
31.
Various researchers have indicated that when managers receive bonuses based on
accounting performance they will:
A. make every effort to maximise profits in any given period.
B. adopt projects with low initial returns to ensure long-term success.
C. ensure income is minimised in a year they will not reach their performance
target so that any profits can be recognised in later periods.
D. undertake long-term research and development projects if they are near to
retirement.
Difficulty: Easy
32.
From an efficiency perspective of PAT, what approach should be adopted when

managers are approaching retirement?
A. Increase the percentage of their remuneration that is paid out as bonuses based
on accounting profit in order to keep them motivated to work hard.
B.
Use a market-based bonus scheme.
C.
Make them redundant as early as possible.
D. Link an additional element of the manager's superannuation package to profits.
Difficulty: Medium
33.
Market-based bonus schemes may be considered more appropriate from a PAT

perspective in industries in which:
A. successful strategies will not be reflected in accounting profits for a number of
periods.
B. the price/earnings ratio is commonly greater than 12.
C. profits may be the subject of manipulation by managers.
D. capital investment is not an important strategic decision.
Difficulty: Easy
34.
Problems associated with rewarding managers based on share-price movements

include:
A. Share prices do not often reflect the value of the business.
B. Share prices are a 'noisy' measure of management performance.
C. Share prices track closely the profit measures so it is more efficient to just use
profit.
D. Share prices do not often reflect the value of the business and share prices are a
'noisy' measure of management performance.
Difficulty: Medium
35.
A combination of well-designed management compensation contracts, the market

for corporate takeovers and a well-informed labour market should:
A.
B.
C.
D.
not be necessary as any one of these methods will control a manager's actions.
ensure that managers only act in their own self-interest.
mean that, on average, managers work in the best interests of owners.
remove any monitoring and bonding costs required under PAT.
Difficulty: Easy
36.
Examples of behaviours that create agency costs of debt include situations where
the borrowing entity:
A.
B.
C.
D.
goes through a broker to raise debt funds.

pays minimal dividends.
invests in high-risk projects.
puts the borrowed money in the bank.
Difficulty: Easy
37.
Managers may be motivated to revalue assets where there are common forms of
debt covenants in place because:
A. It loosens the covenant and allows the business to borrow more.
B. Revaluing assets provides more relevant information for debt-holders to use
when making decisions.
C. Revaluing assets provides greater cash flows out of which to repay debt.
D. Revaluing assets provides more relevant information for debt-holders to use
when making decisions and provides greater cash flows out of which to repay
debt.
Difficulty: Medium
38.
Debt contracts will:

A. stipulate in advance all accounting methods to be used by managers.
B. ensure management has some discretionary ability to loosen restrictions
negotiated by debt-holders.
C. encourage the practice of claim dilution to ensure debts are repaid.
D. occasionally restrict accounting techniques used by a firm.
Difficulty: Medium
39.
Firms are subject to political costs when:

A. They are quite small and have little political influence.
B. They choose accounting policies that best reflect the performance of the firm.
C. They record high profits and share those profits in the form of increased wages.
D. They are highly visible, in the media or other arenas, often as a result of high
profits.
Difficulty: Medium
40.
An example of political costs under the PAT perspective is:

A.
contributions to political parties.
B. costs associated with increased wage claims by trade unions.
C. the cost of remaining largely unnoticed by government regulatory agencies.
D.
wage and salary deductions paid to unions.
Difficulty: Medium
41.
Creative accounting:
A. is a term used by the media to describe the process of selecting accounting
methods when creating reports that provide results desired by preparers.
B. occurs, according to PAT, because managers will work for their own interests.
C. occurs when account preparers choose not to follow accounting standards to
best reflect the performance of the firm.
D. is a term used by the media to describe the process of selecting accounting
methods when creating reports that provide results desired by preparers and
occurs, according to PAT, because managers will work for their own interests.
Difficulty: Hard
Section: 3.05 Accounting policy choice and creative accounting
42.
Criticisms of PAT include:

A. It does not provide a means of improving accounting practice.
B.
It is not value-free as it is claimed.
C. It is scientifically flawed since its hypotheses are frequently not supported by
research.
D.
all of the given answers.
Difficulty: Medium
Section: 3.06 Some criticisms of Positive Accounting Theory
43.
Which of the following are examples of categories of the main normative

accounting theories that were developed in the 1950s and 1960s?
A.
B.
C.
D.
current-cost accounting and conservatism

critical theory and opportunity-cost accounting
ABC costing and historical-cost accounting
deprival-value accounting and exit-price accounting
Difficulty: Easy
Section: 3.07 Normative accounting theories
44.
The general aim of the current-cost accounting theory is:

A. to provide calculation of income which, after adjusting for changing prices, could
be withdrawn from the entity and yet still leave the physical capital of the entity
intact.
B. to provide a statement of financial position valuation method that presents a
reflection of the capacity of the entity to adapt to changing conditions.
C. to provide calculation of income which, after adjusting for changing prices, could
be withdrawn from the entity and yet still leave the financial capital of the entity
intact.
D. to provide a statement of financial position valuation method that allows a more
reliable basis for decision making by providing current costs.
Difficulty: Medium

Difficulty: Hard
46.
Legitimacy Theory and Stakeholder Theory may both generate similar hypotheses
to Positive Accounting Theory. The difference between PAT and the other two
theories is that:
A.
different research methods are applied.
B. PAT does not explicitly consider the organisation in its broader social context.
C. PAT is the only theory that takes a 'positive' research perspective.
D. PAT considers owners and managers who cannot be considered legitimate
stakeholders.
Difficulty: Medium
Section: 3.08 Systems-oriented theories to explain accounting practice
47.
Stakeholders are:
A. anyone with a direct financial interest in the firm.
B. special interest groups concerned with the environmental actions of the firm.
C.
employees.
D. All of the people included in the given answers.
Difficulty: Easy
Section: 3.08 Systems-oriented theories to explain accounting practice
48.
Capture Theory may be described as taking the perspective that:

A. the regulated interest controls the regulation and the regulating body.
B. the principal has control over the agent through contracting and monitoring.
C. stakeholders compete to influence the entity in which they have a stake and
management attempts to capture that influence through voluntary disclosures.
D. the regulated interest is controlled by the regulation agency that generates the
regulations.
Difficulty: Medium
Section: 3.09 Theories that seek to explain why regulation is introduced
49.
Economic interest group theory of regulation adopts the notion that _____________
are considered to dominate the legislative process.
A.
B.
C.
D.
public interests
private interests
shareholders
debtholders
Difficulty: Medium
50.
A machine with a carrying amount of $9000 has a net selling price of $8000. The
replacement cost of this asset is $10 000 and the present value of future cash
flows is $9500. What is the deprival value of the machine?
A.
B.
C.
D.
$0
$8000
$9000
$9500
Difficulty: Medium
51.
An asset that has a deprival value of zero is likely to be:

A.
B.
C.
D.
goodwill.
intangible assets.
land.
goodwill and intangible assets.
Difficulty: Easy
52.
The development of exit-price accounting (or CoCoa) was based on which of the
following key assumptions?
A. Firms exist to increase the wealth of their owners.
B. Firms' successful operations are based on the ability of the firm to adapt to
changing circumstances.
C. Firms' capacity to adapt will be best reflected by the monetary value of the
organisation's net assets at statement of financial position date.
D.
All of the given answers are correct.
Difficulty: Easy
53.
A company has a debt contract in place which requires that the company's
working capital (ratio of current asset to current liabilities) must never fall below 2.
As balance date approaches, the company estimates that the working capital ratio
will be 1.9 and the company may default on its debt contract unless remedial
action is taken. Which of the following action(s) will increase the company's
working capital at balance day?
A.
B.
C.
D.
revalue plant and equipment by 10%

increase allowance for doubtful debts by 10%
increase provision for warranty claims by 10%
accelerate recognition of credit sales by 10%
Difficulty: Hard
54.
As part of the company's compensation plan, a chief executive officer (CEO) is paid
1% of net profit if net profit exceeds $20 00 000 but no more than $40 000 in a
given year. It is estimated that net profit for the year will exceed $45 00 000.
Under PAT the CEO will likely adopt which accounting policy
A.
B.
C.
D.
decrease reported profit as much as he can

decrease reported profit to $20 00 000
increase reported profit as much as he can
increase reported profit up to $40 00 000
Difficulty: Hard
55.
The pharmaceutical industry has been criticised in the financial press for
recognising excessive profits and investing less in research and development so
that the government is threatening the removal of tax concessions to the industry.
Under these conditions, PAT predicts that pharmaceutical companies are subject to
___________ costs and are likely to adopt _________________ accounting policies
A.
B.
C.
D.
agency; income increasing

agency; income decreasing
political; income increasing
political; income decreasing
Difficulty: Easy
56.
A company has a debt covenant in place that limits the amount it can borrow to
50% of its tangible assets. If the company's actual value for that ratio is
approaching violation of this debt covenant, consistent with PAT, management
would try to relax the constraint by:
A. switching from straight-line depreciation to reducing balance method.
B. increasing allowance for doubtful debts from 5% to 10%.
C.
increasing provision for warranty expenses.
D.
revaluing assets upwards.
Difficulty: Medium
57.
A new accounting standard requires ABC Ltd to recognise as expense all sharebased payments, specifically the issue of options to its employees. Prior to this
standard, the company need not do anything until the options are exercised. The
manager of ABC Ltd is worried about this new standard as the company is close to
a technical violation of its borrowing agreements that the debt-to-equity ratio be
less than 40%. Most of the options on issue are cash-settled and will require an
increase in liabilities. Which of the following accounting policies if adopted by the
company could reduce the likelihood of a debt covenant violation?
A. switching from accelerated depreciation to straight-line depreciation method
B.
decreasing provision for warranty expenses
C.
revaluing assets upwards
D.
Difficulty: Hard
58.
The predictions of PAT formulated by Watts and Zimmerman (1990) are largely
concentrated on the following predictions:
A. Managers of companies with bonus plans are likely to choose income increasing
accounting policies.
B. Managers of companies that are close to violating accounting-based debt
covenants are likely to choose income increasing accounting policies.
C. Managers of companies that are subject to greater political costs are likely to
choose income decreasing accounting policies.
D.
Difficulty: Medium
59.
To comply with AASB 101, in which section of the financial report should a
summary of accounting policies adopted by reporting entities be positioned?
A. anywhere in the notes to the accounts as long as this is disclosed
B.
anywhere in the financial report
C.
initial section of the notes to the accounts
D.
middle section of the notes to the accounts
Difficulty: Easy
Section: 3.04 Accounting policy selection and disclosure
60.
Which of the following accounting policies is consistent with creative accounting'?

A. A firm with management compensation contract changes its depreciation policy
from straight-line to accelerated rate method.
B. A start-up firm adopts a policy to expense research and development expenses
as incurred.
C. A profit making tobacco producing firm changes its depreciation policy from
straight-line to accelerated rate method.
D. A firm with debt contracts shifts inventory accounting policy from FIFO to LIFO
method.
Difficulty: Medium
Section: 3.05 Accounting policy choice and creative accounting
61.
Under PAT, a firm is aware that managers are likely to behave rationally. Which of
the following mechanisms will be the appropriate course of action for shareholders
to price protect against self-interested managers?
A.
Compensate managers at a fixed rate.
B. Compensate managers at a fixed rate plus bonus on the basis of performance.
C. Compensate managers at a fixed rate with extra perquisites.
D. Include debt covenants in the management compensation contract.
Difficulty: Medium
62.
A new accounting standard requires the provision of liabilities for share-based

payments that has implications in the firm's debt-to-equity ratio. Which of the
following accounting policy choices will reduce the probability of the firm violating
debt covenants in a debt agreement?
A.
Expense all research and development costs.
B. Shift from FIFO to weighted average inventory method.
C. Shift from straight-line to accelerated method of depreciation.
D. Shift from cost to revaluation method in accounting for land and buildings.
Difficulty: Medium
63.
A firm is close to violating the current ratio debt covenant in one of its loan
agreements. Which accounting action would you recommend to reduce the
likelihood of a technical violation?
A.
The firm should pay it accounts receivable.
B. The firm should obtain more debts from its suppliers.
C. The firm should call to convert a note payable to equity.
D. The firm should sell non-performing assets.
Difficulty: Medium
64.
Failure of an organisation to comply with negotiated debt covenants can lead to:
A. the operations of the organisation being suspended.
B. the organisation being placed in the hands of a party nominated by the lender.
C.
the lender taking control of the organisation.
D.
all of the given answers.
Difficulty: Medium
65.
PAT has been described as:

A.
B.
C.
D.
a vibrant philosophical movement.

providing valuable evidence.
being empty and commonplace.
forward thinking research.
Difficulty: Medium
Section: 3.06 Some criticisms of Positive Accounting Theory
66.
According to CoCoA current cash equivalents are represented by:

A.
the total of the current assets.
B.
the working capital.
C. the amount expected to be generated by selling an asset.
D.
the total of the monetary assets.
Difficulty: Easy
67.
Legitimacy Theory relies on the notion that there is a ________ _________ between
an organisation and the society in which it operates.
A.
B.
C.
D.
formal agreement
social contract
working relationship
government regulation

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Chapter 03

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Chapter 03 Key

An empirically based theory could be described as being:

The agency relationship:

The efficiency perspective in PAT research considers:

In the situation where a contractual arrangement has been negotiated that

In a market where individuals are perfectly informed:

The rational economic person assumption as it is used in PAT is that:

Within the principal/agent perspective of PAT, the price-protection approach is:

From an efficiency perspective of PAT, what approach should be adopted when

Market-based bonus schemes may be considered more appropriate from a PAT

Problems associated with rewarding managers based on share-price movements

A combination of well-designed management compensation contracts, the market

goes through a broker to raise debt funds.

Debt contracts will:

Firms are subject to political costs when:

An example of political costs under the PAT perspective is:

Criticisms of PAT include:

Which of the following are examples of categories of the main normative

current-cost accounting and conservatism

The general aim of the current-cost accounting theory is:

Chapter - Chapter 03 #45

Capture Theory may be described as taking the perspective that:

An asset that has a deprival value of zero is likely to be:

revalue plant and equipment by 10%

decrease reported profit as much as he can

agency; income increasing

Which of the following accounting policies is consistent with creative accounting'?

A new accounting standard requires the provision of liabilities for share-based

PAT has been described as:

a vibrant philosophical movement.

According to CoCoA current cash equivalents are represented by:

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