Accounting Standards: Are We Ready for Principles-Based by William Sinnett, Financial Executives Research Foundation

By William Sinnett, Financial Executives Research Foundation

This informative Q&A variety document summarizes the problems and implications surrounding the potential of an industry-wide swap in accounting criteria from a spotlight on distinctive ideas to a concentrate on huge ideas. specialists from fee WaterhouseCoopers (PwC) and the monetary Accounting criteria Board (FASB) solution thought-provoking questions on the effect of principles-based accounting criteria at the total.

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Given that the accounting measurement s is noisy, it is clear that the capital market is unable to make perfect inferences of either k or θ. The capital market will need to assess posterior distributions of k and θ conditional on s. In order to do this, the market needs to conjecture an investment policy k(θ) that describes beliefs about how the firm would choose an investment level contingent on each value of θ that the manager could observe. Given such a conjectured investment policy, an assessed posterior distribution on θ would statistically imply a posterior distribution on k, so no further assessments are needed.

If it is assumed that the firm’s investments remain unchanged at some prespecified levels, say K ∗ , N ∗ then the ex ante value of the firm would be 2µ(K ∗ )α (N ∗ )β − K ∗ − N ∗ in all three disclosure regimes. Thus it would be moot whether intangibles are measured or expensed, even though the statistical associations between accounting data and stock prices would change with the disclosure regime. Different ways 53 of studying the issue may identify different sources of real effects, but consideration of such real effects is essential to the debate.

3. Given assumptions (A1) through (A4), when the profitability of investment θ is known to the firm’s manager but unknown to the capital market, and the firm’s investment is measured imprecisely, the equilibrium investment schedule has the linear form k(θ) = bθ. The value of the parameter b depends on the amount of noise (σ 2 ) in accounting measurements. Any b in the interval 1c ≤ b ≤ 1+2γ c is sustainable by some corresponding value of σ 2 . Notice that b = 1c corresponds to managerial myopia and b = 1+2γ c corresponds to perfect signalling.

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