INSTRUCTOR’S SOLUTIONS MANUAL
FINANCIAL ACCOUNTING THEORY
8TH CANADIAN EDITION
CHAPTER 1: INTRODUCTION
1.1 The Objective of This Book
1.2 Some Historical Perspective
1.3 The 2007-2008 Market Meltdowns
1.4 Efficient Contracting
1.5 A Note on Ethical Behaviour
1.6 Rules-Based versus Principles-Based Accounting Standards
1.7 The Complexity of Information in Financial Accounting and Reporting
1.8 The Role of Accounting Research
1.9 The Importance of Information Asymmetry
1.10 The Fundamental Problem of Financial Accounting Theory
1.11 Regulation as a Reaction to the Fundamental Problem
1.12 The Organization of This Book
1.12.1 Ideal Conditions
1.12.2 Adverse Selection
1.12.3 Moral Hazard
1.12.4 Standard Setting
1.12.5 The Process of Standard Setting
1.13 Relevance of Financial Accounting Theory to Accounting Practice
,LEARNING OBJECTIVES AND SUGGESTED TEACHING APPROACHES
1. The Broad Outline of the Book
I use Figure 1.1 as a template to describe the broad outline of the book. Since the students
typically have not had a chance to read Chapter 1 in the first course session, I stick fairly
closely to the chapter material.
The major points I discuss are:
• Accounting in an ideal setting. Here, present-value-based accounting is
natural. I go over the ideal conditions needed for such a basis of accounting
to be feasible, but do not go into much detail because this topic is covered
in greater depth in Chapter 2.
• An introduction to the concept of information asymmetry and resulting
problems of adverse selection and moral hazard. These problems are basic
to the book and I feel it is desirable for the students to have a “first go” at
them at this point. I concentrate on the intuition underlying the two
problems. For example, adverse selection can be illustrated by asking who
would be first in line to purchase life insurance if there was no medical
examination, or what quality of used cars are likely to be brought to market.
For moral hazard I try to pin them down on how hard they would work in
this course if there were no exams.
• The environment in which financial accounting and reporting operates. My
main goal at this point is that the students do not take this environment for
granted. I discuss the procedures of standard setting briefly and point out
that this is really a process of regulation. In the past, there have been well-
known cases of deregulation, such as airlines, trucking, financial
institutions, power generation. However, regulation of financial institutions
increased following the 2007-2008 market meltdowns (Section 1.3).
Currently, at least in the United States, some of these regulations are being
rolled back. Instructors may wish to anticipate briefly the pros and cons of
, markets v. regulation now since this topic becomes important in Chapters
12 and 13.
2. The Concept of Information
By now, I will have referred to the term “information” several times. I suggest that it is
easy to take this term for granted, and call for definitions. This usually generates
considerable hesitation by the students. The purpose at this point is simply to get them to
realize that information is a complex commodity. Indeed, I make an analogy between the
financial accounting and reporting industry and a stereotypical manufacturing industry
such as agriculture or automobiles, and ask what is the product of the accounting industry,
why is it valuable, how is it quantified? I do not go deeply into the answers to questions
like these, since some decision-theoretic machinery needs to be developed (Section 3.3)
before a precise definition of information can be given. Nevertheless, I try to end up with
the conclusions that information has something to do with improving the process of
decision-making, and that it is crucial to the operation of securities markets.
3. Relevance to Accounting Practice
My undergraduate accounting theory classes usually consist of a majority of students who
are heading for a professional accounting designation. There are usually also some students
heading for careers in management.
Since students who are facing professional accounting exams can be quite focused in their
learning objectives, it is essential that the nature of the course in relation to these objectives
be discussed up front.
I begin by pointing out that the book is intended to give the student an appreciation and
understanding of the financial reporting environment, which should help with breadth
questions on professional exams. I also argue that one’s career continues well beyond
attainment of a professional accounting designation, and that the nature of the textbook is
longer-run and designed to foster a critical awareness of the financial accounting
environment, which is needed if one is to become a thoughtful professional.
, Arguments such as these can only be pushed so far. Nevertheless, I think it is important to
make them. I also point out that the text includes coverage of major accounting standards
such as financial instruments, impairment, consolidations, and de-recognition; and that
they will have the opportunity to learn the broad outlines of these standards on the way
through.
I also refer the students to Section 1.13, and emphasize that the text recognizes an
obligation to convince them that the material is relevant to their careers. To do this, the text
explains theoretical concepts in intuitive terms, and illustrates and motivates the concepts
based on a series of Theory in Practice vignettes, and problem material based frequently
on articles from the financial press and relevant research findings.
For the management students in the class, and for the professional accounting students who
may some day be managers, I emphasize that the text does not ignore them. Chapters 8 to
11 inclusive (the bottom branch of Figure 1.1) deal with topics of interest to managers,
including economic consequences, conflict resolution, executive compensation and
earnings management. All of these topics demonstrate that management has a legitimate
interest in financial reporting. I also argue that Chapters 2 to 7 inclusive (the top branch of
Figure 1.1) are relevant to managers since they give insights into how financial accounting
information is used by investors. Finally, since management is a major constituency in
standard setting, a critical awareness of the need for standard setting and the standard-
setting process (Chapters 12 and 13) is useful for any manager.
I have not had problems with student course evaluations as a result of using the material in
this book. In fact, I have constantly been surprised at how far one can push the students in
a theoretical direction providing that I rely on the textbook material to give the students an
intuitive understanding, and concentrate in class on illustrating, motivating and discussing
the application of the concepts. For this, I find that the financial media are helpful sources
of current articles which I bring to class to serve as a basis for discussion. Numerous such
articles form the basis of most “Theory in Practice” vignettes scattered throughout the text.
FINANCIAL ACCOUNTING THEORY
8TH CANADIAN EDITION
CHAPTER 1: INTRODUCTION
1.1 The Objective of This Book
1.2 Some Historical Perspective
1.3 The 2007-2008 Market Meltdowns
1.4 Efficient Contracting
1.5 A Note on Ethical Behaviour
1.6 Rules-Based versus Principles-Based Accounting Standards
1.7 The Complexity of Information in Financial Accounting and Reporting
1.8 The Role of Accounting Research
1.9 The Importance of Information Asymmetry
1.10 The Fundamental Problem of Financial Accounting Theory
1.11 Regulation as a Reaction to the Fundamental Problem
1.12 The Organization of This Book
1.12.1 Ideal Conditions
1.12.2 Adverse Selection
1.12.3 Moral Hazard
1.12.4 Standard Setting
1.12.5 The Process of Standard Setting
1.13 Relevance of Financial Accounting Theory to Accounting Practice
,LEARNING OBJECTIVES AND SUGGESTED TEACHING APPROACHES
1. The Broad Outline of the Book
I use Figure 1.1 as a template to describe the broad outline of the book. Since the students
typically have not had a chance to read Chapter 1 in the first course session, I stick fairly
closely to the chapter material.
The major points I discuss are:
• Accounting in an ideal setting. Here, present-value-based accounting is
natural. I go over the ideal conditions needed for such a basis of accounting
to be feasible, but do not go into much detail because this topic is covered
in greater depth in Chapter 2.
• An introduction to the concept of information asymmetry and resulting
problems of adverse selection and moral hazard. These problems are basic
to the book and I feel it is desirable for the students to have a “first go” at
them at this point. I concentrate on the intuition underlying the two
problems. For example, adverse selection can be illustrated by asking who
would be first in line to purchase life insurance if there was no medical
examination, or what quality of used cars are likely to be brought to market.
For moral hazard I try to pin them down on how hard they would work in
this course if there were no exams.
• The environment in which financial accounting and reporting operates. My
main goal at this point is that the students do not take this environment for
granted. I discuss the procedures of standard setting briefly and point out
that this is really a process of regulation. In the past, there have been well-
known cases of deregulation, such as airlines, trucking, financial
institutions, power generation. However, regulation of financial institutions
increased following the 2007-2008 market meltdowns (Section 1.3).
Currently, at least in the United States, some of these regulations are being
rolled back. Instructors may wish to anticipate briefly the pros and cons of
, markets v. regulation now since this topic becomes important in Chapters
12 and 13.
2. The Concept of Information
By now, I will have referred to the term “information” several times. I suggest that it is
easy to take this term for granted, and call for definitions. This usually generates
considerable hesitation by the students. The purpose at this point is simply to get them to
realize that information is a complex commodity. Indeed, I make an analogy between the
financial accounting and reporting industry and a stereotypical manufacturing industry
such as agriculture or automobiles, and ask what is the product of the accounting industry,
why is it valuable, how is it quantified? I do not go deeply into the answers to questions
like these, since some decision-theoretic machinery needs to be developed (Section 3.3)
before a precise definition of information can be given. Nevertheless, I try to end up with
the conclusions that information has something to do with improving the process of
decision-making, and that it is crucial to the operation of securities markets.
3. Relevance to Accounting Practice
My undergraduate accounting theory classes usually consist of a majority of students who
are heading for a professional accounting designation. There are usually also some students
heading for careers in management.
Since students who are facing professional accounting exams can be quite focused in their
learning objectives, it is essential that the nature of the course in relation to these objectives
be discussed up front.
I begin by pointing out that the book is intended to give the student an appreciation and
understanding of the financial reporting environment, which should help with breadth
questions on professional exams. I also argue that one’s career continues well beyond
attainment of a professional accounting designation, and that the nature of the textbook is
longer-run and designed to foster a critical awareness of the financial accounting
environment, which is needed if one is to become a thoughtful professional.
, Arguments such as these can only be pushed so far. Nevertheless, I think it is important to
make them. I also point out that the text includes coverage of major accounting standards
such as financial instruments, impairment, consolidations, and de-recognition; and that
they will have the opportunity to learn the broad outlines of these standards on the way
through.
I also refer the students to Section 1.13, and emphasize that the text recognizes an
obligation to convince them that the material is relevant to their careers. To do this, the text
explains theoretical concepts in intuitive terms, and illustrates and motivates the concepts
based on a series of Theory in Practice vignettes, and problem material based frequently
on articles from the financial press and relevant research findings.
For the management students in the class, and for the professional accounting students who
may some day be managers, I emphasize that the text does not ignore them. Chapters 8 to
11 inclusive (the bottom branch of Figure 1.1) deal with topics of interest to managers,
including economic consequences, conflict resolution, executive compensation and
earnings management. All of these topics demonstrate that management has a legitimate
interest in financial reporting. I also argue that Chapters 2 to 7 inclusive (the top branch of
Figure 1.1) are relevant to managers since they give insights into how financial accounting
information is used by investors. Finally, since management is a major constituency in
standard setting, a critical awareness of the need for standard setting and the standard-
setting process (Chapters 12 and 13) is useful for any manager.
I have not had problems with student course evaluations as a result of using the material in
this book. In fact, I have constantly been surprised at how far one can push the students in
a theoretical direction providing that I rely on the textbook material to give the students an
intuitive understanding, and concentrate in class on illustrating, motivating and discussing
the application of the concepts. For this, I find that the financial media are helpful sources
of current articles which I bring to class to serve as a basis for discussion. Numerous such
articles form the basis of most “Theory in Practice” vignettes scattered throughout the text.
