INSTRUCTOR’S SOLUTIONS MANUAL
for
Financial Accounting
Theory
Seventh Edition
William R. Scott
University of Waterloo
Toronto
Copyright © 2015 Pearson Canada Inc., Toronto, Ontario. All rights reserved. This work is protected by Canadian
copyright laws and is provided solely for the use of instructors in teaching their courses and assessing student learning.
Dissemination or sale of any part of this work (including on the Internet) will destroy the integrity of the work and is not
permitted. The copyright holder grants permission to instructors who have adopted Financial Accounting Theory, Seventh
Edition, by William R. Scott to post this material online only if the use of the website is restricted by access codes to
students in the instructor’s class that is using the textbook and provided the reproduced material bears this copyright
notice.
, Contents
Chapter 1 Introduction.................................................................................................. 1
Chapter 2 Accounting Under Ideal Conditions .......................................................... 7
Chapter 3 The Decision Usefulness Approach to Financial Reporting...................... 68
Chapter 4 Efficient Securities Markets ...................................................................... 129
Chapter 5 The Value Relevance of Accounting Information ..................................... 153
Chapter 6 The Measurement Approach to Decision Usefulness ................................ 194
Chapter 7 Measurement Applications ........................................................................ 237
Chapter 8 The Efficient Contracting Approach to Decision Usefulness.................... 285
Chapter 9 An Analysis of Conflict ...........................................................................321
Chapter 10 Executive Compensation .........................................................................371
Chapter 11 Earnings Management .............................................................................425
Chapter 12 Standard Setting: Economic Issues ..........................................................487
Chapter 13 Standard Setting: Political Issues.............................................................527
Copyright © 2015 Pearson Canada Inc.
,Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 1
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 v. 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
1
Copyright © 2015 Pearson Canada Inc.
, Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 1
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, we are entering what is likely to be a period
of increasing regulation, at least for financial institutions. Instructors
2
Copyright © 2015 Pearson Canada Inc.
for
Financial Accounting
Theory
Seventh Edition
William R. Scott
University of Waterloo
Toronto
Copyright © 2015 Pearson Canada Inc., Toronto, Ontario. All rights reserved. This work is protected by Canadian
copyright laws and is provided solely for the use of instructors in teaching their courses and assessing student learning.
Dissemination or sale of any part of this work (including on the Internet) will destroy the integrity of the work and is not
permitted. The copyright holder grants permission to instructors who have adopted Financial Accounting Theory, Seventh
Edition, by William R. Scott to post this material online only if the use of the website is restricted by access codes to
students in the instructor’s class that is using the textbook and provided the reproduced material bears this copyright
notice.
, Contents
Chapter 1 Introduction.................................................................................................. 1
Chapter 2 Accounting Under Ideal Conditions .......................................................... 7
Chapter 3 The Decision Usefulness Approach to Financial Reporting...................... 68
Chapter 4 Efficient Securities Markets ...................................................................... 129
Chapter 5 The Value Relevance of Accounting Information ..................................... 153
Chapter 6 The Measurement Approach to Decision Usefulness ................................ 194
Chapter 7 Measurement Applications ........................................................................ 237
Chapter 8 The Efficient Contracting Approach to Decision Usefulness.................... 285
Chapter 9 An Analysis of Conflict ...........................................................................321
Chapter 10 Executive Compensation .........................................................................371
Chapter 11 Earnings Management .............................................................................425
Chapter 12 Standard Setting: Economic Issues ..........................................................487
Chapter 13 Standard Setting: Political Issues.............................................................527
Copyright © 2015 Pearson Canada Inc.
,Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 1
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 v. 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
1
Copyright © 2015 Pearson Canada Inc.
, Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 1
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, we are entering what is likely to be a period
of increasing regulation, at least for financial institutions. Instructors
2
Copyright © 2015 Pearson Canada Inc.
