BUSN3001 Exam Questions with Correct
Answers
Why would offering managers only a fixed salary not be in the interests of the owners of an
organisation? - **Lack of Performance Incentive**
- **Misalignment of Interests**
- **Reduced Risk-Taking**
- **No Motivation for Long-Term Growth**
- **Difficulty in Attracting and Retaining Talent**
- **Potential for Complacency**
Traditionally, organisations have tended to choose accounting methods that applied conservative
measures of profits, net assets, and therefore equity. From a contracting perspective, why do you
think this might have been the case? Improved Monitoring for Stakeholders: Conservative
accounting methods are more verifiable and harder to manipulate, making it easier for
shareholders and debtholders to monitor managers' activities effectively.
Protection for Debtholders: Deferring profit recognition through conservative methods reduces
the chance of excessive dividends, preserving funds within the firm to secure debt repayments.
Early Activation of Debt Covenants: Lower net assets and profits mean debt covenants may
trigger earlier, allowing debtholders to intervene sooner to protect their interests if financial
performance declines.
Reduction of Earnings Manipulation: Conservative methods reduce the potential for
opportunistic earnings management by managers, leading to more reliable financial reporting.
,Lower Cost of Capital: By lowering perceived risks for debt and equity holders, conservative
accounting can make the firm more attractive, potentially leading to reduced borrowing and
equity costs.
What are conservative accounting methods Conservative accounting methods are
practices that tend to report lower estimates of profits, assets, and equity, often by recognizing
potential losses or liabilities sooner and delaying the recognition of revenues or gains until they
are more certain. These methods create a "cushion" that provides a more cautious view of a
company's financial health.
Why Analyst Earnings Forecasts Might Affect Earnings Management Pressure to Meet
Expectations: Companies face pressure to meet or beat analyst forecasts to maintain stock price
stability, investor confidence, and management credibility. When forecasts are high, managers
may engage in earnings management techniques to align reported earnings with these forecasts.
Incentive to Avoid Negative Surprises: Negative surprises (earnings below forecasts) can result
in stock price drops, increased financing costs, and loss of market reputation. To avoid these
outcomes, managers might manipulate earnings to reach or exceed analysts' targets.
Impact on Executive Compensation: Performance-based incentives tied to meeting earnings
targets can motivate managers to adjust financial results to meet forecasted numbers.
Why Earnings Management Might Affect Analyst Earnings Forecasts Influence on Future
Projections: When companies manage earnings to meet forecasts, analysts may base future
projections on these managed (and often inflated) figures, setting an artificially high benchmark
that creates ongoing pressure for earnings management.
Distorted Financial Trends: Consistent earnings management creates a misleading view of the
company's financial health and performance trends, leading analysts to issue forecasts based on
inaccurately high or stable past earnings.
, Reinforcing the Expectation Cycle: As managers meet forecasts through earnings management,
analysts may become conditioned to expect this pattern, making it more challenging for
companies to deviate from managed results without triggering negative market reactions.
Why do you think that corporate managers will make lobbying submissions to the IASB when it
is in the process of developing new international financial reporting standards? - **Protect
Existing Contractual Agreements**: Managers may lobby to influence standards that affect
financial covenants, such as debt-to-asset ratios, to avoid potential covenant breaches and
maintain favorable financing terms.
- **Reduce Covenant Breach Risks**: Managers might support standards that increase assets or
decrease liabilities to create a buffer against debt covenant violations, which helps lower
financing risk.
- **Avoid Economic Consequences**: They may oppose standards that decrease assets or
increase liabilities due to negative impacts on reported financial health, which can affect
creditworthiness and investment attractiveness.
- **Preserve Flexibility in Reporting**: From an efficiency standpoint, managers often believe
they are best suited to choose accounting methods that accurately reflect their organization's
financial performance, so they might lobby to maintain flexibility in reporting standards.
- **Oppose Restrictions on Accounting Methods**: Managers may lobby against IASB-imposed
limitations on existing accounting practices, as they perceive these restrictions could hinder their
ability to report efficiently.
- **Mix of Self-Interest and Reporting Efficiency**: Lobbying efforts may stem from both self-
interest (to protect managers' positions and interests) and genuine concerns over efficient and
accurate financial reporting.
- **Transparency of Lobbying Submissions**: The IASB makes these lobbying submissions
publicly available, allowing stakeholders to see the positions and concerns of interested parties.
Answers
Why would offering managers only a fixed salary not be in the interests of the owners of an
organisation? - **Lack of Performance Incentive**
- **Misalignment of Interests**
- **Reduced Risk-Taking**
- **No Motivation for Long-Term Growth**
- **Difficulty in Attracting and Retaining Talent**
- **Potential for Complacency**
Traditionally, organisations have tended to choose accounting methods that applied conservative
measures of profits, net assets, and therefore equity. From a contracting perspective, why do you
think this might have been the case? Improved Monitoring for Stakeholders: Conservative
accounting methods are more verifiable and harder to manipulate, making it easier for
shareholders and debtholders to monitor managers' activities effectively.
Protection for Debtholders: Deferring profit recognition through conservative methods reduces
the chance of excessive dividends, preserving funds within the firm to secure debt repayments.
Early Activation of Debt Covenants: Lower net assets and profits mean debt covenants may
trigger earlier, allowing debtholders to intervene sooner to protect their interests if financial
performance declines.
Reduction of Earnings Manipulation: Conservative methods reduce the potential for
opportunistic earnings management by managers, leading to more reliable financial reporting.
,Lower Cost of Capital: By lowering perceived risks for debt and equity holders, conservative
accounting can make the firm more attractive, potentially leading to reduced borrowing and
equity costs.
What are conservative accounting methods Conservative accounting methods are
practices that tend to report lower estimates of profits, assets, and equity, often by recognizing
potential losses or liabilities sooner and delaying the recognition of revenues or gains until they
are more certain. These methods create a "cushion" that provides a more cautious view of a
company's financial health.
Why Analyst Earnings Forecasts Might Affect Earnings Management Pressure to Meet
Expectations: Companies face pressure to meet or beat analyst forecasts to maintain stock price
stability, investor confidence, and management credibility. When forecasts are high, managers
may engage in earnings management techniques to align reported earnings with these forecasts.
Incentive to Avoid Negative Surprises: Negative surprises (earnings below forecasts) can result
in stock price drops, increased financing costs, and loss of market reputation. To avoid these
outcomes, managers might manipulate earnings to reach or exceed analysts' targets.
Impact on Executive Compensation: Performance-based incentives tied to meeting earnings
targets can motivate managers to adjust financial results to meet forecasted numbers.
Why Earnings Management Might Affect Analyst Earnings Forecasts Influence on Future
Projections: When companies manage earnings to meet forecasts, analysts may base future
projections on these managed (and often inflated) figures, setting an artificially high benchmark
that creates ongoing pressure for earnings management.
Distorted Financial Trends: Consistent earnings management creates a misleading view of the
company's financial health and performance trends, leading analysts to issue forecasts based on
inaccurately high or stable past earnings.
, Reinforcing the Expectation Cycle: As managers meet forecasts through earnings management,
analysts may become conditioned to expect this pattern, making it more challenging for
companies to deviate from managed results without triggering negative market reactions.
Why do you think that corporate managers will make lobbying submissions to the IASB when it
is in the process of developing new international financial reporting standards? - **Protect
Existing Contractual Agreements**: Managers may lobby to influence standards that affect
financial covenants, such as debt-to-asset ratios, to avoid potential covenant breaches and
maintain favorable financing terms.
- **Reduce Covenant Breach Risks**: Managers might support standards that increase assets or
decrease liabilities to create a buffer against debt covenant violations, which helps lower
financing risk.
- **Avoid Economic Consequences**: They may oppose standards that decrease assets or
increase liabilities due to negative impacts on reported financial health, which can affect
creditworthiness and investment attractiveness.
- **Preserve Flexibility in Reporting**: From an efficiency standpoint, managers often believe
they are best suited to choose accounting methods that accurately reflect their organization's
financial performance, so they might lobby to maintain flexibility in reporting standards.
- **Oppose Restrictions on Accounting Methods**: Managers may lobby against IASB-imposed
limitations on existing accounting practices, as they perceive these restrictions could hinder their
ability to report efficiently.
- **Mix of Self-Interest and Reporting Efficiency**: Lobbying efforts may stem from both self-
interest (to protect managers' positions and interests) and genuine concerns over efficient and
accurate financial reporting.
- **Transparency of Lobbying Submissions**: The IASB makes these lobbying submissions
publicly available, allowing stakeholders to see the positions and concerns of interested parties.
