Practice exam Financial Accounting
Theory: Spring 2019
First four questions are from Litjens himself, other ones are created based on notes/slides.
1. Which industry could be best measured by the Healy Model?
A. Tesla
B. Shell
C. Apple
2. Which industry should not be calculated by using the DeAngelo Model?
A. Shell
B. Tesla
C. Philips
3. Do Brugstahler and Dichev (1997) identify Earnings Management to meet analysts’
expectations?
A. Yes, if not, the authors would expect to observe a relatively smooth cross-sectional distribution
of deviations of realized earnings from forecast.
B. No, since the authors haven’t executed a smoothness test they cannot conclude that Earnings
Management is been used to meet analysts’ expectations.
C. Yes, since the authors haven’t observed a sharp discontinuity in the vicinity of zero.
4. Looking at Equitation 1 from Ball & Shivakumar (2004), how do you interpret and explain a
negative α3 (alpha three)?
A. Alpha three is a dummy variable and can therefore not be zero.
B. Timely recognition of economic losses implies they are recognized as “transitory” increases in
income components that do tend to reverse.
C. Economic losses are recognized in a more timely fashion than gains.
5. Why have Watts & Zimmerman (1990) reviewed their prior publication regarding Positive
Accounting Theory?
A. To empirically test if Positive Accounting Theory is been used more than normative accounting.
B. To convey their perspective on the evolution and current state of Positive Accounting Theory.
C. To develop models that recognize the endogeneity among the variables in the regressions.
6. Watts & Zimmerman tested multiple hypotheses in their prior work. What is not a hypothesis
tested by Watts & Zimmerman (1990)?
A. Bonus plan hypothesis
B. Political cost hypothesis
C. Financial leverage hypothesis
, 7. Why is there a negative correlation between cash flow and accruals found by Bushman et al.
(2015)?
A. Presumably because accruals tend to mitigate timing and matching problems in cash flows
when reflecting firm performance.
B. Accruals have no statistical influence on cash flows.
C. The decreasing values of the sample confirm the drastic decline in the smoothing relationship.
8. Why does the correlation between cash flows and accruals found by Bushman et al. (2015)
have a declining trend?
A. The declining trend suggests that the relative prominence of the timing role of accrual
accounting has dramatically declined over time.
B. The declining trend suggests that the absolute prominence of the timing role of accrual
accounting has partially declined over time.
C. Bushman et al. cannot explain the declining trend since the adjusted R² is not significant.
9. What could be the economic effect of timely accounting loss recognition, by accurate
timeliness of write-downs e.g. stated by Vyas (2010)?
A. Increase of a firm’s risk exposure.
B. A more timely market loss recognition.
C. Preventing stock price adjustments.
10. How is the paper of Vyas (2010) linked to the paper of Watts & Zimmerman (1990)?
A. They both imply that managers’ choice of accounting are irrelevant since standards dominate
incentives.
B. They both empirically test the same hypotheses.
C. Positive accounting tries to explain actual accounting practices like timeliness of write downs.
11. Figure 1 of Ball & Brown (1968) describes what?
A. It demonstrates that the information contained in the annual income number is useful in that
if actual income differs from expected income, the market typically has reacted in the same
direction.
B. It demonstrates that the information contained in the annual income number is useful in that
if actual income differs from expected income, the market typically has reacted in the opposite
direction.
C. It reveals a market negative association between the sign of error in forecasting income and
the Abnormal Performance Index.
Theory: Spring 2019
First four questions are from Litjens himself, other ones are created based on notes/slides.
1. Which industry could be best measured by the Healy Model?
A. Tesla
B. Shell
C. Apple
2. Which industry should not be calculated by using the DeAngelo Model?
A. Shell
B. Tesla
C. Philips
3. Do Brugstahler and Dichev (1997) identify Earnings Management to meet analysts’
expectations?
A. Yes, if not, the authors would expect to observe a relatively smooth cross-sectional distribution
of deviations of realized earnings from forecast.
B. No, since the authors haven’t executed a smoothness test they cannot conclude that Earnings
Management is been used to meet analysts’ expectations.
C. Yes, since the authors haven’t observed a sharp discontinuity in the vicinity of zero.
4. Looking at Equitation 1 from Ball & Shivakumar (2004), how do you interpret and explain a
negative α3 (alpha three)?
A. Alpha three is a dummy variable and can therefore not be zero.
B. Timely recognition of economic losses implies they are recognized as “transitory” increases in
income components that do tend to reverse.
C. Economic losses are recognized in a more timely fashion than gains.
5. Why have Watts & Zimmerman (1990) reviewed their prior publication regarding Positive
Accounting Theory?
A. To empirically test if Positive Accounting Theory is been used more than normative accounting.
B. To convey their perspective on the evolution and current state of Positive Accounting Theory.
C. To develop models that recognize the endogeneity among the variables in the regressions.
6. Watts & Zimmerman tested multiple hypotheses in their prior work. What is not a hypothesis
tested by Watts & Zimmerman (1990)?
A. Bonus plan hypothesis
B. Political cost hypothesis
C. Financial leverage hypothesis
, 7. Why is there a negative correlation between cash flow and accruals found by Bushman et al.
(2015)?
A. Presumably because accruals tend to mitigate timing and matching problems in cash flows
when reflecting firm performance.
B. Accruals have no statistical influence on cash flows.
C. The decreasing values of the sample confirm the drastic decline in the smoothing relationship.
8. Why does the correlation between cash flows and accruals found by Bushman et al. (2015)
have a declining trend?
A. The declining trend suggests that the relative prominence of the timing role of accrual
accounting has dramatically declined over time.
B. The declining trend suggests that the absolute prominence of the timing role of accrual
accounting has partially declined over time.
C. Bushman et al. cannot explain the declining trend since the adjusted R² is not significant.
9. What could be the economic effect of timely accounting loss recognition, by accurate
timeliness of write-downs e.g. stated by Vyas (2010)?
A. Increase of a firm’s risk exposure.
B. A more timely market loss recognition.
C. Preventing stock price adjustments.
10. How is the paper of Vyas (2010) linked to the paper of Watts & Zimmerman (1990)?
A. They both imply that managers’ choice of accounting are irrelevant since standards dominate
incentives.
B. They both empirically test the same hypotheses.
C. Positive accounting tries to explain actual accounting practices like timeliness of write downs.
11. Figure 1 of Ball & Brown (1968) describes what?
A. It demonstrates that the information contained in the annual income number is useful in that
if actual income differs from expected income, the market typically has reacted in the same
direction.
B. It demonstrates that the information contained in the annual income number is useful in that
if actual income differs from expected income, the market typically has reacted in the opposite
direction.
C. It reveals a market negative association between the sign of error in forecasting income and
the Abnormal Performance Index.
