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ACCOUNTING AND FINANCE
AcF 311 FINANCIAL ACCOUNTING II
(Duration: available for 24 hours)
It is recommended that you attempt to complete the exam within 3 hours
Answer any TWO questions. ALL QUESTIONS carry equal marks.
The examiner will mark the answers to the first two questions submitted. Do not submit
answers to more than two questions as it will not be marked.
This exam is open-book.
1. Your answers must be typed and saved with the file name AcF 311 Exam
2020 as either a word file or a pdf. Please include the number of the
questions you have attempted in the file name.
2. Include your student number at the top of your answers.
3. You must upload your answers to moodle by 9.30 am on Tuesday 19th May
2020 (UK time).
4. The examiner will take account of the way in which answers are presented.
5. Maximum word limits are given for relevant discursive sections.
6. Show all relevant workings.
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QUESTION 1
Answer both Part A and Part B
Part A
An investor can choose between two actions ∈ ∀ ∈ {1, 2}. He faces three possi-
ble states ∈ ∀ ∈ {1, 2, 3} with probabilities ≥ 0 ∀ ∈ {1, 2, 3}:
states
1 2 3
probability 0.3 0.35 0.35
Outcomes conditional on states [ ∈ ∀ = (,) ] are the following:
states
1 2 3
actions 1 60 40 40
2 20 44 32
REQUIRED:
a) Assume that the investor has no additional information. Identify and explain the
action (1 or 2) the investor would choose.
(5 marks)
b) Now assume that the investor has access to an accounting system that partitions
the state space. Specifically, he has access to the information partition ∆1={1, 2} = {{1, 3}, {2}}.
Explain whether access to this information partition would
change the investor’s action choice. To answer the question, first describe the
investor’s action choices separately for each information signal and then derive
his overall expected outcome.
(10 marks)
c) Now assume that the investor can choose between two accounting systems.
Specifically, he can either access the information partition ∆1= {1,2} ={{1, 3}, {2}}
or the information partition ∆2= {1, 2} = �{1, 2}, {3}�. Identify the
information partition (∆1 or ∆2) the investor would choose. To do so, compare the
expected outcomes of both partitions and explain your rationale. You can refer to
your answers from a) and/or b) where appropriate.
(7 marks)
d) Think of the information partition ∆1 as an accounting system that prescribes fair
value measurement rules. Assume that, in the abstract model setting above, the
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investor would want to have access to the information partition ∆1. In a real-world
setting, explain why the investor might refrain from using ∆1. Provide at least
three reasons and explain each.
(8 marks)
Maximum word limit for Part A = 1,350 words
Part B
“[…] the valuation role of accounting will gradually decline from its now dominant role
and hence the relative importance of stewardship will increase. Both roles will remain
important; and their importance will vary across firms.”
[Zimmerman, J. L. (2015). The role of accounting in the twenty-first century firm, Ac-
counting and Business Research 45(4): p. 500]
REQUIRED:
a) Zimmerman (2015) discusses the objectives of financial accounting, i.e.,
valuation and contracting (or stewardship). He argues that the importance of
these objectives varies with the firm type. He describes two types of firms,
traditional firms and twenty-first century firms. Evaluate for which firm type the
valuation objective is more important and for which firm type the stewardship
objective is more important. Explain the underlying firm characteristics that drive
the differences in importance.
(8 marks)
b) Referring to the above quotation: Explain whether you agree with the author and
set out your rationale.
(12 marks)
Total for question 1: 50 marks
Maximum word limit for Part B = 900 words
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QUESTION 2
a) Accounting and real earnings management are different types of earnings
management. Define and explain both types and provide an example for each.
(6 marks)
Maximum word limit for part a) = 270 words
b) Accounting researchers work, among other things, with accrual models to
measure earnings management empirically. A specific accrual model is the
Jones (1991) model:
= 0 + 1∆ + 2 +
where i stands for firm and t for year. is total accruals, ∆ is change in
revenue and is gross property, plant and equipment. All variables are
scaled by total assets.