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    The Decision Usefulness Approach To Financial Reporting

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    Aisyah Fitri
    Financial Accountaning Theory, William R. Scott

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    The Decision Usefulness Approach To Financial Reporting

    Uploaded by

    Aisyah Fitri
    140 views16 pages
    Financial Accountaning Theory, William R. Scott

    Original Title

    scot_ch03

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    Financial Accountaning Theory, William R. Scott

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    140 views16 pages

    The Decision Usefulness Approach To Financial Reporting

    Uploaded by

    Aisyah Fitri
    Financial Accountaning Theory, William R. Scott

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
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    Chapter 3

    The Decision Usefulness


    Approach to Financial
    Reporting

    Copyright 2009 by Pearson Education Canada

    3-1

    Chapter 3
    The Decision Usefulness Approach to Financial Reporting

    Copyright 2009 by Pearson Education Canada

    3-2

    3.2 The Decision Usefulness


    Approach
    It is the investors responsibility to make
    investment decisions
    Role of financial reporting is to supply
    information that is useful for this purpose
    To prepare useful information, the accountant
    must know how investors make decisions

    Copyright 2009 by Pearson

    3-3

    3.3 The Rational Decision Theory


    Model
    A model of rational decision making in the face of
    uncertainty
    Definition of rationality?

    A game against nature: nature does not think


    Other ways to make decisions?

    Continued

    Copyright 2009 by Pearson

    3-4

    3.3 The Rational Decision Theory


    Model (continued)
    Role of the rational decision theory model in
    financial reporting
    Helps us understand how financial statement
    information helps investors to make investment
    decisions
    Captures average investor behaviour?

    Copyright 2009 by Pearson

    3-5

    Bayes Theorem
    A device to revise state probabilities upon
    receipt of new evidence
    is state of nature
    m is message received
    P() is prior probability of (subjective)

    Formula
    P / m

    P P m /
    P m / P

    Copyright 2009 by Pearson

    3-6

    Bayes Theorem Applied to


    Accounting Information
    is state of firm
    1 = H = high future firm performance
    2 = L = low future firm performance

    m is evidence received from the financial statements


    m1 = GN = net income shows good news
    m2 = BN = net income shows bad news

    Suppose GN is received:

    Copyright 2009 by Pearson

    3-7

    3.3.2 The Information System I


    Shows Evidence Probabilities, Conditional on
    Each State, for Input into Bayes Theorem

    Current Financial Statement


    Evidence
    GN
    BN
    H
    State of
    Nature

    Total

    P(GH/H)

    P(BN/H)

    P(GN/L)

    P(BN/L)

    Copyright 2009 by Pearson

    3-8

    The Information System II


    The higher the main diagonal probabilities, the better
    the investor can predict the state of nature (i.e., future
    firm performance)
    The main diagonal probabilities capture financial statement
    informativeness
    Highly informative financial statements also called:
    Transparent
    Precise
    High quality

    Copyright 2009 by Pearson

    3-9

    The Information System III

    Information system probabilities are objective


    Reflect quality of GAAP
    How known by investor?

    Prior probabilities are subjective


    Investor assesses them based on all information
    available prior to the investment decision

    Copyright 2009 by Pearson

    3-

    The Information System IV

    If prior probabilities are subjective, so are


    posterior probabilities
    However, if financial statement information is
    informative, posterior probabilities are better predictors
    of future firm performance than prior probabilities

    Copyright 2009 by Pearson

    3 - 11

    3.3.3 Definition of Information

    Information is evidence that has the potential to


    affect an individuals decision

    Copyright 2009 by Pearson

    3-

    Theory of Investment
    Points to note:

    The rational investor


    Risk aversion
    Portfolio diversification
    beta

    Copyright 2009 by Pearson

    3-

    3.8 Do Professional Accounting


    Bodies Accept the Rational Decision
    Theory?
    SFAC 1

    Oriented to investors
    Oriented to rational investment decisions
    Accepts that investors are risk averse
    Financial statements provide information to help
    investors assess (posterior probabilities of) the
    amounts, timing, and uncertainty of investment
    proceeds (i.e., of future firm performance)
    Note that Bayes theorem is implied
    Continued

    Copyright 2009 by Pearson

    3-

    3.8 Do Professional Accounting


    Bodies Accept the Rational Decision
    Theory? (continued)
    SFAC 2
    To help investors, financial statement information
    should be:
    Relevant
    Can make a difference

    Reliable
    Faithful representation
    Verifiable
    Neutral

    Copyright 2009 by Pearson

    3-

    Conclusions
    Rational decision theory provides a theoretical
    underpinning for study of information needs of
    investors
    Conceptual framework SFAC 1 and SFAC 2
    accept the rational decision theory model

    Copyright 2009 by Pearson

    3-

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