Question 1

Which of the following best describes the concept of information asymmetry in financial accounting?

Accepted Answer

It refers to the situation where one party has more or better information than another party.

Question 2

A company’s CEO is able to make decisions that benefit themselves at the expense of shareholders because shareholders cannot observe all the CEO’s actions. This scenario is best described as:

Accepted Answer

Moral hazard

Question 3

Which of the following is an example of costly signalling used to overcome adverse selection in accounting?

Accepted Answer

Paying dividends to shareholders

Question 4

Which regulatory body is responsible for establishing financial accounting and reporting standards for companies that follow GAAP in the United States?

Accepted Answer

Financial Accounting Standards Board (FASB)

Question 5

A manager manipulates reported earnings to meet debt covenant requirements. This is an example of:

Accepted Answer

Earnings management

Question 6

Which qualitative characteristic of accounting information helps to alleviate both adverse selection and moral hazard?

Accepted Answer

Verifiability

Question 7

According to efficient market theory, in a semi-strong form efficient market:

Accepted Answer

Security prices reflect all publicly available information.

Question 8

Which of the following is NOT a motivation for upward earnings management?

Accepted Answer

To reduce additional taxes or regulations

Question 9

A company chooses FIFO instead of LIFO for inventory valuation, resulting in higher reported earnings during inflation. This is an example of:

Accepted Answer

Earnings management through accounting policy choice

Question 10

Which of the following best describes the principal-agent problem in accounting?

Accepted Answer

Owners (principals) cannot fully monitor managers (agents), leading to potential conflicts of interest.

Question 11

If a market is strong form efficient, which of the following statements is true?

Accepted Answer

Prices reflect all information, both public and private.

Question 12

Which of the following is a trade-off that must be made when preparing accounting information?

Accepted Answer

Balancing relevance with reliability and verifiability

Question 13

A bank includes covenants in a loan agreement to ensure the borrowing firm maintains certain financial ratios. This is primarily intended to:

Accepted Answer

Mitigate moral hazard

Question 14

Which of the following is a real-world example of adverse selection?

Accepted Answer

A seller of a used car knowing more about the car’s condition than the buyer

Question 15

Which of the following is NOT a branch of accounting?

Accepted Answer

Auditing Standards Board

Question 16

If a company wants to reduce its tax liability in a bad year and improve future compensation, which earnings management strategy might it use?

Accepted Answer

Big bath earnings management

Question 17

Which of the following formulas best represents the relationship between net income, revenues, and expenses in financial accounting?

Accepted Answer

$$ Net\ Income = Revenues - Expenses $$

Question 18

Which of the following is a key implication of efficient market theory for accounting?

Accepted Answer

Security prices react quickly to new accounting information.

Question 19

A company holds investments in shares traded in securities markets. According to accounting theory, the market prices of these shares are used to:

Accepted Answer

Indicate their fundamental values

Question 20

Which of the following is a reason why accounting standards are written in general terms?

Accepted Answer

To allow application to a variety of businesses and situations

Fundamentals of Financial Accounting Theory – Intermediate Accounting Chapter 1 Study Notes

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