Module 1: Accounting under ideal conditions

This module reviews and analyzes the present value model, under both certainty and uncertainty. Under ideal conditions, accounting is based on the present values of future cash flows. The module explores reserve recognition accounting as an example of present value accounting. The important concepts of relevance and reliability are introduced. Historical cost accounting is revisited to compare it to theoretically ideal present value accounting and to explore the concepts of relevance and reliability with respect to both historical cost and present value accounting.

Module 2: Decision usefulness approach to financial reporting

The theory of rational investment decision making is explored. Accountants need to supply information that is useful to investors. Accounting policy therefore should follow a decision usefulness approach. The principle of portfolio diversification is explored, and how it relates to the decision making of rational riskaverse investors is investigated. Finally, this module looks at how the professional accounting bodies use the decision usefulness approach in standard setting.

Module 3: Efficient securities markets

Module 3 contains a critical evaluation of efficient securities market theory. Its implications for financial reporting, such as the decision usefulness approach and the principle of full disclosure, are explained and illustrated. The important concept of information asymmetry is introduced.

Module 4: Information perspective on decision usefulness

Module 4 reviews some of the empirical evidence on decision usefulness. If theories of investor decision making and efficient securities markets are to be taken seriously by accountants, you need to observe securities’ prices responding to accounting information as these theories predict. For example, if a firm’s earnings are unexpectedly high this period, you should observe a rapid increase in its share price as rational investors evaluate the impact of this good news on expected future firm performance. While this prediction may seem obvious, guidance from theory is needed to find hard statistical evidence in its favour. Nevertheless, research has shown that the market responds in surprisingly sophisticated ways to the implications of current information for future firm performance. Efficient securities market theory also predicts that the market will react to information from any source, not just accounting information. To increase their competitive advantage in supplying useful information, accountants have supplemented the financial statements proper with a large amount of additional information, such as notes to the financial statements. This perspective on financial reporting, whereby the historical cost framework is retained in the body of the financial statements but is supplemented with additional information, is called the information perspective on financial reporting. It dominated financial accounting theory and practice for over 25 years.

Module 5: Measurement perspective on decision usefulness

More recently, standard setters have been requiring the incorporation of more value-based information into the financial statements proper, thereby moving the financial statements in the direction of the present value model. Reasons for this measurement perspective on financial reporting are explained. Various accounting

standards that illustrate this measurement perspective are described and evaluated. There is a debate over the value of present value accounting and its impact on the volatility of net income. This volatility increases the perceived risk of the firm. The module goes on to address recent developments in the reporting on risk.

Module 6: Economic consequences

In Module 6, the concept of economic consequences is introduced. This concept has implications that, at first glance, contradict the efficient securities market theory. To begin to reconcile economic consequences with the theory, Module 6 describes positive accounting theory. This theory attempts to explain why firm managers choose particular accounting policies and to make good predictions of the accounting policies that managers will choose in specific circumstances. Much of the theory is built around a study of the contracts that firms enter into.

Module 7: An analysis of conflict

Module 7 develops the concept of conflict between managers and investors, and illustrates some simple game theory-based models to predict how this conflict may be resolved. Much of the conflict arises because of information asymmetry between managers and investors (the moral hazard problem). Provisions in compensation and debt contracts to control the consequences of this information asymmetry are essential in reconciling efficient securities markets with economic consequences.

Module 8: Conflict between contracting parties

Module 8 explains some of the theoretical and practical aspects of compensation and debt contracts and how these contracts affect managers' accounting policy choices. The module then looks
at earnings management and whether it is "good" or "bad." Finally, the module assesses the stock market’s reaction to earnings management.

Module 9: Standard setting: Economic issues

Module 9 begins a study of the process of setting accounting standards concerning the economics and regulation of information production. This process is viewed as a way to resolve the conflict that often arises between managers and investors over the choice of accounting policies for financial reporting. The module also considers whether standard setting is needed to resolve such conflict, or whether market forces suffice to encourage managers to supply enough useful information to investors.

Module 10: Standard setting: Political issues

Module 10 describes two theories of regulation (standard setting is a form of regulation) and evaluates the structure of major accounting standard-setting bodies in relation to the theories. Consideration is given to the conflicts and compromises arising in standard setting and the ethics involved in the process. The module also

explains the criteria that must be met if a new accounting standard is to be acceptable to both investors and managers.