textbook: Financial Accounting Theory 8E - William Scott *I need at least 5 sentence explanations for...

textbook: Financial Accounting Theory 8E - William Scott *I need at least 5 sentence explanations for each question.thanks* X Ltd. is a growth firm that uses very conservative accounting policies. Y Ltd. Is growing more slowly and uses fair value accounting for its capital assets and related amortization. Otherwise, X Ltd. and Y Ltd. are quite similar. They are the same size and have similar capital structures and betas. Required: 2 a) Both X and Y report the same GN in earnings this year. Which firm would you expect to have the greater security market response (earnings response co-efficient) to this good earnings news? Explain. 4 b) Suppose that X Ltd. had a much higher debt-to-equity ratio and beta than Y did. Would your answer to part a) change? Explain the effect each of these two factors has on the security market response. 4 c) Use the concept of signalling to explain why X and Y Ltd. might choose different accounting policies.

Expert Solution

Dear, if two firms are similiar in size and resources, it depends on its accounting method for market response to which investors will be paying more attention. If a firm is using fair value accounting, it reflects a better picture in the mind of stakeholders than a other firm. So,

1) X ltd.' s market response would be higher

2) higher debt-equity doesn't mean the firm is much risky, it depends on market sentiments and other factors, if all other factors are favourable , the firm with more debt-equity ratio will attract stakeholders because it will give higher returns

On the other hand, if a firm is having high drbt-equity ratio, and market sentiments are not so good or predictable then the firm with less debt-equity will get higher response.

Assuming other factors are favourable, my answer to part 1 will not change vice versa

3) if we talk about accounting policies and method adopted by a enterprise depends on the type of business and management concerns. If the management thinks the investor to attract for long-term plans, it wouldn't follow fair-value on the other side if the firm wants to have a clear cut perception about the enterprise, it would follow fair value approach.

ekkarill92 answered 2 years ago

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