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    Bonus Plan Hypothesis

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    Shamsinaz Mat Isa
    The document discusses three hypotheses related to managerial accounting choices: 1) Managers with bonus plans may choose accounting policies that shift earnings from future to current periods to increase current bonuses. 2) Managers near debt covenant violations may shift future earnings to the current period to avoid technical defaults and costs. 3) Highly profitable companies may choose more conservative accounting to avoid potential political costs like windfall taxes or investigations.

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    Bonus Plan Hypothesis

    Uploaded by

    Shamsinaz Mat Isa
    1K views2 pages
    The document discusses three hypotheses related to managerial accounting choices: 1) Managers with bonus plans may choose accounting policies that shift earnings from future to current periods to increase current bonuses. 2) Managers near debt covenant violations may shift future earnings to the current period to avoid technical defaults and costs. 3) Highly profitable companies may choose more conservative accounting to avoid potential political costs like windfall taxes or investigations.

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    BONUS PLAN HYPOTHESIS

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    The document discusses three hypotheses related to managerial accounting choices: 1) Managers with bonus plans may choose accounting policies that shift earnings from future to current periods to increase current bonuses. 2) Managers near debt covenant violations may shift future earnings to the current period to avoid technical defaults and costs. 3) Highly profitable companies may choose more conservative accounting to avoid potential political costs like windfall taxes or investigations.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    1K views2 pages

    Bonus Plan Hypothesis

    Uploaded by

    Shamsinaz Mat Isa
    The document discusses three hypotheses related to managerial accounting choices: 1) Managers with bonus plans may choose accounting policies that shift earnings from future to current periods to increase current bonuses. 2) Managers near debt covenant violations may shift future earnings to the current period to avoid technical defaults and costs. 3) Highly profitable companies may choose more conservative accounting to avoid potential political costs like windfall taxes or investigations.

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    BONUS PLAN HYPOTHESIS DEBT AGREEMENT HYPOTHESIS POLITICAL COST HYPOTHESIS

    All else equal, managers of firms with bonus For companies that would violate the debt agreement, Companies that have high profitability tend to shift
    plans are more likely to choose accounting the manager would have the possibility to choose their income from this period to the coming periods to
    policies that shift reported earnings from accounting procedures that shift future income to the avoid political cost.
    future periods to the current periods current period as to increase net income and avoid
    technical errors.
    Manager of firms: use accounting method that • Sweeney (1994) found that agreements were most • Jones (1991) found that the company reduced the
    increase current period income often violated had to do with maintaining working net income it reported during investigation of
    capital and shareholder equity, while debt to equity import relief/exemption
    ratios and interest coverage ratios were not
    violated too often
    METHODS OF REWARD: • Debt agreement contain. Covenants • Some firms are expose to media due to their size,
    • Fixed basis : salary independent of • Failing to meet covenants lead to technical default, fame , industry
    performance which is costly • Other firm may attract attention irregularly due to
    • Salary plus remuneration (bonus scheme) • Thus, manager will. Adopt accounting policies which sudden report huge profits
    increase current income to reduce the risk of • Such firms are subject to risk that regulators will
    technical default impose windfall tax upon them , or investigate if the
    market is truly competitive
    • These firms try to hide /avoid from reporting their
    high profits
    REMUNERATION: Managers with high debt to equity ratio will: Managers will :
    • EPS (profit) • Choose less conservative accounting policies • Choose more conservative accounting policies
    • Sales of firm • Oppose new standards which restrict their ability to • Less likely to oppose income-reducing accounting
    • Return on asset do this standards
    • If their pay depends upon reported
    earnings then they will report the highest
    earnings possible.
    • Do it by adopting accounting policies which
    increase current earnings
    • Eventhough accruals reverse, leading to
    reduced future earnings and bonus, PV of
    future bonus stream is increased by
    shifting income forwards
    • Managers of firm with bonus plans:
    - choose less conservative and less volatile
    accounting policies
    -oppose new accounting standards that
    reduce net income
    - object to volatily- increasing accounting
    standards
    • Healy research (1985) found that company
    managers who have bonus plans will
    systematically adopt accrual policies to
    maximise their bonus.

    EBIT
    - Important in stock market
    - If use profit after tax and interest, it may not really comparable as different company has different capital structure

    Covenant Ratio
    - Need to be positive? Use to figure out the capability of firm to pay its debt

    If the remuneration committee had used Operating Profit instead of underlying EBIT , the CEO would not meet the minimum performance

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