The Decision Usefulness Approach to Financial Reporting

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Instructor’s Manual—Chapter 3 CHAPTER 3 The Decision Usefulness Approach to Financial Reporting 3.1 3.2 Overview The Decision Usefulness Approach 3.2.1 Summary 3.3 Single-Person Decision Theory 3.3.1 Decision Theory Applied 3.3.2 The Information System 3.3.3 Information Defined 3.3.4 Summary 3.4 3.5 The Rational, Risk-Averse Investor The Principle of Portfolio Diversification 3.5.1 Summary 3.6 The Optimal Investment Decision 3.6.1 Summary 3.7 Portfolio Risk 3.7.1 Calculating and Interpreting Beta 3.7.2 Portfolio Expected Value and Variance 3.7.3 Portfolio Risk as the Number of Securities Increases Copyright © 2009 Pearson Education Canada 57 Instructor’s Manual—Chapter 3 3.7.4 Summary 3.8 The Reaction of Professional Accounting Bodies to the Decision Usefulness Approach 3.8.1 Summary 3.9 Conclusions on Decision Usefulness LEARNING OBJECTIVES AND SUGGESTED TEACHING APPROACHES 1. Decision Usefulness The main purpose of this Chapter is to provide a framework for understanding the concept of decision usefulness of financial reporting. Consistent with SFAC 1, I assume that the major decision problem to which financial reporting is oriented is the investment decision. I then argue that if accountants are to produce financial statements that are useful for investment decisions, they need to understand how rational investors make such decisions. 2. Single-person Decision Theory I use this theory, including the revision of beliefs by means of Bayes’ theorem, as a model of rational investment decision making. Prior to getting into the theory itself, I usually discuss with the class how they would proceed to make investment decisions if they had a sum of money to invest, and steer the discussion to make the point that single-person decision theory provides a systematic and formal way to do what many of them would do anyway. Some instructors and students

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