Problem: As a result of a new union agreement, Company AA adopts a new long-term disability plan for its large workforce, with the cost borne entirely by the company. Under IAS 19, the company must record a liability for the discounted expected cost of the plan, with discount rate based on the yields of high-quality corporate bonds. As a result, a large new liability is recorded on Company AA's statement of financial position. This new liability raises the company's debt-to-equity ratio to the point where violation of debt covenants is threatened. A manager of AA decides to adopt significant amounts of positive discretionary accruals, which increase its net income and thus reduce its debt-to-equity ratio to an acceptable level.
1) Explain which hypothesis of PAT is consistent with this accounting decision.
2) Discuss whether this is an example of efficient contracting or of managerial opportunism.