Real Life Relevance to the Development of Accounting and Finance Regulation - Essay Example

? Academic research has real life relevance and contributes to the development of accounting and/or finance regulation The area of accountingand finance involves real life. Accounting and finance are concerns of organisations and organisations involve “social structure with life”. A subject area of accounting and finance, financial regulation, involves preventing economic crises (International Monetary Fund 2009). Accounting deals with “identifying, measuring and communicating economic information to enable informed judgements and decisions by users of the information” (Collier 2003, p. 3, citing a 1966 definition). At the same time, accounting is grounded on philosophical assumptions about knowledge and on the “relationship between theory and practice”. Meanwhile, for Oatley (2001), financial regulation is about regulating banks to protect depositors and shareholders. For Carvajal et al. (2009), financial regulation is something more encompassing because its key objective is to “ensure that all financial activities that may pose systemic risks are appropriately overseen.” The same perspective is also in Truman (2009). For Carvajal et al. (2009), the scope or perimeter of financial liberation involves three aspects. First, it must provide regulators with the widest view of the status of regulation action. Second, it must enable regulators to monitor and respond to risks. Finally or third, it must provide regulators with early warnings of risks. The subject area of financial regulation is important because we have a highly “financialized economy” worldwide (Andersson et al. 2010). Accounting is important for managers (Webster 2004). At the same time, accounting financial statements can provide regulators with important tools through which they can monitor the financial system, check on the progress of regulation, and anticipate possible risks so they can be addressed or eliminated (Taylor 2009). Accounting financial statements can also be used to monitor the performance of nongovernmental organisations (Morgan 2010). Financial regulation, however, is not entirely dependent on financial statements because financial regulation can cover all of the economy while financial statements from accounting cover only the economic conditions of firms or group of firms under a conglomerate (Borio and Tsatsaronis 2005; HM Treasury 2010). For example, financial regulators would also be monitoring liquidity, interest rates, capital flows, and other macroeconomic variables, not merely financial statements. Another type of regulation also uses financial statements but is different from financial regulation: strengthening corporate governance. Academic research contributed to the sciences or fields of accounting, financial regulation, and corporate governance. In the process, academic research protected and advanced modern living and, thus, it can be said that academic research improved our lives. Although not all journal articles are academic research, I review a few accounting journals to illustrate how academic research has been developing the field of accounting and, relatedly, financial regulation. In doing so, I will attempt to illustrate how academic research contributes to protecting and advancing life (Humphrey and Lee 2004; Sterling 1975). Barth and Landsman (2010) examined how financial reporting contributed to the financial crisis. They concluded that fair value accounting played little or no role in the financial crisis. Unfortunately, however, the lack of transparency in securitization and derivatives misled investors from assessing properly property values and the risk of bank assets and liabilities (Barth and Landsman 2010). Because of this, they proposed to require banks to “recognize whatever assets and liabilities they have after the securitization” to reflect better the “underlying economics” of banks. Further, they recommended “disclosure of more disaggregated information, disclosure of the sensitivity of derivative fair values to changes in market risk variables, and implementing a risk-equivalence” to enable investors to understand better the leverage inherent in derivatives” (Barth and Landsman 2010). Future research may or may not confirm the validity of the Barth and Landsman perspective but the important point is that they have forwarded a point of view that promotes research inquiry so their recommendations can be confirmed or rejected based on evidence. The expected result from such academic research endeavours is a stable financial system, particularly stable banks, as research findings are applied to policy. Laux and Leuz (2009) identified what they believed to be the key issues of the debate on fair value accounting as opposed to accounting based on historical costs. In summary, Laux and Leux (2009) argued that while there are problems related to fair cost accounting, it will be unlikely that historical cost accounting will be the remedy. This is because the problems associated with historical cost accounting are larger than those associated with fair value accounting (Laux and Leux 2009). Nevertheless, Laux and Leux (2009) pointed out that there are implementation problems associated with fair value accounting. Further, Laux and Leux argued (2009) that there will be trade-offs in the choice between fair value versus historical cost accounting. One trade-off is between relevance and reliability (Laux and Leux 2009; Huizinga and Laeven 2009). Further, fair value accounting can introduce volatility even in normal times and “can give rise to contagion effects in times of crisis” (Laux and Leux 2009; Novoa et al. 2009). Laux and Leux (2009) argued that the directions for future research involve several routes. First, studies must analyze whether or not fair value accounting contributed to the current financial crisis through contagion effects. Second, studies must find in-depth the implementation problems associated with fair value accounting, reviewing in particular whether litigation risks can have a serious effect on the performance of fair value accounting. Third, studies must also assess whether historical cost accounting play a role in financial crises. Finally or fourth, studies must find out the role of political processes in enhancing the role played by accounting systems in making countries less vulnerable to financial crises. Overall, the work of Laux and Leux (2009) is a contribution to the efforts to adopt an accounting system that would enable countries to become less vulnerable to financial crises and economic crises in general. Although the Laux and Leux (2009) study did not end the debates on what accounting system to adopt between fair value and historical cost accounting, the Laux and Leux (2009) study identified the research that must be advanced in order to resolve the debate. In contrast, Lefebre et al. (2009) and Rabin (2009) assessed and predicted that fair value accounting is and will be most preferred. The study of Leuz and Wysocki (2008) strongly indicates that disclosure through the tools of accounting has economic consequences at the firm, industry, and overall-economy levels. For example, firm disclosure through financial report provided by accounting can reduce the costs of capital acquisition by firms (Leuz and Wysocki 2008). Meanwhile, the work of Penman (2007) provides a background for the work of Laux and Leux (2009). The focus of Regulatory bodies such as International Accounting Standards Board (IASB) and the Financial Accounting Standard Board (FASB) have concentrated on how fair values of assets and liabilities should be measured. According to Penman (2007), “fair values have been mandated for some assets and liabilities under both IASB and FASB standards.” However, at the same time, the principles governing the applicability of fair values have yet to be articulated. Thus, Penman (2007) was a study seeking to identify the circumstances under which fair value accounting works. Penman (2007) concluded that at the conceptual level, fair value accounting is a plus but implementation can be problematic. He also concluded that fair value accounting works well for valuation and stewardship. Yet, fair value accounting is unable to solve the problems associated with historical cost accounting making fair value accounting an imperfect system (Penman 2007; Ronen 2008; Ryan 2008). The study of Arnold and Lange (2004) reviewed the collapse of Enron that, together with the collapse of WorldCom, weakened the United States economy by US$64 billion in 2002. According to Arnold and Lange (2004), it was estimated that “17% of the decline in share prices is attributable to investor concerns about fraud and mistreatment of earnings as a result of corporate collapse.” The important contribution of Arnold and Lange (2004) is that they upheld the view that the Enron collapse was an outcome of a failure to recognize and address the corporate difficulties of Enron as a “principal-agent problem” from the perspective of theory. The stockholders of Enron constitute the principal and the managers are the agents. Some of the “decisions of managers are motivated by self-interest” that can reduce the welfare of the principal (Arnold and Lange, 2004). Failure to recognize the Enron situation within the principal-agent framework weakens the will to regulate the agent that is supposed to act on behalf of the principal and can lead to a corporate collapse. Viewing the Enron collapse as a principal-agent problem implies actions that would appropriately regulate agents to behave more consistently with the interests of the principal. In conclusion, our narrative strongly indicated that academic research has real relevance to life and contributes to the development of accounting and financial regulation. The foregoing makes it very clear that academic research on accounting is addressing a most serious concern of living in the 21st century: that of making modern life less vulnerable to crises and corporate collapse. The concerns are highly relevant to making our lives more bearable in the modern world. References Andersson, T., Gleadie, P., Haslam, C., and Tsitsianis. N. (2010) ‘Bio-pharma: A financialized business model’. Critical Perspectives on Accounting. 21 pp. 631-641. Arnold, B. and Lange, P. (2004) ‘Enron: An examination of agency problems’. Critical Perspectives on Accounting. 15 pp. 751-765. Barth, M. and Landsman, W. (2010) ‘How did financial reporting contribute to the financial crisis’. European Accounting Review. 19 (3) pp. 399-423. Borio, C. and Tsatsaronis, K. (2005) ‘Accounting, prudential regulation and financial stability: Elements of a synthesis. BIS Working Papers No. 180. Switzerland: Monetary and Economic Department, Bank for International Settlement. Carvajal, A., Dodd, R., Moore, M., Nier, E., Tower, I., and Zanforlin, L. (2009) ‘The perimeter of financial regulation’. IMF Staff Position Note. 26 March. Collier, P. (2003) ‘Accounting for managers: Interpreting accounting information for decision-making’. West Sussex: John Wiley & Sons Ltd. Huizinga, H. and Laeven, L. (2009) ‘Accounting discretion of banks during a financial crisis’. Working Paper 09-207. Washington: International Monetary Fund. HM Treasury (2010). A new approach to financial regulation: Judgement, focus, and stability. London: HM Treasury. Humphrey, C. and Lee, B. (2004) ‘The real life guide to accounting research: A strategy for inclusion’. Qualitative Research for Accounting and Management. 1 (1) pp. 66-84. International Monetary Fund (2009) ‘Lessons of the financial crisis for future regulation of financial institutions and markets and for liquidity management’. Washington: Monetary and Capital Markets Department, International Monetary Fund. Laux, C. and Leuz, C. (2009) ‘The crisis of fair-value accounting: Making sense of the recent debate’. Accounting, Organizations and Society. 34, pp. 826-834. Leuz, C. and Wysocki, P. 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Washington: International Monetary Fund. Webster, W. (2004) Accounting for managers. New York and London: McGraw Hill. Read More