Approaches to Standard Setting in Accounting - Essay Example

?Topic: Approaches to Standard Setting in Accounting Affiliation: Introduction Accounting standards are developed to enhance financial information provision to relevant and interested stakeholders. This information is basically about entities in which different parties are involved and interested in. Parties herein refer to individual and group investors, markets and securities analysts, creditors as well as different entities in that regard. The underlying need for financial information provided through set accounting standards is to aid the decision making process, where the interest is to reach informed, effective and efficient decisions about resource allocation. Financial statements are prepared and presented through observation of relevant accounting standards and procedures. Users of these statements, therefore, need to derive assessments that are realistic in regard to any given entity’s financial status. These users are spread across the economic context, based on the interest of each of them in the financial positions of different entities. To act in the satisfaction of these stakeholders, accounting standards are crucial in ensuring that financial reporting is effective enough. In this regard, capital markets operations are assessed for their efficacy in the context of accounting standards integration. The impacts of accounting standards on different entities can take more than one way. The impacts can be individual-entity-based or even broader to encompass several sectors of the economy or the entire economy at large, including capital and other markets. On a smaller scale, accounting standards enhance individual entity accountability and further provide strong basis upon which investors, creditors and other stakeholders are managed. In general, corporate governance is improved prior to business arrangements of different entities. On the other hand, the impacts of accounting standards can also be diverse and dynamic and, therefore, broad in scope. The entirety of the significant market is provided with accurate, transparent and reliable financial information (Deaconu, Nistor & Filip, 2009, p. 143). Accounting standards, therefore, set out a concrete framework through which financial reporting is done in order to maintain capital markets that are sophisticated and efficient. Literature Review McLeay and Merkl (2004, p.341) notes that accounting standards operate by setting out general rules to be followed in financial statements’ preparation and financial reporting. These rules are practical prior to the accounting work in question. Entities differ in financial reporting methods through similar or close accounting standards are observed. This is due to the fact that there are a number of setters of accounting standards around the world. According to Bennett & Loucks (2008, p.407-419), major accounting standard setting bodies around the world include: Basel Committee on Banking Supervision (BCBS), Committee on the Global Financial Systems (CGFS), Committee on Payment and Settlement System (CPSS), Financial Action Task Force on Money Laundering (FATF), Financial Accounting Standards Board (FASB), Financial Stability Board (FSB), International Association of Deposit Insurers (IADI), International Association of Insurance Supervisors (IAIS), International Accounting Standards Board (IASB), International Monetary Board (IMF), World Bank (WB), among others. In the UK, GAAP is responsible for setting accounting standards and regulating observance of company law. Accounting standards have three basic concepts that they account for. The first concept is to present the underlying problem. In this case, an intensive description of the underlying problem is presented. Upon the realization of a problem, there is the need to get a solution to the problem. The second concept is therefore that of fixing the problem highlighted in the first concept. Fundamental accounting theory is explored in pursuit of finding a viable solution to the underlying problem as Meier, Alam & Pearson (2003, p.477-487) highlights. Reasonable discussions characterize this concept prior to the cause that effect relationship of the identified problem. Finally, the third concept relates to a solution prescription to the problem. Accounting standards, therefore, account for a great deal of scenarios that pose problems to accounting processes, especially financial statements’ preparation and financial reporting as Blommaert (2005, p. 76) outlines. Approaches to Standard Setting in Accounting Regulatory approach This approach provides a framework of practical rules and guidelines to works of accounting. The best aspect of this approach is seen through the UK GAAP. This is where there are specific requirements that firms are supposed to adhere to when preparing their financial statements and when undertaking their financial reporting. Regulatory approach is an approach to accounting standards that seeks to account for any improper presentation and misreporting if financial information by firms. GAAP, for example, regulates preparation of company accounts in the UK. In the light of its interests, UK GAAP goes over and above accounting standards to oversee adherence to company laws in the country. Regulatory approach takes two distinctive concepts in the light of its operational factor. These are public interest and interest group concepts. In the public interest factor, public demands influence the degree of regulation supply. The primary considerations in this approach are made in reference to the protection and benefits of the general public (Georgiou, 2005, p.323-347; Georgiou, 2010, p.130-118). In this regard, the approach is characterized by rules, laws and regulations to be followed. The interest group concept relates to the demands of special groups in the preparation of financial statement, reporting of financial information and accounting in general. All identified stakeholders in the field of accounting have special expectations that further build special demands from the interests of these special groups. Since their expectations, interests, needs and demands may not be met by the market model, a standardized model must be put in place in order to balance the identified factors and the demands of these special groups. Special groups’ demands range from income maximization, political interests to economic factors. Regulation therein takes similar notions; income, political and economic regulation. Non-regulatory approach This is an approach that is not necessarily characterized by rules, laws and regulations, but is rather an informal form of setting accounting standards. It is characterized by voluntary preparation and reporting of financial information. Basically, firms engage in no-regulatory approach to standard setting in accounting in order to have an added advantage to their business aspects. It is more or less a competition strategy, where accounting standards are developed by firms, not because they are regulated, monitored or required to do so, but because they predict that the impact of self-driven standards in accounting are positively related to business welfare in the market and the industry at large (Kelly, 2005, p.619-632). Free market approach A free market is characterized by free flow of information. Demand and supply of information is that of a free market mechanism. There are no limitations as to what information can be made available to the demanders by the suppliers. In other words, there is a perception that there is perfect information in the market. Symmetric information is assumed to characterize the market. The primary role of free market approach in setting accounting standards is to try and alleviate financial information asymmetries in order to uniformly benefit the entire accounting sector stakeholders. Participants in the information market are said to have equal access to relevant accounting information. The interaction of the different parties to the information free markets behave in a certain way that eventually define a uniform and a unique way of going around their business. Over time, a standard that governs preparation and reporting of financial information is set up (McLeay and Merkl, 2004, p.317-346). The free market interaction, therefore, contributes to the setting up of an accounting standard that is uniformly accepted to the participants in the free market mechanism. Traditional Approaches A number of approaches are outlined under this mode of standard setting in accounting. These are: deductive, inductive, ethical, sociological, economic and electic approaches (Durocher, Fortin & Cote, 2007, p. 54). Deductive approach relates to the use of general principles to arrive a valid and logical conclusion. A closer examination of accounting principles reveals the need for a standardized mode of accounting. The underlying objective is uniformity in reporting, so that different interest groups can deduce logical facts and expectations from financial information. Inductive approach on the other hand moves from a particular fact to arrive at a conclusion. In this regard, accounting principles and evaluated and assessed for their applicability, after which a generalized accounting standard is set. Ethical approach is basically based on moral; that is right and wrong. Firms are expected to be ethical in their dealings and business aspects in order to maintain high levels of customer confidence. In this regard, ethical and unethical concerns necessitate the development of a uniform accounting code of conduct in a bid to account for ethical concerns. Sociological approach further encompasses the interests of diverse and dynamic groups of people around the world. It takes the same notion as the ethical approach but its scope is rather broad to encompass the social diversities and dynamisms. Economic approach looks deeper into the economic variables integral to accounting activities. Economic growth and development can only be achieved under certain conditions. Accounting activities are part and parcel of these conditions. There must be standardized accounting activities in order to trigger the required effect to an economy. In the context of accounting, this is done through establishment of standards that based on economic variables, but significantly accounting in nature. Finally, electic approach combines two or more of the already discussed approaches to arrive at an accounting standard. This approach examines the concepts and principles of each of the said approaches and chooses the most appropriate for combination, consequently giving an accounting standard whose concepts and principles have been closely examined for effectiveness. New approaches Behavioural approach Decisions in the business context are made based on the available relevant information, given the desired result of the business aspects of a firm. Behavioural approach makes and emphasis of the relationship between financial information and decision making by firms. Behavioural approach to standard setting in accounting strongly upholds the relevance of communicated financial information. The idea is to monitor the behaviour of the interest groups prior to communication of available financial information. In order to influence stakeholders’ behaviour in the context of financial information reporting, certain guidelines must be followed so that the overall standard of the information and consequent behaviour are matching and favourable in accounting terms. Human behaviour is highly influenced by accounting information and associated accounting problems. The behavioural approach is designed to account for this factor, thereby providing a general framework through which both the human behaviour and the accounting information are matched. The primary objective in this case is to evaluate and assess all possible accounting contexts in order to predict and explain the underlying behaviour of all interest individuals and groups in accounting and financial information (Durocher, Fortin & Cote, 2007, p.29-59). This approach seeks to standardize the behaviours therein. Application and Arguments in Relation to Accounting Policy Concept As earlier mentioned, accounting standards foster strong relationships between and among different market stakeholders in the context of financial reporting. Over and above this factor, accounting standards have other interest to serve. These are social, public and market interests (Konigsgruber, 2009, p.81). All the stakeholders identified in the light of accounting principles are part and parcel of the participating and non-participating public. However, the public in general is interested in the financial positions of business entities even when they are not directly or indirectly linked to those entities. This is because the inefficiency of the market has dire consequences to the entire economy. Market failures are in one way or another accounted for by accounting standards. Disclosing information often faces reluctance from firms. Fraudulent activities may go unnoticed where set standards are inadequate or lacking. Over and above this fact, accounting information may be under-produced, thereby impacting negatively on the interests of accounting stakeholders. Accounting standards are crucial to bring in in order to aid financial reporting. Transparency and accountability are fundamental to address, and it is, therefore, necessary to have a guiding financial framework that is characterized by accounting standards. Finally, in the social context, accounting standards promote fairness of financial reporting, make financial information symmetry as opposed to asymmetry and also ensure that investors among other parties are protected (Blommaert, 2005, p. 76). In the context of internal business environment, principle –agent conflicts can be solved even in the absence of accounting standards. This is because firms have incentives to report voluntarily (Gee, 2002, p. 257). This is in the light of the need to address owner-manager conflicts as aforementioned. On the same note, firms that fail to report raise questions as to the reason why they fail to. Whatever the case, with or without accounting standards, financial reporting is inevitable. It is in this regard that it becomes critical to consider the concepts and approaches to standard setting in accounting in the light of the above discussion. Conclusion Different stakeholders react differently to accounting standards. Even with enormous support for accounting standards, there are a number or arguments against accounting standards. Even where financial reporting is lacking or inadequate, different users have enough capacity to seek for and get information that is relevant to their interests. Accounting standards are also associated with increasing costs of operation due to the fact that additional compliance costs are introduced where set financial reporting frameworks are to be followed. However, the fundamental role of accounting standard in financial reporting cannot be refuted. References Bennett, R. & Loucks, C. (2008). PAC Contributions from Sectors of the Financial Industry, 1998-2002, Atlantic Economic Journal, 4(36), pp. 407-419. Blommaert, J. (2005). Discourse: A Critical Introduction, Cambridge: University Press. Brasher, H. & Lowery, D. (2006). The Corporate Context of Lobbying Activity, Business and Politics, 1(8), pp. 1-23. Deaconu, A., Nistor, S. & Filip, C. (2009). 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