Theoretical concepts of accounting - Essay Example

? Accounting Theory This report presents a review and discussion related to the different theoretical concepts of accounting in the practical world. The areas discussed in the report include arguments related to the free market perspective with respect to the regulation of accounting and their validity after the recent financial crisis, difference between the assumptions underlying the capital market research and behavioural research and main criticisms of Positive Accounting Theory. Proponents of free market approach have also supported a wait and see approach in relation to economic and financial changes taking place all over the world. In fact, the free market proponents reject the idea of intervention by governments for the sake of adjusting the distracted economy, and have based their arguments on the claim that demand and supply forces interact to ultimately bring stability in the distracted economic conditions (Deegan and Unerman; Rankin, Stanton and McGowan). However, malpractices of those charged with the governance and misuse of authority often overrun the expected balances to be attained in a free market model through demand and supply interaction (Deegan and Unerman; Rankin, Stanton and McGowan). One of the most relevant and quotable example in this regard can be of the Enron Scandal, which obviously had nothing to do with the free market model and demand and supply forces, but government intervention to safeguard the interests of general public through Sarbanes Oxley Act (SOX) was deemed appropriate (Deegan and Unerman; Rankin, Stanton and McGowan). Apart from the usefulness and desire for introducing regulatory measures to curb the economic imbalance and deal with similar situations of financial crisis, the current practices of regulating accounting is often questioned on the grounds of objectivity. In other words, an optimum solution to this dilemma would be that both free market propositions, which reflect a laissez faire approach towards regulating the accounting practices, and government oversight and intervention coexist. This coexist is meant to be supportive and complimentary of each other rather than assuming contradictory roles. Thus, laissez faire approach, under free market approach, shall be opted to enhance the role of market forces and when needed, government intervention, whether in the form of accounting regulations or other regulatory frameworks shall be introduced to ensure that no deviation from the objective of benefiting society and corporate entities takes place (Deegan and Unerman; Rankin, Stanton and McGowan). Certainly, after the recent experiences of financial crisis and the increasing debate regarding the lack of ethical practices towards corporate governance and corporate social responsibility, the need to bring regulatory measures have been felt as never before (Deegan and Unerman; Rankin, Stanton and McGowan). Before going into the details of differences between the assumptions underlying the capital market research and behavioural research, it is pertinent to understand what capital market research and behavioural research implies (Deegan and Unerman; Rankin, Stanton and McGowan). The capital market research evaluates the overall impact of financial reporting on investors only; whereas behavioural research takes into consideration the responses towards financial reporting by separate individuals, which is reflected by the decisions made by different users of financial statements. The assumptions for each of the research type are based on the nature of these researches (Deegan and Unerman; Rankin, Stanton and McGowan). As for instance, under capital market research it is assumed that investors are the most important stakeholders who take into consideration the financial reporting by business entities to base their decisions upon them. On the other hand, the assumptions used under behavioural research are entirely contrasting to the capital market research, as it is assumed that every stakeholder, which may include financial institutions, regulatory institutions, customers, banks, etc., considers the financial information included in the financial statements produced by a company and considers the information presented therein to make their respective decisions (Deegan and Unerman; Rankin, Stanton and McGowan). Positive accounting refers to the accounting research which aims at determining the actual practices related to accounting. In other words, the positive accounting theory presents ideas which are in contradiction with the normative accounting, which aims at determining accounting standards which are optimal. According to Deegan, the Positive Accounting Theory (PAT) “does not provide prescription and therefore does not provide a means of improving accounting practice” (235). In light of the theoretical propositions laid under the positive accounting theory, there are two main perspectives which can be related to the theory. These perspectives include efficiency perspective and opportunistic perspectives. The efficiency perspective views managers as considering the methods and accounting practices which reflect transparent and fair view the financial condition of the business. On the other hand, opportunistic perspective regards management as agent of the shareholders, but acting in a way to protect their own respective interests. Among the criticisms noted in relation to Positive Accounting Theory, there are three main areas focused upon by critics. First of all, it is criticised that the positive accounting theory fails to put forward a particular prescription regarding what should have existed. In fact, the theory determines what would be the case in a given situation (Deegan and Unerman; Rankin, Stanton and McGowan). Although this is the main aim of the theory, but this aim appears not to be sufficient. Secondly, another major criticism regarding the positive accounting theory is that it only predicts and determines how individuals may behave and what they may do in future, rather than providing information regarding what should be done by them. Thus the role of positive accounting theory is only of a predictor rather than a value free theoretical framework (Deegan and Unerman; Rankin, Stanton and McGowan). Lastly, another main criticism related to positive accounting theory is its assumptions about the management and shareholders of a business entity. In light of the agency theory, managers act in the capacity of agents for the owners of the business enterprise, who are principals (Deegan and Unerman; Rankin, Stanton and McGowan). As per the assumptions of the positive accounting theory, management, who are agents, and shareholders, who are principals, have intentions which suit their own respective interests. In other words, the theory takes the viewpoint that management and owners are selfish in a way that both parties consider maximization of their respective shares in wealth at the expense of others (Deegan and Unerman; Rankin, Stanton and McGowan). The arguments and criticisms in relation to the Positive Accounting Theory are quite agreeable on the grounds that it only warns about what may be the case in future, but no solutions to the problems identified and no way forward are suggested by the theory (Deegan and Unerman; Rankin, Stanton and McGowan). The discussion and review presented in this report relates to important theoretical concepts in accounting. First of all it has been determined that although free market proponents’ views about accounting regulations do have certain justification, but it is equally important to consider governmental interventions as a means to ensure oversight of accounting practices of corporate entities. Secondly, the capital market research and behavioural research are based on different assumptions, which reflect that financial information presented in the financial statements produced by business entities are considered by different users to base their decisions on them. Lastly, a comprehensive review of the positive accounting theory (PAT) has been presented. This review entails the main criticisms on the theory. The criticism on the theory is considered as valid as it only make predictions but does not provide a way forward regarding the issues dealt with in the theory. Works Cited Deegan, C and J Unerman. Financial Accounting Theory. Roseville: McGraw-Hill, 2011. Deegan, C. Financial Accounting Theory. Roseville: McGraw-Hill, 2000. Rankin, M, et al. Contemporary Issues in Accounting. New York: Wiley, 2012. Read More