Whether or Not Accounting Is an Objective Subject - Coursework Example

Resolve: Whether or Not Accounting is an Objective Subject Introduction Accounting was, at the time it first began to evolve, conceived of as performing a stewardship role. It was a record of events and transactions in a business that was basically a mere extension of the proprietor’s personal memory. As time passed, business evolved into a predominantly important economic activity, and business organizations became bigger and more complex. Accounting ceased to be the owner’s personal journal, and instead developed into a fiduciary activity imbued with public interest and regulated by the state. Accounting records and financial reports became the bases of decision-making by managers, investors, creditors, and the state (for taxation purposes), and as such assumed such importance in the allocation of economic resources and undertaking of social processes. It is for this reason that accounting evolved from a mere procedural activity, to a socio-economic-political undertaking around which the body of accounting theory has thrived. The nature of financial accounting Financial accounting is that subfield of accounting which is concerned primarily with the historical, custodial and stewardship aspects of external reporting to shareholders, government and other users of accounting information outside of the business entity (Mukherjee & Hanif, 2006. In the course of developing a standard method of preparing and interpreting financial reports for the eternal publics, the need for a cohesive conceptual framework became evident. This led to the FASB initiative towards defining a viable approach to financial accounting theory. According to accounting researcher Hendriksen (1970, in Deegan, 2006 p. 4), theory is defined as “a coherent set of hypothetical, conceptual and pragmatic principles forming the general framework of reference for a field of inquiry.” The US Financial Accounting Standard Board’s concept of accounting theory, in undertaking the Conceptual Framework Project, is “a coherent system of interrelated objectives and fundamentals that can lead to consistent standards.” (FASB, 1976) For the purposes of the accounting profession, the term “theory” need not connote the “grand theories” that convey broad generalized truths, but rather refers to any framework which helps the accounting professional make sense of aspects of the real world, and which aids in providing cohesion, stability and a structure by which to understand the truth of daily experiences. (Deegan, 2006, p. 4) Because of the many different perspective on the role of accounting theory. there is no universal agreement on how accounting theories should be developed. However, Deegan and Unerman (2006, p. 5) distinguished among three broad categories of accounting theory: 1. Prescriptive (normative) accounting theories Based on what the researcher believes what financial accounting should be, what should be regarded as assets, liabilities, etc., and how they should be valued. These theories are not based on observation, and therefore do not necessarily reflect accounting practice. For instance, Chambers advocated the valuation of assets at market values at a time that historical cost accounting was the accepted form (Deegan & Unerman, 2006, p. 10) 2. Inductive accounting theories Constructed by observation and by drawing generalized conclusions from practical observations and measurements. This is the oldest method of theory construction in the history of accounting. Observations emanated out of hands-on experiences in a spontaneous and even haphazard manner, generalisations drawn therefrom and eventually documented. 3. Predictive (positive) accounting theories Focus on explaining and predicting accounting practice instead of formulating or prescribing such practice. Like inductive theories, these are also based on observation, but proceed in an organize manner towards accounting research, the aim of which is to attempt to predict possible future outcomes. For instance, positive accounting research may speculate on what accounting policies managers may adopt in particular circumstances. One example of this type of theory is the agency theory, which tried to explain and predict what accounting policies managers would tend to select. (Deegan and Unerman, 2006, p. 212). Critical Theory in Accounting Research During course of past decades, many theories have developed concerning the methods of reporting and analysing accounting data. Because of the apparent confusion created by these various approaches, the critical theory was developed to provide a perspective by which to more effectively critique the employed accounting practices. The emergence of complementary sets of issues is regarded as a sign that the field of accounting research is a maturing discipline. Harbermas (1972) elucidated what is probably the most definitive of the critical theories. He explores the relationship between knowledge and human interests. He is aware that knowledge may be distorted and confused by social structures that serve certain interests, and in the process systematically mislead and manipulate. Critical social science is thus necessary in order to emancipate and rid language, interaction, and communication of distortions as a precursor to decision-making. Critical theory thus seeks to provide a form of knowledge that questions the prevailing social arrangements, that is, to present a form of alternative knowledge (Roslender, 1985). In the mid-1970s, a group of scholars the most notable of whom were Tony Lowe and Tony Tinker, explored an alternative sociological perspective to the established, mainly functional, approach to understanding accounting practices. At about the same time, other theorists such as Berry, Capps, Cooper, Ferguson, Hopper and Lowe published a study which also took the sociological turn in accounting research. Towards the end of the 1980s, another influential writer, Richard Laughlin, designated Critical Theory as “a further methodological approach”. Laughlin viewed Critical Theory as ideally suited to the study of accounting systems in their organizational contexts, for the reasons that it links power and practice; that it is concerned with critique and the need to transform into something better; and it always goes beyond what is merely given or visible (Roslender, 1985). The Use of Imagery The development of accounting theory through the use of imagery was pioneered in large part by David Solomon and Tony Tinker, for the purpose of applying the characteristic of the image in the context of accounting to aid in analysis. Solomon was a firm advocate of neutrality and employed the images of journalist (who report news and don’t make it), telephone (convey information impartially), speedometer (capture the economic speed of the economy), and cartography (produce maps of economic reality) to illustrate his concept of accounting. (Tinker et al., 1991, p. 297) Tinker disagreed with Solomon’s use of metaphors, because they are unsuitable and problematic. Firstly, journalists portray reality by discarding some facts and, in the process, screen what is important to report and what is not; the speedometer is usually tampered with by the drivers; telephones convey what people say, not what they think, which leads to bias and selectivity; and cartography does not represent facts but their distortion, through the use of color and size (Tinker et al., 1991, p. 300). In effect, Solomon and Tinker demonstrate that there is no one image that effectively captures completely the essence of accounting practice. The disagreements only serve to highlight the problematic nature and loopholes of accounting theory development. The verifiability and objectivity of evidence It is imperative that all accounting information be neutral, such that data are not manipulated in favor of one party over another, or to intentionally convey a false or misleading interpretation. It should uniformly satisfy the information needs commonly required by different users. In the recording and reporting of accounting information, verifiability and objectivity go hand in hand. By verifiability is meant that the measure obtained by one individual or interest is capable of being confirmed as true by another individual or interest. Verifiable data are received with a high level of consensus by different, independent measurers – that is, independent accountant arrive at the same substantial result, using the same measurement process in compliance with accepted convention. On the other hand, objectivity refers to the characteristic absence of bias. In the situation accountants find themselves in, they are able to ensure objectivity only if they are free from the influence of different interests or groups. Accountants should employ objective means of measuring and reporting transactions (i.e., means that are neutral and verifiable), and avoid the use of subjective means (i.e., means that are based on personal feeling and prejudices). Objectivity is most closely equated to a statement of facts. Objectivity is an elusive characteristic which is sought to be attained by the observance of certain principles, such as that of value relevance. Value relevance of financial information dia type of research that examines the empirical relationship between particular accounting numbers and stock market values, or a change in these values (Deegan & Unerman, 2006, p. 377). At times, even when accountants are acting independently, entertain no personal prejudices nor have any intention to misrepresent the information, there are certain events or transactions that present particular difficulty in conveying factually. 1. Some intangible items present a challenge in pecuniary valuation, such as the goodwill generated by the business, the value of a highly successful trademark as a business asset, and intellectual property rights. 2. Also, there are items that require one to predict future events or occurrences. For instance, the calculation of depreciation expenses (a non-cash, non-transaction expense) requires the accountant to forecast the future life of an assets, so as to realistically distribute the value of the asset over time. 3. The very choice of depreciation method is also allowed the accountant, necessitating the exercise of judgment and preference. 4. Furthermore, estimating the salvage value of the life of the asset is educated guesswork, because it is difficult to ascertain at what price the fully depreciated asset will sell ten or twenty years in the future. 5. The use of the accrual basis of accounting also creates confusion on when a transaction should be recognized. There are other instances wherein the accountant is allowed to exercise his discretion in order to portray the true nature of the financial performance or condition of the business. The above are the most common, however, and they each introduce an element of subjective consideration that tends to detract form the objectivity of the accounting information, that is, to portray a purely factual account of events and business transactions. It is for this reason that objectivity cannot be fully achieved in accounting. (Meigs, Johnson & Mosich, 1970). Recent issues affecting the objectivity of accounting data Full disclosure is an important issue that impacts on the verifiability, reliability and objectivity of data reported for financial accounting purposes. A study conducted by Ball, Jayaraman and Shivakumar (2009) examined the relationship of audited financial reporting and voluntary disclosure of private information. It was determined that disclosure of private information and audited financial reporting play complementary roles, implying that they could not be evaluated separately. Corollary to this finding is that audited financial reporting is a necessary requisite for full disclosure by management to be voluntarily undertaken. Another issue of interest to objective financial reporting is the matter of fair value reporting. Fair value accounting, a relatively new concept that seeks to capture the current valuations of assets as against historical valuation, has come under attack because of the flexibility it allows the accountant in smoothing earnings. Barth and Taylor (2009) sought to clarify and defend the role of fair value accounting for asset securitization, finding the method a useful and reasonable method that aids in reporting the true nature of the asset’s value. Still in connection with fair value accounting, in another article, Pozen (2009) highlighted the dilemma of investors and corporate executives on a lack of consensus in the matter of valuing distressed assets. The possible causal role of fair value accounting in the 2008 financial crisis was analysed. The “mark-to-market” accounting method – that is, the practice of revaluing an asset quarterly according to the price it would fetch if it were sold in the open market – was blamed by several observers as the culprit behind the meltdown of the US financial system. Mark-to-market is an important component in fair value accounting. It appears a great majority of financial assets in the form of mortgages, corporate bonds and structure debts were valued at market, causing a bubble to emerge. In other articles, the crux of controversy is the threat posed on the independence of accountants in the practice of their profession. In 1978, the issuance of Statement on Standards for Accounting and Review Services No. 1 made independence a “reporting pre-condition” requirement for review, i.e., a necessary pre-requisite without which a review is “impaired” and therefore invalid. Since then, the objectivity of financial reports has always been attributed to the integrity, expertise, and independence of the accountant in preparing his reports. Recently this time-honored principle came under fire. In 2003, four academics developed a reliability framework founded on the premise that public interest could be better served “if reliability in fact and appearance – rather than relationship-based independence” became the cornerstone of the accounting profession. The academics, who were college professors in accountancy, stated that while they were not espousing a radical change in the rules on independence, nevertheless expressed the opinion that independence is one of the key factors that compromise objectivity, implying that independence exercised by accountants tended to render data less reliable than if that independence were curtailed. The proposal is still under consideration at present. Conclusion: Accounting is not an objective subject. Accounting is tasked with the goal of providing a fairly accurate financial picture of a business, for the purpose of scrutiny of parties external to the business. Accuracy entails objectivity, thus what is put in question is the objectivity of financial accounting. In the discussion herein presented, it is apparent that full objectivity is impossible to obtain. The various theories presented different ways of understanding the accounting activity, and in interpreting the information with which it deals. The need for a common and standard basis for accounting has led to the development of conceptual frameworks, to try to capture the truth of the events and transactions reported. However, the very emergence of different concepts, imageries, and the nature of the accounting activity – whether prescriptive, inductive or predictive – already highlights the complexity of the undertaking. Recent developments, such as the globalization of business, emergence of new sectors such as e-commerce, intangible assets such as intellectual property, and novel financial instruments such as derivative securities, all contribute to increase the subjectivity and inconsistency of the accounting process. There is thus a necessity in order for the accountant, acting independently, to use his judgment and perception to be able to more substantially give a true picture of the firm. The implication is thus that an accurate picture need not be fully objective; judicious use of discretion is at times just as important. Accounting is an art at the same time as it is a science. Accounting is therefore tempered by studied judgement to present a fairly accurate account of the financial performance and condition of a firm, sufficient to serve the purpose of the user. REFERENCES Accounting Principles Underlying Corporate Financial Statements. 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