Advanced Financial Accounting - Essay Example

Running header: Advanced financial accounting Student’s name: Instructor’s name: Subject code: Date of submission: 1. The theories of regulation People usually have different feelings concerning business regulation. The general public recognizes the great economic power possessed by the business and hence the need to regulate it. On the other hand, the public at times view the governmental bureaucracy as being too intrusive and controlling especially when it puts in restrictions that are not welcome by the public. Why does regulation exist then? Generally, there are three theories of regulation which include the public good theory, the capture theory and the special interest theory. The theories together with the assumptions underlying the motivation of regulators are explained below. a) The public interest theory The theory stems from the perception that the government should step in to regulate markets when they are unable to regulate themselves. The so called market failures arise when the price mechanism supposed to regulate demand and supply is no longer operational triggering the government to step in. natural monopolies and market externalities are excellent types of market failures. The monopolies arise when the fixed costs of producing certain goods or services is so high that it makes sense for only one firm to produce and supply the good or services (Ahmed, 2004). Unfortunately, monopolies tend to use their market powers in ways that can be highly detrimental to the society. On the other hand, externalities arise when the costs of producing goods are not fully incorporated into the price of the good. Such cost includes the impact of environmental pollution which can have undesired effects on the surrounding community. Without regulation by the government, there is nothing that would compel the company to minimize environmental pollution or even compensate the surrounding community for bearing the environmental damage. The sorts of market failures described above coupled with the general need for mechanisms of regular public disclosure by the business motivate the government to regulate the business in order to protect the public interest. This is aimed at protecting the community from the negative impact of the market failure as well as other harmful market behavior. b) The capture theory of regulation According to this theory, regulation exists not because the public needs it but because the regulated industry wants it. This occurs when a regulatory agency created to act in the interest of the public acts for the commercial interests that dominate the sector or industry it is supposed to regulate. In effect, the agency is captured by the industry it is regulating. The government regulator therefore acts as the decision making head of a now monopolized industry. This is possible when the members of the regulating agency are former and future employees of the industry. Instead of promoting efficiency, the agency creates inefficient resource allocation (Jacint, 2005). An industry may acquire its regulatory agency since regulatory agencies require a lot of specialized knowledge on the industry. Unfortunately, those with such knowledge can only be found within the same industry. A person might therefore leave the industry for the agency but with the hope of returning back to the industry when his term in the agency expires. Therefore, any decisions passed by the agency will be in favor of the industry rather than the public. The regulators in this case are therefore motivated by the commercial as well as special interest of the industry being regulated. The benefits of regulation which are the motivating factors for regulators are obvious according to the capture theory. The agency can influence the government through the agency to grant subsidies or ban direct competition leading to increased prices, the government can maintain minimum prices and restrict entry more easily than a cartel and suppress the use of substitutes but support the use of complements. In all this cases, regulation will most likely benefit the industry but it may not have desirable effects on the public supposed to benefit from regulation. c) The special interest theory Another theory of regulation is the special interests theory which asserts that multiple groups do compete for control of a regulatory agency’s activities. The citizen is not a significant factor in the theory but powerful groups fight among themselves to use coercive authority of the government to make rules and regulations that would be of benefit to their particular business. Such rules might therefore help one company but hurt others. Just as in the capture theory, government regulation is not regarded as being bad. Instead, the regulated industry or company demands for it. However in this case, the competition among the various special interest groups is both widespread and intense. However, the regulator is motivated by achieving special interests for the regulated industry at the expense of others or the public. 2. Normative measurement theories of accounting The normative accounting theories of accounting were developed in the 1960s and 1970s as alternatives to the historical cost accounting. This was triggered by the shortcomings that characterized the historical cost accounting and hence making it irrelevant for accounting measurement and reporting. Historical cost accounting methods were criticized for failing to recognize the current market value when dealing with asset acquisitions (Yuji, 2007). The method reveals the acquisition cost and the depreciation to date but fails to recognize that the current market value of the asset may be higher or lower than it reports. Furthermore, historical cost accounting method has obvious flaws during the times of inflation since it assumes that the currency in which transactions are recorded remain stable over a period of time. It is as a result of these shortcomings that normative theories of measurements were developed. The normative accounting theories tend to advocate their opinions on accounting based on subjective opinion, deductive logic as well as inductive methods. The theory seeks to prescribe some basis of accounting measurement, particular accounting procedures and the contents of financial reports. Normative accounting theory is a theory which prescribes how the accounting practice ought to be done and is not based on observation. As such, the theory may suggest radical changes to current practices in accounting as it makes use of several different approaches to come up with one correct accounting opinion. The normative approach makes use of formula to figure out income based on value as opposed to cost. There are various theories that have been advanced in a bid to deal with the shortcomings of historical cost accounting. One such theory includes the current purchasing power accounting. The theory was developed on the premises that in times of rising prices, if an organisation was to distribute its unadjusted profits based on historical costs, it will result in the reduction in the entity’s real value. In other words, distributing income based on historical costs would lead to a firm distributing part of its capital. The theory advocates for adjustment of the firm’s income at the year end based on current purchasing power price index. However, non-monetary items are not adjusted for purchasing power loses or gains as purchasing power losses only arise as a result of holding monetary assets. Another method fronted by the normative theorists is the current cost accounting method which considers actual valuation. The method differentiates between trading profits and gains from holding assets. The holding gains or realizable cost savings refer to increase in the current cost of the assets held by the firm in the current period. This is treated as business profit in the income statement. McNeal also suggested what he called exit pricing accounting whereby he argued that accountants ought to report all profits and losses and values as determined in competitive markets. As such, marketable assets should be valued at market price while non marketable assets should be valued at replacement costs. Furthermore, income should include all profits and losses whether realized or not. Although the historical cost accounting method continues to be a preferred method of accounting measurement by many organizations, the normative measurement theory has been found to be effective especially during times of high inflation / price changes. This is because the theories recognize that the monetary unit is not fixed and not constant over time. Normative theories have been found effective in production of financial reports that portray the real value of an entity assets based on the current prices. Unlike the historical cost accounting method, the normative approach does not add together assets acquired with dollars of different purchasing power (Richard, 2010). The method also takes account of changing prices. This means that the entity’s earnings can never be overstated in times of rising prices. The distribution of the entity’s profits can therefore not lead to an erosion of its operating capacity as purchasing power remains intact. Unlike the historical costing method, normative methods do not distort the current years operating results through inclusion of the current year’s income holding gains which actually occurred in the previous periods. The normative theories of measurement are therefore effective in ensuring capital maintenance i.e. The methods ensure that the financial capital as well as purchasing power remains intact. By using current values in accounting measurements, the approach ensures that the physical operating capital of the firm is kept intact. This is because measurement is based on present values, entry or exit prices. References: Ahmed, H2004, Accounting theory, Routledge, London Jacint, J2005, The politics of regulation: institutions and regulatory reforms, oxford university press, Newyork. Yuji, I2007, theory of accounting measurement, McMillan, Melbourne Richard, G2010, financial accounting theory and analysis, Routledge, London Read More