Regulation of Accounting and Financial Information - Literature review Example

ACCOUNT REGULATION Name Course Tutor Institution Date Account Regulation Introduction Regulation of accounting has been an issue for some time now, especially after the 1920-30s economic crash. According to Shapiro and Irons (2011, p. 15), the main purpose of accounting is to offer interested parties information that they do not have access to, so that they can make key economic decisions. Such parties may either lack complete or necessary access to information, leading to an information asymmetry situation (Shapiro & Irons 2011, p. 15). The existence of information asymmetry is used to justify the accounting regulation need. According to Gaffikin (2008, p. 2), regulations are synonymous with the law, and therefore, they can mean norms or rules that a government adopts, and are backed up by the threat of negative consequences, especially penalties. Accounting regulation is not only targeted to the kind of information interested parties get, but also, to the people preparing the information (Gaffikin 2008, p. 34). Professional competence of auditors and accountants is important, and therefore, they are subjected to various forms of regulations that ensure their capabilities to provide or supervise the provision of efficient financial information (Gaffikin 2005, p. 4). Bennear and Coglianese (2005, p. 22) states that neutrality in accounting requires that information found in financial statements be free from bias. Financial information should, therefore, portray a balanced view of a company’s affairs, without showing biasness. According to Bennear and Coglianese (2005, p. 22), accounting is not neutral, and there is deliberate and systematic bias in financial information, hence the need for accounting regulations. This essay focuses on the need for accounting regulations, history of accounting regulations in Australia, reasons to accounting regulations and whether or not accounting is neutral, and finally, gives an overview of the economic and social impacts of accounting regulations and accounting regulation theories. History of accounting regulation in Australia In the past, accounting standards were developed by professional bodies of accounting that enforced the standards within their code of ethics. The professional accounting bodies were in operation from 1966, under the Australian Accounting Research Foundation (AARF) (Camfferman & Zeff 2007, p. 45). AARF consisted of both Public Sector Accounting Standards Board (PSASB) and Accounting Standards Board (AcSB), who worked in collaboration, to prepare accounting standards in both public and private sector organizations (Camfferman & Zeff 2007, p. 45). The Accounting Standards Review Board (ASRB), which is currently the Australian Accounting Standards Board (AASB) was established in 1984, to review the accounting standards provided by the professional accounting bodies. AASB shifted the control of accounting regulation from profession to government (Guthrie 1998, p. 13). In 2000, the AASB merged with PSASB under the Australian Securities and Investments Commission Act 1989 (Guthrie 1998, p. 13). The regulation changes saw the formation of the Financial Reporting Council (FRC), by the government of Australia to supervise the activities of AASB (Chua & Sinclair 1994, p. 669). Currently, the standards of AASB apply under Corporations Act 2001 (Chua & Sinclair 1994, p. 669). Camfferman and Zeff (2007, p. 145) states that the standard setters in Australia contributed largely to the development of international accounting standards under the International Accounting Standards Committee (IASC), which was formed in 1973, and in 2001, became International Accounting Standards Board (IASB). The development of accounting regulation in Australia happened in three time periods, before 1970, which was a largely unregulated period, professional regulation period, which brought about non-compliance problems and the current regulation by legislation period, which started after 1984 (Camfferman & Zeff 2007, p. 245). Currently, various bodies exist in Australia, for regulating the accounting profession. The Australian Securities Investments Commission is a regulatory body that regulates liquidators and auditors, financial planners and company directors (Chua & Sinclair 1994, p. 669). The Tax Practitioners Board regulates tax practitioners, Australian Prudential Regulation Authority (APRA) regulates auditors or superannuation funds trustees and directors of insurance companies and finally, Insolvency Trustees Service Australia (ITSA) regulates trustees in bankruptcy (Chua & Sinclair 1994, p. 672). The Financial Reporting Council oversees the process of standard setting in Australia (Guthrie 1998, p. 113). According to Guthrie (1998, p. 131), in Australia, ethics is a fundamental requirement in the accountability of the accounting profession. The code of ethics is important because the chartered accounting is designed to act in the interests of the public. Reasons for accounting regulations While information from financial statements should be balanced and neutral, it is sometimes, either deliberately or systematically biased. According to Hines (1988, p. 255), deliberate bias occurs when the management is forced by conditions and situations to misstate the information in financial statements intentionally. For example, when the managers of a company are given bonuses, they might be tempted to adopt the accounting policies that lead to the company having higher profits than the ones reflected in the company’s GAAP, with the intention of gaining more bonuses. On the contrary, systematic bias occurs when one outcome is favoured over another, due to the inherent tendency of accounting systems (Walker 1988, p. 255). There are various reasons for regulations in existence. According to Walker (1987, p. 270), regulations are necessary when there is the potential for growth of monopolies. Monopolies exist when there is a market failure because of lack of competition (Posner 1974, p. 335). Regulation is, therefore, effective in preserving competition. In economies that are centrally controlled, the creation of monopolies occurs because of forms of bureaucratic control. In countries such as Australia, it is believed that there is a need to keep the environment conducive for competition. (Gaffikin 2011, p. 236) states that the Australian Competition and Consumer Commission (ACCC) play the role of making sure that there is competitiveness in Australia, and compliance with the 1974 Trade Practices Act rules that are against anti-competitive behaviour. Gaffikin (2011, p. 236) also adds that competition and efficacy of markets are the hallmarks of capitalism. Natural monopolies can, however, arise in some cases when some economies of scale make sure that a market is served at the least cost (Shapiro & Irons 2011, p. 15). Regulations of accounting are designed to make sure that there is fair-trading in such cases. Regulation of accounting is needed in the cases where there are windfall profits. Windfall profit situations happen when a firm is able to make profits that are above normal due to some fortuitous event (Gaffikin 2005, p. 434). For example, there have been occurrences of natural disasters recently, and suppliers of search and recovery equipments are required to offer their services in such situations efficiently. Due to the urgency, the suppliers may attempt to charge prices that are above normal, therefore, generating abnormal profits. According to Bennear and Coglianese (2005, p. 122), in the past, costs related to some productive activities were not determined, and therefore, true costs were not recognized, making them externalities. In recent times, there are costs related to reducing pollution, such as discharging into river systems, which affects the society. To make sure there is environmental and social responsibility, accounting regulation is necessary (Bennear & Coglianese 2005, p. 221). Regulation of accounting is also needed to avoid the situation of profit skimming, which Chua and Sinclair (1994, p. 669) describes as the situation when a supplier supplies only to customers who lead to greater profit gains and ignore the rest. In Australia, the issue of profit skimming can be witnessed in the privatization of Telecom Australia whereby, the government has to make sure that all Australians (whether living in the urban or rural setups), continue to receive telecommunication services equally and fairly (Gaffikin 2008, p. 34). Regulation in such a case is used to ensure that there are availability and continuity of services on an equitable basis. When anti-competitiveness and predatory pricing are witnessed, regulation is used to outlaw such activities and acts as a preventative measure. Accounting regulation is necessary to avoid instances of the free ride effect, where some consumers benefit from services they have not paid for, at the expense of others who have paid for them (Gaffikin 2008, p. 34). For example, a business that has been recently opened next to a large public car park may want to avoid the costs associated with providing car-parking services to potential customers. In such a case, the producers of the car-parking service will see this as a disincentive and a government may levy a tax on the car-parking service. In the context of securities market, the situation of free rider effect may apply with respect to firms and the amount of financial information they disclose. If accounting regulations insist on high levels of disclosure, Bennear and Coglianese (2005, p. 22) states that some firms might not bear the cost of provision of the information, yet they will benefit from the disclosure. According to Hines (1988, p. 255), regulations are necessary to avoid the situation of moral hazard, which is a situation occurring mostly in the insurance industry, where some consumers not paying for a service make heavy consumptions at the expense of others paying for them. For example, some people make excessive claims against their insurance policies, while others do not make any claims. The need for regulations in such industries is to rationalize or coordinate their behaviours efficiently (Hines 1988, p. 255). Arguments against accounting regulations While there has been a rapid evolution of the regulatory environment in which firms operate, some firms have stated that accounting regulations are not necessary because markets are aware of their accounting necessities (Hines 1988, p. 255). Opponents of accounting regulations state that the institutional framework is not similar to the settings of the ideal market therefore; the free market should be left to provide accounting information. Walker (1988, p. 255) claim that regulation of accounting does not achieve its aim of comparable, reliable, consistent and accurate financial reporting. Furthermore Bennear and Coglianese (2005, p. 212) adds that opponents of accounting regulation suggest that the process of standard setting favours the setters. According to opponents of regulation, the primary effect of accounting regulations is to harm employment and the economy (Gaffikin 2008, p. 34). For instance, Gaffikin (2011, p. 4) argues that accounting regulations raise the costs firms undergo, resulting to a raise in costs of production and products, and a reduction in employment and sales. Social and economic impacts of accounting regulations Regulations of accounting have various economic and social benefits and costs. Some of the economic benefits include more credibility in financial reporting, leading to the increase in public confidence, to financial markets (Gaffikin 2005, p. 4). Other economic benefits include the allocation of resources efficiently, and increased credibility when an individual is entering their external financial statements (Camfferman & Zeff 2007, p. 45). Shareholders and lenders can make better evaluations due to accountability of the managers. Some of the apparent and readily identifiable economic impacts caused by accounting regulations, are out-of-pocket costs, such as costs of collecting, understanding and processing the information required to regulate accounting standards and audit costs (Camfferman & Zeff 2007, p. 45). When standards are changed, users incur costs, which include costs of interpreting, analyzing and understanding the new information. Costs of disseminating information to the users are also a readily identifiable economic impact (Guthrie 1998, p. 13). According to Chua and Sinclair (1994, p. 669), another economic impact can be felt in the response of management, especially when they deem a standard designed to serve external uses, to be inappropriate for internal performance of a company. Furthermore, Chua and Sinclair (1994, p. 669), states that more social and economic impacts can be felt when regulated accounting standards cause management to behave uneconomically, with the purpose of gaining short run improvement or what seems to be greater financial strengths (Walker 1988, p. 257). Theories of accounting regulation There are three main theories in accounting regulations, namely: public interest theory, capture theory and economic interest theory (Walker 1988, p. 255). Such theories are important in figuring out why some accounting prescriptions form part of the legislation, while others do not. There is a clear distinction between positive accounting theory and normative accounting theory. Public interest theory of regulation seeks the purpose of achieving positive or desired results to the public, which would not have been obtained if left to the market (Walker 1988, p. 256). According to public interest theory, regulations are pursued for the interest of the public, as opposed to private entities (Posner 1974, p. 335). Governments, therefore, impose regulations, according to the public’s interest. Interest group regulation theory, on the other hand, is targeted to making regulations, due to the relationships between certain groups and the state (Posner 1974, p. 338). The capture regulation theory states that initially, regulations are formed according to the interest of the public, but the regulators find it hard to remain independent. The regulated captures the management of the regulations, and therefore, when the regulations are applied, they are interpreted to benefit the regulated, rather than benefiting the interest of the public (Posner 1974, p. 339). Conclusion In conclusion, there exists inefficient information markets, and therefore, accounting regulation makes sure there is optimal disclosure of information. Neutrality in accounting occurs when the information in financial statements is balanced, and does not favour any party over another (Shapiro & Irons 2011, p. 15). This is, however, not the case in most Australian firms, and the information contained in financial statements is either systematically or deliberately biased. Regulations are, therefore, necessary to ensure balance of financial information. Regulation further protects the rights of individual investors, and allows access to information. While Gaffikin (2011, p. 236) states that regulation offers protection from fraudulent organizations, Shapiro and Irons (2011, p. 145) adds that regulation makes sure there is comparability, accuracy and fairness in financial information. Reference List Bennear, LS & Coglianese, C, 2005, ‘Measuring progress: program evaluation of environmental policies,’ Environment: Science and Policy for Sustainable Development, 47(2), pp. 22-39. Camfferman, K & Zeff, SA, 2007, ‘Financial Reporting and Global Capital Markets: A History of the International Accounting Standards Committee, 1973-2000: A History of the International Accounting Standards Committee, 1973-2000,’ Oxford University Press. Chua, WF & Sinclair, A, 1994, ‘ʺInterests and the profession‐state dynamic: Explaining the emergence of the Australian Public Sector Accounting Standards Boardʺ,’ Journal of Business Finance & Accounting, 21(5), pp. 669-705. Gaffikin, M, 2005, ‘Regulation as accounting theory,’ Gaffikin, M, 2011,’ What is (accounting) history?’ Accounting History, 16(3), pp. 235-251. Gaffikin, MJ, 2008, ‘Accounting theory: Research, regulation and accounting practice,’ Guthrie, J, 1998, ‘Application of accrual accounting in the Australian public sector–rhetoric or reality,’ Financial Accountability & Management, 14(1), pp. 1-19. Hines, R, 1988, ‘Financial Accounting: In communicating reality, we construct reality. Accounting, Organizations and Society,’ 13 (3), pp. 251-261 Posner, RA, 1974, “Theories of Economic Regulation.” Bell Journal of Economics and Management Science 5: pp. 335-358. Shapiro, I & Irons, J, 2011, ‘Regulation, Employment, and the Economy: Fears of job loss are overblown,’ Economic Policy Institute, pp. 15. Walker, RG, 1987, “Australia's ASRB: A Case Study of Political Activity and Regulatory Capture.” Accounting and Business Research 17 (67): pp. 269-286. Read More