Discussion on argument that explain reasons of regulation in accounting practice based on theory

1. LECTURE 3
APPLYING THEORY TO
ACCOUNTING REGULATION
ARTHIK DAVIANTI, SE. MSI. AK. CA.

2. THE THEORIES OF REGULATION
RELEVANT TO ACCOUNTING AND
AUDITING
Managers have incentives to voluntarily provide
accounting information, so why do we observe
the regulation of financial reporting?
Explanations are provided by:
 theory of efficient markets
 agency theory
 theories of regulation
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3. THEORY OF EFFICIENT MARKETS
The forces of supply and demand influence
market behaviour and help keep markets efficient
This applies to the market for accounting
information and should determine what
accounting data should be supplied and what
accounting practices should be used to prepare it
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4. THEORY OF EFFICIENT
MARKETS
The market for accounting data is not efficient
The ‘free-rider’ problem distorts the market
Users cannot agree on what they want
Accountants cannot agree on procedures
Firms must produce comparable data
The government must therefore intervene
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5. AGENCY THEORY
The demand for accounting information:
 for stewardship purposes
 for decision-making purposes
A framework in which to study the relationship
between those who provide accounting
information - e.g. a manager - and those who
use it – e.g. a shareholder or creditor
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6. AGENCY THEORY
Because of imbalances between data suppliers
and data users, uncertainty and risk exist
Resources and risk are likely to be mis-
allocated between the parties
To the extent the market mechanism is
inefficient, accounting regulation is required to
reduce inefficient and inequitable outcomes
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7. THEORIES OF REGULATION
There are three theories of regulation:
 public interest theory
 regulatory capture theory
 private interest theory
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8. PUBLIC INTEREST THEORY
Government regulation is required in the
‘public interest’ whenever there is market
failure (inefficiency) due to:
 lack of competition
 barriers to entry
 information asymmetry
 public-good products
Assumption: economic markets are subject to a
series of market imperfection or transaction
failures.
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9. PUBLIC INTEREST THEORY
Governments intervene:
 Legislative action – to get votes (competing
candidates)
 because public interest groups – agents -
demand intervention in pursuit of public
interest objective
 Government has no independent role
because they are neutral arbiters – intervene
costlessly
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10. REGULATORY CAPTURE
THEORY
The purpose to protect the public interest is
not achieved
The public interest is not protected because
those being regulated come to control or
dominate the regulator
The regulated protect or increase their wealth
Assumes the regulator has no independent role
to play but is simply an arbiter between
battling interest groups
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11. REGULATORY CAPTURE
THEORY
Assumption:
• All member of society are economically
rational – private marginal benefit from
lobbying
• Government has no independent role in the
regulatory process
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12. REGULATORY CAPTURE
THEORY
Situations of occurrence – the regulated
entities:
• Control the regulation and regulation agency
• Succeed in coordinating the regulatory body’s
activities
• Neutralise or ensure non-performance
• In a subtle process of interaction
Professional accounting bodies or the
corporate sector seek to control the setting of
accounting standards
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13. PRIVATE INTEREST THEORY
Governments are not independent arbiters, but are
rationally self-interested
They seek re-election
They will ‘sell’ their power to coerce or transfer
wealth to those most likely to achieve their re-
election (if they are elected officials) or increase
their wealth (if they are appointed officials) or both
This theorists believe – a market for regulation with
similar supply and demand (with many bidders)
Only the highest bidder will be successful
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14. PRIVATE INTEREST THEORY
Producer groups of regulation able to use the
power of government for their own advantage:
1. Organised interest group – seeking political
protection. Other groups (more diffuse) have
limited ability to bid effectively (due to
organisation and information cost)
2. Government officials are rationally self-
interested
This theory predicts – regulators will use their
power to transfer income from those with less
political power to those with more.
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15. APPLICATION OF PUBLIC
INTEREST THEORY
The Sarbanes-Oxley Act (US, 2002)
Accounting Standards Review Board (AUS,
1984)
But:
 Managers have incentives to voluntarily
correct market failure perceptions about
their firms
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16. APPLICATION OF CAPTURE
THEORY
Was the ASRB captured by the accounting
profession?
Is international harmonisation evidence of
capture by large companies, the ASX and the
accounting profession?
Has the IASB been captured by the FASB?
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17. APPLICATION OF PRIVATE
INTEREST THEORY
The private interest theory could be applied to
the establishment of the ASRB
The various theories of regulation are not
mutually exclusive
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18. STANDARD SETTING AS A
POLITICAL PROCESS
Standard setting is a political process because
it can affect many conflicting and self-
interested groups
The regulator must make a political choice
The regulator must have a mandate to make
social choices
The recognition of doubtful debts can affect
entities differently
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19. REGULATORY FRAMEWORK
FOR FINANCIAL REPORTING
A financial reporting environment is made up
of:
 legal setting
 economic setting
 political setting
 social setting
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20. REGULATORY FRAMEWORK
FOR FINANCIAL REPORTING
The elements of a regulatory framework are :
 statutory requirements
 corporate governance
 auditors and oversight
 independent enforcement bodies
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21. STATUTORY REQUIREMENTS
Company law
Securities market law
Accounting standards
 force of law
Taxation law
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22. CORPORATE GOVERNANCE
‘The structures, processes and institutions
within and around organisations that allocate
power and resource control among
participants.’ Davis
Supranational and national bodies have issued
corporate governance recommendations
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23. THE IASB AND FASB
CONVERGENCE PROGRAM
Convergence program commenced in 2002
 Norwalk agreement
Convergence is a complicated process
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