Word Count: 1195
Table of Contents:
1.0 Argument in favour of tight accounting regulation:
The agency problem
Comparability of financial statements
Auditor’s independence concerns
Credibility of financial reporting
2.0 Argument in favour of “Free market” regulation:
Market for managers
Market for Corporate takeovers
3.0 Summary of both arguments and position taken:
1.0 In favour of tight accounting regulation:
Since the share market crash of 1929, accounting regulation has been introduced and developed to avoid further economic disasters. Tight regulation of accounting standards provide users of financial information with reliable and accurate information free of charge that will contribute to informed and educated decision making. The aim of the following paper will be to support and confirm the need for tight regulation of accounting standard setting process. 1.2 The Agency Problem:
Management have more knowledge of the firm than outsiders such as shareholders and debt holders and could theoretically create individually tailored and individually audited financial reports to every financier. Active trading in primary and secondary markets would mean that the number of separate contracts could become very large and thus strict uniform accounting standards have evolved as a low cost and efficient solution to a potentially expensive agency problem. 1.3 Comparability of financial statements:
The development of global businesses has led to demands for greater international comparability in financial reporting. Improved comparability benefits both producers and users of financial statements. Producers would achieve cost savings by avoiding the restatement by translation of accounting information, and there would be more efficient decision making by capital providers. Financial markets would also become more liquid and competitive resulting in less information risk and a lower cost of capital to firms.
The free market perspective assumes that auditing will take place in the absence of regulation and thus reducing the risk to shareholders. However how are these auditors going to effectively evaluate and analyse a company’s financial statements without a financial reporting framework to adhere to? The tighter the regulation of accounting standards, the more efficient the auditors conduct will be. External audits will be much more expensive and time consuming to comprehend the particular accounting methods the company chooses to adopt if high regulatory standards are not in place. 1.5 Auditor’s independence concerns:
Auditor’s independence has been a significant issue in recent times which has contributed to major corporate collapses such as HIH and Enron. If tight regulation is not in place auditors will need to continually interact with management to comprehend the accounting methods chosen by management. This continuous interaction with management could represent a potential risk to the auditor’s independence and possibly lead to the public witnessing further corporate failures. 1.6 Credibility of financial reporting:
A question posed by Lafferty (1979) was “How do you explain to an intelligent public that it is possible for two companies in the same industry to follow entirely different accounting principles and both get a true and fair view audit report? The public may want to know how many true and fair views there are and whether there is any common standard against which to measure them all.”
References: 1. Brown, P, & Tarca, A 2001, ‘Politics, Processes and the future of accounting standards’, Abacus, Vol. 37, no. 3, pp. 267-96.
2. Lafferty, M, 1979 ‘Why it is time for another leap forward’, accountancy, p. 51.
3. Skinner, D. J. 1994, ‘Why firms voluntarily disclose bad news’, journal of accounting research, Vol. 32, no. 1, pp. 38-60.
Please join StudyMode to read the full document