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Accounting and Sosial Reality
Financial accounting theory
• Accounting theory is a form of understanding that is used to denote speculation,
methodology, and framework forms and study forms of financial reporting.
Accounting theory also discusses how the principles of financial reporting are
applied in industries related to accounting. This theory is basically used as a study
to understand financial reporting and how companies or institutions submit these
reports using the right methods and strategies.
• Accounting theory then has an interest in producing general statements, namely
in the form of hypotheses as concrete explanations in accounting practice to
ultimately be used as material for consideration in making decisions. That is why
this theory is free from value judgments and becomes the center of attention
that needs attention.
• Financial accounting theory focuses on the “why” of accounting – the reasons
why transactions are reported in certain ways
The core of Scott's book
• Accounting theory (in terms of descriptive or prescriptive):
– Normative: what should be done (prescriptive) Suwardjono
– Positive: explanation of “what” & “how”.
• The core of Scott's book
about accounting,
not about how to count
• book goals
provide an understanding of the accounting environment and
current financial reporting
from the point of view of investors and managers
Historical Perspective
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Accounting has a long history
1494: Luca Paciolidoble entry bookkeeping system (Italy)
1543: Pacioli's works are Englishized
1844: companies act
1909: development of Aki to the U.S.; introduction of income tax in the US
1929: stock market crisis in the US
1934: establishment of the SEC (securities and Exchange Commission) by the Securities
Act
1940: historical cost accounting, this basis received the highest expression
Paton & Littleton's famous monograph, Introduction of Corporate Accounting
standard
Read: Historical Dates in Accounting (Accounting review)
Notes on Ethical Behavior
• How to restore public trust in financial reports (case: Enron & Worldcom) Improved
REGULATION
• Ethical behavior:
• Do everything right
• Accountants must behave with integrity and be independent in placing the public
interest above the interests of employers and clients which may conflict.
• Dimensions of ethical behavior: social, time
• Hobbes (1700s)—social:
• If people act alone for their own benefit, society will lose out. Laws, rules, and courts are
not enough to restore cooperative behavior, as long as rules do not anticipate all human
interactions
• Beneficial ethical behavior for society, achieved:
• Full disclosure, usefulness of financial statements, cooperative behavior, reputation
Information Complexity in Accounting and
Financial Reporting
• The accounting environment is very complex and challenging
• Complex: accounting product is INFORMATION, a powerful and
important commodity
• Challenging: surviving and doing well in a complex environment,
characterized by conflicting pressures from different groups in the
financial sector
Accounting Research Role
• Two ways to look at the role of research
• 1. The effect on accounting practice
• 2. Increase our understanding of the accounting environment
• – Ad 1-Accounting Theory is based on fundamental research
• • Improvements in disclosure based on investor decision-making
theory and capital market theory
• – Ad 2-Use of other models/theories in research, increasing
understanding of the accounting environment
• Fundamental research on agency theory models has enhanced our
understanding of managers' interest in financial reporting
the importance of information asymmetry
• Information economics recognizes: some parties involved in transactions may
have an information advantage over others.
• Such economics is characterized by information asymmetry, which includes two
types viz
• (1) difficult/unfavorable selection (adverse selection) and
• (2) deviant behavior (moral hazard).
• – Type one when one party (the manager or an insider) has an information
advantage over the other party, there are many ways managers and other
insiders can exploit their information advantage at the expense of outsiders,
whereas
• the second type if one party can observe the actions of the other party in the
transaction.
• Accounting plays a role in reducing information asymmetry.
Fundamental Problems of Financial
Accounting Theory
Information for investors:
• Make better investment decisions & better operate capital markets
• Controlling/ controlling adverse selection and controlling moral hazard
• Information based on fair value (market) will be able to fulfill it
Information manager:
• Compensation contracts are efficient and operate better in managerial
labor markets
• Historical cost based information
• Problem of TA: how to reconcile the above different roles for accounting inf
Regulation as a Reaction to Fundamental
Problems
Action Theory Problems? two reactions
• 1. As a result of the question, what is the problem?
• 2. Regulations to protect investors:
• Information is a complex & important commodity
• Market strength alone fails to control for two types of information
asymmetry.
• Standard setting role: laying down GAAP as the answer to the
problem