Theory of Accounting and
Control
Shyam Sunder, Yale University
Kozminski University, Warsaw, Poland
May 16, 2009
ACCOUNTING AND CONTROL IN ORGANIZATIONS:
A CONTRACT THEORY
PART I:
CONTRACT THEORY OF THE FIRM
CHAPTER 1: INTRODUCTION
CHAPTER 2: ACCOUNTING AND CONTRACT MODEL OF THE FIRM
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
3:
4:
5:
6:
7:
8:
PART II:
MICROTHEORY OF ACCOUNTING AND CONTROL
CONTRACTING FOR MANAGERIAL SKILLS
MANAGERS AND ACCOUNTING DECISIONS
INCOME AND ITS MANAGEMENT
INVESTORS AND ACCOUNTING
ACCOUNTING AND THE STOCK MARKET
AUDITORS AND THE FIRM
PART III:
MACROTHEORY OF ACCOUNTING AND CONTROL
CHAPTER 9: CONVENTIONS AND CLASSIFICATION
CHAPTER 10: DECISION CRITERIA AND MECHANISMS
CHAPTER 11: STANDARDIZATION OF ACCOUNTING
CHAPTER 12: GOVERNMENT, LAW AND ACCOUNTING
CHAPTER 13: ACCOUNTING FOR PUBLIC GOOD ORGANIZATIONS
ACCOUNTING AND CONTROL IN ORGANIZATIONS:
A CONTRACT THEORY
Part I: CONTRACT THEORY OF THE FIRM
Chapter 1: Introduction
THREE BASIC IDEAS
– Organizations as a Set of Contracts
– Shared Facts for Conflict Resolution g
– Control in Organizations as Balance and Equilibrium
MICROTHEORY OF ACCOUNTING AND CONTROL
– Functions of Accounting and Control
– Managers and Income
– Shareholders, Stock Markets, and Auditors
MACROTHEORY OF ACCOUNTING AND CONTROL
– Basic Features of Accounting
– Social Choice Criteria, Mechanisms, and Standardization
– Government and Public-Good Organizations
Chapter 1 References
Chapter 2: Accounting and the Contract Model of the Firm
THE FIRM AS A SET OF CONTRACTS
ACCOUNTING AND THE FIRM
– Measuring Contributions
– Measuring Entitlements
– Distribution of Information about Contract Fulfillment
– Liquidity of Markets for Contractual Slots
– Common Knowledge for Renegotiation of Contracts
CORRESPONDENCE BETWEEN ORGANIZATIONAL AND ACCOUNTING
FORMS
– Bookkeeping
– Managerial Accounting
– Financial Reporting
Chapter 2 References
Part II: MICROTHEORY OF ACCOUNTING AND CONTROL
Chapter 3: Contracting for Managerial Skills
CHARACTERISTICS OF MANAGERS
– Human Capital
– Measuring Managerial Contribution
– Contact with Other Agents
FORMS OF CONTRACTS FOR MANAGERS
– Manager’s Preferences
– Contracts of Top, Middle, and Lower Level Managers
Chapter 3 References
Chapter 4: Managers and Accounting Decisions
HIERARCHY OF ACCOUNTING DECISIONS
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Discretionary Decisions on Expensing-Capitalization of Costs
Accounting Estimates
Accounting Principles
Disclosure Policy
Internal Controls
Accounting Standards
CERTAIN FEATURES OF CONTROL SYSTEMS
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Cost of Accounting
Transfer Pricing
Cost Allocations
Participative Budgeting
Standards and Variance Analysis
MANAGERIAL CONSEQUENCES OF ACCOUNTING DECISIONS
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–
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–
–
–
The LIFO Puzzle
Accounting for Leases
The Restructuring of Troubled Loans
Cost of Exploration, Research and Development
Recognizing Option Value as Compensation Expense
Rationality of Apparently Irrational Decisions
OBSERVABLE BEHAVIOR OF MANAGERS
–
–
–
Preference for Status Quo
Income Management
Prediction of Accounting Methods by Firm Characteristics
Chapter 4 References
Chapter 5: Income and its Management
INTRODUCTION TO INCOME
FUNCTIONS OF INCOME IN A FIRM
– Assessing Viability of the Firm
– Managerial Evaluation and Contract Renegotiation
ATTITUDES OF AGENTS TOWARD INCOME
– Shareholders
– Managers
– Determination of Entitlements
MANAGEMENT OF INCOME
–
–
–
–
–
Statistical Measures of Smoothness
Income Processes: Smoothness vs. Smoothing
Income-Smoothing vs. the “Big Bath” Hypotheses
Instruments of Income Management
Summary of Empirical Findings
Chapter 5 References
Chapter 6: Investors and Accounting
DESCRIPTION OF THE INVESTOR CLASS
– The Lack of Active Participation
– Transferability of Contract
– Heterogeneity of Preferences
– Information and Speed of Price Adjustments
– Information Intermediaries
– Creditors
INVESTOR ATTITUDES AND PREFERENCES
– Reporting on Contract Performance
– Incentives to Managers
– Aggregation Adds Information
ACCOUNTING CHOICE MECHANISMS FOR
INVESTORS
– Organization of the Firm
– Trading in Capital Markets
– Voting and Proxies
– Sociopolitical Institutions
CONSEQUENCES OF ACCOUNTING POLICY FOR
INVESTORS
–
–
Accounting Information as Public Goods
Production of Information By Intermediaries
Chapter 6 References
Chapter 7: Accounting and the Stock Market
INTRODUCTION
– Limited Role for Valuation Rules
– Role of Information Intermediaries
QUESTIONS ABOUT ACCOUNTING AND THE STOCK MARKET
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–
–
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Money from Accounting Numbers
Money from Advance Access to Accounting Numbers
Effect of Accounting Methods on the Stock Market
Effect of the Stock Market on Accounting
Accounting Without the Stock Market
The Stock Market Without Accounting
PROBLEMS OF INFERENCE
– The Needle in a Haystack Problem
– The Expectations Problem
– The Self-Selection Problem
Chapter 7 References
Chapter 8: Auditors and the Firm
INTRODUCTION
THE FUNCTION OF AUDIT IN THE FIRM
AUDITOR DECISIONS
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Allocation of Resources in an Audit Assignment
Audit Opinion
Pricing of Services and Bidding for Clients
Audit Policies, Training, Quality Control, and Self Regulation
Technology of Audit
Institutional Structure of the Audit Profession
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Development of Audit Standards
Development of Accounting Standards
Who Sets the Standards?
Auditors’ Responsibility for Detection of Fraud
Competition, Entry, Discipline
Chapter 8 References
Part III: MACROTHEORY OF ACCOUNTING AND CONTROL
Chapter 9: Conventions and Classification
CONVENTIONS

ACCOUNTING CONVENTIONS
ECONOMIC FEATURES OF ACCOUNTING
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Entity
Going Concern or Continuity
Period
Valuation
Accrual
TEMPORAL STABILITY OF ECONOMIC FEATURES
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Double Entry
Economic Resources
UNIFORMITY AND CLASSIFICATION
Chapter 9 References
Chapter 10: Decision Criteria and Mechanisms
CRITERIA FOR SOCIAL CHOICE
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Technological Efficiency
Simple Economic Efficiency
Multi-Person Economic Efficiency
Multi-period Problem
Uncertainty Problem
SOCIAL COST-BENEFIT ANALYSIS
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Which costs and which benefits?
Problems of partial analysis
Nonlinear utilities
Measures of Efficiency
MECHANISMS FOR SOCIAL CHOICE
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Limitations of Voting Mechanisms
Market Mechanisms in Accounting Standards
Legal Rights and Markets
Chapter 10 References
Chapter 11: Standardization of Accounting
RULES AND ECONOMIC DECISIONS
 Rules as Constraints
 Rules as Payoff Functions
 Voluntary and Mandatory Behavior
ECONOMICS OF RULES AND
STANDARDS
 Benefits
 Costs
 Distribution and Equity
 Adjustment to New Standards
ECONOMIC THEORIES OF
STANDARDS
 Monopoly and Limiting
Competition
 Provision of Public Good
ACCOUNTING STANDARDS
 Types of Standards
 Enforceability of Standards
 Market Argument
 Argument for Market Failure
 A Synthesis
INSTITUTIONS FOR SETTING
ACCOUNTING STANDARDS
 Models of Social Institutions
 Force of Standards
 Capture of Institutions
EFFECTS OF STANDARDS
• On Accounting Systems
• On Accounting Education
• On the Auditing Profession
Chapter 11 References
Chapter 12: Government, Law, and Accounting
GOVERNMENT AS A CONTRACTING AGENT
 Government as Tax Collector
 Government as Customer
GOVERNMENT AS A SUPER-FIRM
 Charter of Firms
 Sale of Securities
 Certification, Licensing, and Discipline of Auditors
Chapter 12 References
Chapter 13: Accounting for Public Good Organizations
NOMENCLATURE AND CLASSIFICATION
ECONOMIC CHARACTERISTICS OF NRIOs
 Markets for Resources
 Agents
CHARACTERISTICS OF ACCOUNTING IN PUBLIC GOOD ORGANIZATIONS
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Entities and Funds
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Government Funds
Proprietary Funds
Fiduciary Funds
Consolidation and Detail
Recognition and Accrual
Fixed Assets, Depreciation and Long Term Liabilities
Budgets, Appropriations, and Encumbrances
INTERACTION BETWEEN ACCOUNTING FOR NRIOs AND ARIOs
Chapter 13 References
CHAPTER 1
SHARED FACTS FOR CONFLICT RESOLUTION
Disputes, waste of resources
Role of evidence (shared info)
Common knowledge
 Theoretical abstraction
 Practical Approximation
Games of imperfect, incomplete information
Firm as a game of incomplete information
Role of public disclosure
CONTROL IN ORGANIZATION
Conflict and cooperation
Bargaining example
Balance & Equilibrium
Contrast from control OF organizations
CHAPTER 3
CHARACTERISTIC OF MANAGERS
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Wealth as human capital
Contribution hard to measure
Procedural centrality
HUMAN CAPITAL
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Stock of human capital is inalienable
Long term contracts are on flow, which are not enforceable
– Contracts must be self-enforcing
Human capital used at work but not used up (actually it is accumulated at
work)
Compensation: current + accretion of human capital
(Accounting is important for both)
Short run supply of managerial human capital is inelastic
– Opportunity to extract rents
– Vulnerable to expropriation
Managers cannot sell their job slots
Managerial market transactions rely on reputation
– accounting permanence data
Managers have an un-diversified portfolio of personal wealth which is
sensitive to small changes in current performance
Performance data extrapolated by investors/superiors
Performance smoothing by managers
MEASURING MANAGERIAL CONTRIBUTIONS
 Not directly measurable
 More difficult at higher levels
 Difficulty in designing their contacts
PROCEDURAL CENTRALITY:
CONTACT WITH OTHER AGENTS
 Procedural centrality of managers
 Managing contracts
 Surprises: nature, unanticipated behavior of others
 Privileged access to info about other contracts
 Info asymmetry in favor of managers
 Problems of adverse selection
– they know what others don’t
Moral hazard
– others do not know what they did
Could sell info to competitors for personal gain
Prohibition on sharing services of managers across competitors
FORMS OF CONTRACTS FOR MANAGERS
Enforcement difficult because of
 Nature of work
 human capital
 involvement in contracts of others
Legal system could help if shared
information is available
HOW DO WE MAKE IT SELF-ENFORCING?
FLAT SALARY: IN PUBLIC GOOD
ORGANIZATIONS
EVEN OUTPUT IS DIFFICULT TO
MEASURE
POOR MOTIVATIONAL TOOL
PERFORMANCE CONTINGENT
CONTRACTS
NO SINGLE MEASURE IS PERFECT
FACTORS OUTSIDE MAN.
CONTROL
SUBJECT TO MAN.
MANIPULATION
CONDITIONS FOR JOB LOSS LEFT
UNSPECIFIED
RIGHT TO UNILATERAL
TERMINATION
WITHOUT CAUSE
ROLE OF ACCOUNTING IN
MANAGERIAL CONTRACTS
MANAGERS’ PREFERENCES
PECUNIARY VARIABLES
NONPECUNIARY VARIABLES
(FUTURE COMP.)
SALARY IS ABOUT HALF OF
TOTAL FOR CEOS
BENEFITS DRIVEN BY TAX LAW,
TRANS.
COSTS, SIGNALING
INTERACTION BETWEEN
PECUNIARY AND OTHERS
Chapter 4
Managers and Accounting Decisions
Accounting and control includes
– Basic data collection
– Performance reports
– Financial reports
Choice of organizational form includes the choice of
accounting and control
Managers directly in charge of accounting and
control
Other agents participate less directly
– Reacting and “voting with their feet”
– Managers must anticipate and consider
such reactions
Managers also participate in shaping accounting
regimes
Consider the range of managerial accounting
decisions
– Review some features of accounting from
contract perspective
– Consequences of accounting decisions
for managers
– Consequences for observable managerial
behavior
Hierarchy of Accounting Decisions
By frequency of decisions
Expensing-Capitalization decisions
– Managerial unique access to causes and
consequences
– Create facts by classification
– Discretion unavoidable, no perfectly
mechanical solution for classification is
possible
– Demarcation of capital improvements,
repairs, overhauls, rebuilding, salvaging
and maintenance
– Managers can choose timing of
transactions
– Law of conservation of income
– Performance measures and contractual
consequences
– Short-term contracts induce
capitalization
– Countervailing factors: smoothing, longer
term compensation plans, and auditing
Accounting estimates
– Bad debt allowance, warranty costs, NRV
of byproducts, salvage values and
economic life
– Varying degrees of flexibility
– Same motivations as the expensing
decisions
Accounting Principles
– Short term consequences for
compensation
– Longer term consequences and
constraints
– Image and signal
– Auditing
Disclosure Policy
– Compliance with the law and
disclosure beyond the required
level
– Better information for
participating/other agents
– Temptation to disclose selectively
– Trade off between credibility and
cost of verification
– Effect on liquidity of factor markets
– Consequences of performance
forecasts by managers
– Competitors and investor
diversification
– (Competing against privately held
firms)
– Disclosure to limit opportunism of
managers
– Is less disclosure necessarily good
for managers?
– Is more disclosure necessarily good
for shareholders?
Internal Controls
– Broad managerial discretion
– Foreign Corrupt Practices Act 1977
requirements
– Sarbanes-Oxley 2002 requirements
– Cost Accounting Standards Board
for government vendors
– Manager is a principal as well as
an agent in different contractual
relationships within the firm
– Consistency of internal controls
helps balance motives
– Ideal: self-enforcing contract for
control
Accounting Standards
– SEC, FASB, IASB make rules
– Managers often participate on
behalf of the firm
– Can we distinguish managerial and
firm interests?
– Bank loan restructuring example
– Reflexivity of accounting: does it
only represent reality or does it
also create reality?
– What should be role of
firms/managers in setting
standards?
Certain Features of Control Systems
Cost-benefit analysis of accounting and control systems
Transfer Pricing
Standard textbook solution discards the
problem
Essence of decentralization: trade-off
between benefits and costs
– Benefits of central coordination
– Informational disadvantage of the
center
Heart of organizational design problem
Cost Allocation
– Declared a dead issue many times,
but not dead yet
– Does allocation of sunk costs to
divisions make sense
– Ex post efficiency of resource
utilization versus ex ante efficiency
of resource acquisition decisions
Participating Budgeting
– Empowerment vs. dispersed
information argument
– Hayek: Information is dispersed in
the economy
– Trade-off: better decisions based on
more information
– Worse decisions shaded by
information agents choose to share
– Management consulting fads wax
and wane
– People bring their own expectations,
no blank slate
Standards and Variance Analysis
– Budgets and standards imply a
discontinuity in managerial reward
functions
– Anticipation by agents
– Complex non-linear dynamics
Managerial Consequences of
Accounting Decisions
– The LIFO Puzzle
– Accounting for Leases
– Restructuring of Troubled Loans
– Cost of Exploration, Research and
Development
– Recognizing Option Value as a
Compensation Expense
– Rationality of apparently irrational
decisions?
Observable Behavior of Managers
– Preference for status quo
– Income management
– Prediction of accounting methods
by firm characteristics
Chapter 5
Income and Its Management
Firm as a source of “income” for all
participants
– Wage income
– Personal service income
– Interest income
– Land rent
– Sales income, etc.
– Each agent looks at own return from
the contributions
Shareholder income—a narrower perspective
What is special about shareholder income
– Residual nature
– Defined independently of others’ income
– The Degree of freedom problem—n
pieces of a pie
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Timing of transfer of income to
claimants: delay for shareholders’
Other agents get their share on
predefined schedule
Dividend is discretionary
Diffuse of body of shareholders cannot
enforce contracts on timing of transfer
of income
Taxation makes it difficult to
automatically transfer income
–
–
Income to equity cannot be measured precisely
and in a timely manner
No “ship accounting,” no periodic liquidation of
assets, continued long term asset investments
with imperfect and incomplete markets
Indeterminacy of valuation, combined with the
control of management over
valuationopportunity for income
management
Difficulty of measuring managerial
inputlinking compensation to
output/income  use of managerial discretion
for self-serving purposes
Shareholders rely on information in possession
of the mangers but cannot be sure that
management will use this information only for
shareholders’ benefit
Independent audits to put constraints
Imperfections of monetary representation of
income vs. real income
Law of Conservation of Income
Law of Conservation of Discounted Residual Income
Functions of Income in the Firm
– Assessing viability
– Everybody makes projections to the
future
–
Managerial evaluation and contract
renegotiation
Determination of Entitlements
Management of Income
–
–
–
–
–
Statistical measures of smoothness
Smoothing = smoothness?
Income smoothing and big baths
Instruments of income smoothing
Incentives for covering the tracks
Attitudes of Agents towards Income
–
–
–
Shareholders: money income as an estimate of real income
Would like to get the first best estimate
Fundamental model of valuation—relevance?
–
Managers: Use of accounting to advance their own welfare (job security, level,
compensation, firm size all linked to corporate income), risk: dislike abrupt changes in
income
Employment horizons shorter than firm horizon
–
Look at income management from the point of view of managers (bonus, options, could be
terminated before the fruits of labor appear in the financial statements)
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–
–
–
Managers’ expectations of what the shareholders would do
Manager cannot iron out the kinks in the income streams (no retrospective adjustments)
Limits on choice of accounting methods
Not certain about the consequences of choices they make
How do you “smooth” a random walk series?
CHAPTER 6
INVESTORS AND ACCOUNTING
WHAT IS SPECIAL
― PRECOMMITMENT
― TIME DELAY
― RESIDUAL CLAIM ONLY
― MEASUREMENT AND CONT.
FULFILLMENT CRUCIAL
DESCRIPTION
― LITTLE PARTICIPATION
― ON PURPOSE, DESIRABLE,
DIVERSIFICATION
― ROE ON OWNER MANAGED
FIRMS SAME
―
TRANSFERABILITY
― MINIMAL COST, RAPID PRICE
ADJUSTMENT
― SYMMETRY OF INFO (PUBLIC
DISCL.)
― CONTRAST PRIVATELY HELD
FIRMS
― COST OF TAKING THEM PRIVATE
―
PREFERENCE HETEROGENEITY
― LIQUID MARKET GIVES A UNIQUE
MEASURE
―
PRICE ADJUSTMENTS TO
INFORMATION
― DETERMINE DISTRIBUTION OF
WEALTH
― EQUITABLE RELEASE OF
INFORMATION
―
INFORMATION INTERMEDIARIES
―
―
―
―
DEMAND FOR INFORMATION
COST OF INFORMATION
DIVERSIFICATION BY INDIVIDUAL
INFORMATION INTERMEDIARIES
― PROBLEM OF EVAL.
PORTFOLIO MAN.
― DO NOT ASK FOR DISCL.
― ANALYSTS DEMAND
DISCLOSURE,
DETAIL
― CREDITORS
― NONPERMANENT COMMITMENT
― SHORT TERM CREDITORS
― SECURED CREDITORS
― UNSECURED LONG TERM
CREDITORS
― LARGE CREDITORS-LITTLE
INTEREST
― DESIGN OF DEBT COVENANTS-GAAP
― WHY RELIANCE ON GAAP
― AUDIT COST
― INTERDEPENDENCE OF FIRM
CONTRACTS
― SPECIAL GAAP FOR EVERY
AGENT
INVESTOR ATTITUDES AND PREFERENCES
― REPORTING ON CONTRACT
PERFORMANCE
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–
–
―
INCENTIVES TO MANAGERS
–
–
–
―
IMPORTANCE OF CONTRACT
FULFILLMENT
CONTROLS AND REDUNDANCY
SYMMETRY OF INFO DISTRIBUTION
TOP MANAGER CONTRACTS
LIMITS ON RELEVANCE AND RELIABILITY
RRA IN OIL INDUSTRY
–
–
NATURE OF CHARTER
GOING PUBLIC
TRADING IN CAPITAL MARKETS
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DIVIDENDS AND VALUATION
ANALOGY OF BUYERS AND CARS
REACTIONARY MODE
MANAGERS ANTICIPATE INVESTOR PREF.
VOTING AND PROXIES
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―
–
INFORMATION IN AGGR. FUNCTION
ACCOUNTING CHOICE MECHANISM
― ORGANIZATION OF THE FIRM
―
–
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AGGREGATION ADDS INFO
–
―
CONSEQUENCES OF ACCOUNTING
POLICY FOR INV.
― ACCG. INFORMATION AS PUBLIC
GOOD
NOT AN EFFECTIVE INSTRUMENT FOR
INV.
SOCIO-POLITICAL INSTITUTIONS
–
–
LEGISLATURE, REGULATORY BODIES
CHANGES IN REGIME
–
–
―
UNDER PRODUCTION?
COMMON COST OF CONTRACTS
SPECIAL VULNERABILITY OF
INVESTORS
NOT IN DIRECT TOUCH WITH
OPERATIONS
FREE DIST. OF INFO--DYNAMIC
STABILITY
ADVERTISING ANALOGY
PRODUCTION BY
INTERMEDIARIES
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–
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WHO PAYS, WHO BENEFITS
EARLY EFFICIENT MARKET
EUPHORIA
ECONOMICS OF INFORMATION
MARKET
CRITICISM OF DETAILS FOR
ANALYSTS
 OPEN ENTRY TO ANALYST
MARKET
Chapter 7: Accounting and the Stock Market
Accounting interface with
shareholders
1.
2.
3.
4.
5.
Contributions: cash or real, made in
advance
Entitlements: real capital on basis of
accounting records, converted to
money in financial reports through
valuation rules
Reports of contract fulfillment:
unnecessary
Liquidity: verified reports to potential
investors
Public disclosure: to reduce
information asymmetry
Limited role for valuation rules
Entitles to real capital, not money
Imperfection of valuation rules,
vulnerability to manipulation
Only function (4) affected by
valuation rules
Role of information intermediaries
Primary, secondary and tertiary
markets: firm involved in P
Derived demand in P market, bankers’
compensation
Reputation of banker as protection
against collusion (effectiveness??)
Change of auditors, insurance
Money from Public Accounting
Numbers
Discovery and use of information
Competition in the market for
information
Trade off between the speed of
dissemination and depth of markets
Prospecting for gold
Academic studies vs. practical
implementation of money making
Impossibility of informationally efficient
markets
Money from Advance Access to
Accounting Numbers
Effect of the Stock Market on
Accounting
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We would like to have direct evidence
about the money that can be made from
advance access
Insider trading studies
Ball & Brown (event studies) don’t quite
do it
Effect of Accounting Numbers on
Stock Market
 Investor expectations  stock prices
 Accounting data  investor
expectations
 Difficulty of doing studies on
formation of investor expectations
(not from field data)
 Role of accounting in preserving the
resources of the firm (control)
 Role of accounting in
managerial/employee motivation
 Linking investor and employee
behavior into an equilibrium
 Managerial selection
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
Not much research on the topic
Beginning of efforts to standardize
accounting after creation of the SEC
Reynolds example
Managerial concerns about stock
market reaction (LIFO)
Accounting without Stock Market

Choice of going public
Stock Market without Accounting
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Think about the question before the
next value relevance study
Accounting a must for mutual
observables to contract on
Stock market would be impossible
without accounting
Problems of Inference
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Needle in the Haystack Problem
The Expectations Problem
The Self-selection Problem
Chapter 8: Auditors and the Firm
Functions of the Audit in the Firm
Auditor Decisions
 Allocation of resources in an audit assignment
 Audit Opinions
 Pricing audit services and bidding for clients
 Audit policies, training, quality control, and self-regulation
Institutional Structure of the Audit Profession
 Development of Audit Standards
 Development of Accounting Standards
 Who Sets the Standards?
 Auditors’ Responsibility for Detection of Fraud
 Competition, Entry and Discipline
Chapter 9: Conventions and Classification
Examination of the traditional terms of
accounting in terms of contract
theory of the firm
 Link them to familiar social science
concepts
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–
–

Features of accounting as economic
choice of convention
Temporal stability does not mean
convention
Distinction is important for setting
accounting standards
Rules as systems of classification
–
Importance of the nature of
classification for standard setting
Conventions
 A coordinating device in a game
 Games in which coordination can yield
Pareto superior outcomes but
communication is difficult or
impossible
 Applied to recurrent situations
 Must be common knowledge
 It is in the interest of everyone that one
more person will conform to the
convention

Existence of an alternative which is just as
good
–
–
–
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
Driving on the right or left
Debits on the right or left
Balance sheet in order of decreasing or
increasing liquidity
In accounting literature a lot of confusion
and confusing definitions of conventions
(Gilman, Kohler’s Dictionary)
Stake in maintaining the status quo
Differentiated from economic choices
Economic Features of Accounting

Features which are not conventions
–
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Will changing the feature affect any
agent?
Conservatism
Entity
Going concern: use and disposal values
Period
Valuation
Accrual
Accrual
Temporal Stability
Double Entry
 Causal and classificational interpretations
 Economic resources
 Uniformity and classification
Chapter 10. Decision Criteria and Mechanisms
Criteria for social choice
 Technical efficiency
 Simple economic efficiency
 Multiperson economic efficiency
 Multiperiod problem
 Uncertainty problem
Social cost benefit analysis
 Which costs, which benefits?
 Problem of partial analysis
 Nonlinear utilities
 Measures of efficiency
Mechanisms for Social Choice
 Market or Political/Administrative
 Limitations of voting mechanisms
 Market mechanisms for accounting standards
 Legal rights and markets
Outline of Current Research In Accounting
Contract Model of the Firm

A Useful Framework for Organizing Accounting Research
Micro-Level Research


Research on Decisions of Various Participants
Research on Effects on Various Participants
Macro-Level Research
 Research on characteristics of the system
 Research on alternative designs of the system
Survey the research work being carried out in each category
 What are interesting questions in each category?
 What have we learned so far?
 What questions remain open?
 (Use of Table of Contents of the Sunder book manuscript)
Functions of accounting and control
Chapter 5:
Managers and income
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Difficulty of measurement
Link compensation to output
Choice of accounting methods
Income: role in organization multiple management
Share holders, stock market & auditors
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Basic features: conventions, economic features
Social choice mechanism &criteria
Standards
Government & law
Accounting for public good organization