Home/Essays Examples/Economics/Financial Accounting Theory

Financial Accounting Theory

Introduction

Regulation of markets is aimed at redistributing of scarce economic resources fairly among the subjects of an area. If regulation is not properly than the markets can be imperfect thus putting wealth in the hands of a few. In regulation there a number of stakeholders with various interests but one stakeholder is interested in the social well being of the society. Regulation of the market involves various activities and costs that should be met by the regulator without hurting the interest of stakeholders. The costs of regulations include the cost of coming up with policies to be implemented, implementing this policies, maintaining the policies and other related costs. Then question is who is best suited to implement these policies and what is the justification for such stakeholder being suited. This has been explained by theories of regulation such as economics interest theory, public interest theory, private interest theory (capture theory) and Chicago theory of regulation. This paper is concerned with giving the differences in the economic and public interest theories.

Public Interest Theory

In public interest theory the main aim of advocates of this theory is achieve socially and publically acceptable results which cannot be attained in a normal demand and supply environment. This information is necessary to the general public and it acts as a control or a collection measure to the market forces which may not be fair. For example if proper regulation is not put in place the market that the stock exchange may commit some acts which in the opinion of the public are an fair, therefore the public interest theory is aimed at ensuring proper information is provided and fair trade is carried out. Public interest theory was not heard of until recently when the public become aware of the public interest.

Public interest theory takes into considerations the society his needs before any extra needs are taken care off. Take for example the companies are required to be reporting socio or sustainable activities carried out by the company. A question arises as to what is to public interest in normal trading activities of the market. However, it is easier to determine what is public interest from the perspective of social responsibility of socio investment? Public interests can loss meaning if the parties involved such as the regulators loss focus on the public issues. The public interest theory can be highlighted from four perspectives that is the interest of the public in regulations, regulators having interest on public affairs while the interest theory does not cater for the public activities and it is easier for the regulators to regulate the amount of activities carried out. The argument for public interest is that the market does not reflect all the information efficiently. In a normal marketing environment it shows three forms of efficiencies which may not be at the interest of the public but at the interest of the consumers of the product been sold in that market. In a nutshell there three forms of marketing efficiencies which without control should be expressed.

Weak form it says that the current prices of stocks already fully reflect all the information that is contained in the historical sequence of prices. Therefore, there is no benefit- as far as forecasting the future is concerned- in examining the historicary known as the random –weak theory clearly, if this weak form of the market hypothesis is true, it is a direct repudiation of technical analysis. If there is no value in studying past prices and past price changes, there is no value in technical analysis. As we saw in the preceding however, technicians place considerable reliance on the charts of historical prices that they maintain even though the efficient-market hypothesis refutes this practice. In later sections of this we will analyze the statistical investigations of this weak form of the efficient-market hypothesis.

Semi strong form;-the efficient-market hypothesis says that current prices of stocks not only reflect all information content of historical prices but also reflect all publicly available knowledge about the corporations being studied. Further more, the semi strong form says that efforts by analysis and investors to acquire and analyze public information will not yield consistently superior returns to the insistent basis to the analyst are corporate reports, corporate announcements. Information relating to corporate divided policy, forthcoming stock splits and so forth. In effect the semi strong form of the efficient market hypothesis maintained that as soon as information becomes publically available, it is absorbed and reflected in stock prices. Sometimes the adjustments will be over adjustments and sometimes they will be underadjustments.therefore, an analyst will not be able to develop a trading strategy based on these quick adjustments to new publically available information. Test of the semi strong form of the efficient –market hypothesis have tended (but not unanimously) to provide support for the hypothesis. More on this test will be discussed.

Strong form the weak form and of the efficient –market hypothesis maintains that past prices and past prices changes cannot be used to forecast future price.several studies that tend to support the semi strong theory of the efficient hypothesis were cited. Finally, the strong form of the efficient –market hypothesis maintains that not only is publically available information useless to the investor or analyst but all information is useless. Specifically, no information that is available be it public or inside, can be used to earn consistently superior returns.

Economic Interest Theory

Economic interest theory correctly assumes that accounting information is reflective of economic activities of the company and regulators must ensure that the economic should be reported. The economics interest of the company and the public and other stake holders should be properly reported in the accounts of an organization therefore financial statements should reflect a true, reliable, and verivable accounting information. Economic interest theory approaches regulation in manner that it aims at solving the problems which are associated with the organization. It considers the economic benefits of regulation which can be attained after regulation has been carried out.

The economic interest theory considers the economic interest of each group member of the public. For example customer:-This is an individual or group which receives or consumes the final product or services of the company. For the company to increase and maintain its level of clients, it must produce high and good quality products or services. This will ensure that customers demand will be loyal and high. Also because of competition in the market, the corporation should be dynamic in its activities and the price for the product should be fair as different people have different perceptions to price hence should set fair prices to accommodate all customers. The company communicates through advertisements, trade exhibitions & promotions, giving free samples, cash discounts, offering credit facilities among others. This increases customer awareness of the product or service.

Suppliers:-These are short term financiers of the company. Their confidence in the company depends on how prompt the corporation honors their credit facilities and how regular they carry on their businesses. The company communicates to this group through cheques, when they make payments, purchase orders.

Shareholders:-They are the owners of the company. Their shares form the equity capital of the company. For them to retain their interest they must receive good dividends from the profits of the company and their investments must keep on appreciating in that company. This will increase the value of the shares and the company’s’ reputation. The company communicates to is shareholders through the Annual General Meeting, AGM which is convened yearly. These people are important to the company because if they have no confidence in the company, the value of shares will reduce in stock market, investors will withdraw their investments from the company and no new investors will invest, creditors will stop offering their services, employees will not receive their salaries, sales will go down and the hence the corporation will collapse.

Employees:-These are the managers of the company. The receive salary from the company and they are motivated if their working conditions in the company is good. the company communicates to the employees through holding meetings, letters of appointments, letters of dismissal, journals, e.t.c.

The importance of the employees in the company is to ensure that the resources of the company are taken care of to achieve high results. This will increase sales and improve the reputation of the company. Also investors will be high and hence the value of the shares will increase.

However the company is interested economic performance. Economic Performance focuses on the organizational impact on the economic circumstances of its stakeholders. Economic interest theory emphasizes on: profit, earning and income of the organization, investment in intellectual capital such as research and development, employee training, educational initiatives and employee compensation. Community development in terms of purchase of goods at different regional levels, donation to the communities and customer satisfaction are also included in the report.

The major reasons the companies cite against this regulation are the cost factor and time. The factors affecting cost of report may be stated as: Scope of report, i.e. the extent of company’s operations – domestic or international and development of information management system within the company for the first time reporters. They cite availability of information required and degree of stakeholders’ consultation and need of external support.

The case study

The case study fails to take economic interest of the corporation who have come together to argue against the case the argument has put forward by the corporation is itself a suspect. The banks arguments based on economic interest which considers the economic impact on company while the government and the board of accounting was trying to regulate for purposes public interest.

The standard is aimed effective and efficient reporting for all transactions of the company. The following steps are helpful to produce an effective Sustainability Report:

  • The audience or users of the report are to be identified first and then the report should be prepared to cater their specific information requirements.
  • The relevance of the company objectives and the issues chosen to discuss should be explained clearly.
  • There should be a concise description of the company’s business line, activities and countries of operation at the beginning of the report.
  • The scope of the report including the dimensions of the triple bottom line should be depicted clearly. The reason for excluding any topic should also be mentioned.
  • All the policy statements of the company including environmental policies, corporate codes of conduct, health and safety policies, etc. with proper explanation should be included in the report.
  • Both quantitative and qualitative targets should be included in the report to indicate company’s accountability for its performance. Qualitative target needs to be set for certain dimensions of social issues which cannot be quantified. The progress in these respects can be depicted in subsequent reports.
  • Past performance data with proper explanation help user to compare performance trend and understand the reasons behind such trend. These are important components of the report to be effective.
  • Stakeholders should be informed through the report about the problems faced by the company and the actions taken to overcome such problems.
  • To show responsibility and accountability towards the commitments made in the report a statement from the CEO and identification of responsible officials will be helpful.
  • The source of additional information should also be mentioned in the report to guide users to any specific information segment. (Government of Canada, 2003)

All this is seen an impediment to profitability of the firm. However companies opt to concentrate greewashing which is a mere gimmick to diversity attention from the real issues. The companies generally engage in greenwashing to divert attention of the regulators, to attract social investors, to expand market, to attract staff or to persuade critiques. There are a number of ways to determine the quality of data supplied in the Sustainability Report and to detect greenwashing. Data verification play and important role in this context. Involvement of stakeholders in the process of report preparation is an effective means to verify the data and ensure quality (Government of Canada, 2003) It also helps conforming to the reporting standards such as GRI. Therefore from this case I conclude that the agreement frontier but the corporation against these standards is for economic benefits of companies not to the general public. While the movers are interested in the public interest.

Conclusion

This paper has distinguished between economic interest theory and public interest theory of regulation, identified each stakeholder and their interest in the regulation and given some insights of the theories. Public interest theory deals with mainly social regulation while economic interest theory mainly deals with economic regulations. These theories have shown the goodness of both economic and social regulation of markets. The benefit of regulation surpass the cost of regulation therefore, it shows its importance.

References

Clarke, F, G Dean and K Oliver (2003), Corporate Collapse, Accounting, Regulatory and Ethical Failure, 2 ed, Cambridge, CUP.

Deegan, C 2006, Financial accounting theory, 2nd edn, McGraw-Hill, Sydney

Gaffikin M. J. R.; (2008);School of Accounting & Finance: Regulation as Accounting Theory; School of Accounting & Finance, University of Wollongong

Government of Canada (2003), “What is the business value in reporting?” Web.

Global Reporting Initiative (2004), “Public Agency Sustainable Reporting”, A Resource Document in Support of the Public Agency Sector Supplement Project, Web.

Johnstone, R J, D Gregory, G Pratt and M Watts (eds) (2000), The Dictionary of Human Geography, 4 ed, Oxford, Blackwell Publishers Ltd

SourceWatch (2008), “Greenwashing”, Web.

Sunder S. and Haribhakti S.; economic Interest and accounting standards. Web.

Van Lent, L (1997), “Pressure and Politics in Financial Accounting Regulation: The Case of the Financial Conglomerates in the Netherlands”, Abacus, v 33, pp 88-114

Walker, R G (1987), “Australia’s ASRB. A Case Study of Political Activity and Regulatory Capture”, Accounting and Business Research, v 17, pp 269–286.