Group 1

Applying Theory to Accounting

Regulation
Diovanno Darajatun -
Farhan Ahmad Ghifari - 1806268502
Ramadhan Namora – 1806268710
THE THEORIES OF REGULATION RELEVANT
TO ACCOUNTING AND AUDITING
 Capital market theorists suggest that managers have many incentives to
voluntarily provide accounting information to parties external to the
firm, and to have that information verified by independent auditors.
 Why do we observe the regulation of financial reporting through
company law and accounting standards? Why do most countries have
legal requirements to produce audited financial statements?
 There are several theories which are relevant to understanding the
regulation of financial:
 theory of efficient markets
 agency theory
 theories of regulation - public interest, regulatory capture and private
interest
Theory of efficient markets
 Free market economists would argue that markets function best
without government intervention, and that maximum efficiency is
achieved by allowing forces of supply and demand to dictate
market behaviour.
 Accounting can be seen as an information industry. An equilibrium
price therefore, can theoretically be found for accounting
information.
 Critics of the free-market approach say the theory is unrealistic.
Accounting information cannot be considered in the same way as
the other products. Once the information is released by a
company, it is available to everyone (Free Rider Problem)
Theory of efficient markets
 Even if a free market existed for accounting information, a
regulatory board would still be needed. because users are unable
to agree on what they want and accountants will not agree on the
procedures to derive the desired information.
 Further, the value of information provided by companies to users
is greatly enhanced if it can be compared with information from
other companies.
 Regulation can make companies provide information needed to
meet actual demand and ensure an efficient capital market.
 Agency Theory
 The demand for financial information can be categorized as being
either for stewardship or for decision-making purposes
 Atkinson and Feltham state that agency theory considers mainly the
stewardship demand for information.
 The theory concentrates on the relationships in which the welfare of
one person (e.g. the owner) is entrusted to another, the agent (e.g. a
manager)
 Atkinson and Feltham explain that the demand for stewardship
information relates to the desire to:
 motivate the agent
 distribute risk efficiently
 Because there is an imbalance between data providers and data
users, uncertainties and risks arise.
Theories of regulation
There are three types Theories of regulation:
 Public Interest Theory
 Regulatory Capture Theory
 Private Interest Theory
Public Interest Theory

 The central economic reason for the origins of government

intervention in the operations of various markets in the 'public
interest' is that of market failure
 Examples of potential failures include:
 lack of competition (monopoly, oligopoly)
 barriers to entry
 imperfect information gaps (information asymmetry) between buyers and
sellers or certain market signals
 the 'public-good' nature of some products (e.g. financial information)
Public Interest Theory

 The government feels they need to intervene in the market

because basically they are politicians who need populism in order
to get votes during elections.
 On the other hand, public interest need government intervention
because the government is seen as a neutral Arbiters.
Regulatory capture theory
 This theory maintains that although the 'purpose in fact' or origin of
regulation is to protect the public interest, this purpose is not achieved
because, in the process of regulation, the subject of regulation comes to
control or dominate the regulator
 Capture is said to occur in any one of four situations, namely, if the
regulated entities:
 control the regulation and the regulatory agency
 succeed in coordinating the regulatory body's activities with their activities, so
that their private interest is satisfied
 neutralise or ensure non-performance (or mediocre performance) by the
regulating body
 in a subtle process of interaction with the regulators, succeed in co-opting the
regulators into a mutually shared perspective, thus giving them the regulation
they seek
Private Interest Theory
 A third theory has emerged in response-to dissatisfaction with
explanations provided by both the public interest and the capture
theories
 The politicians seek to maximise their chances of future electoral
success. Government officials will 'sell' aspects of their right to
coerce others in the form of supplying regulatory programs and
legislation, which will act to enhance their ability to win votes and
raise money to finance election campaigns
How The Theories of Regulation Apply
to Accounting & Auditors Practice
Application of Public Interest Theory

 Accounting Standard Review Board,

Australia,1984

 The Sarbanes-Oxley Act

US , 2002
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?
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

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
Example of political process creates a
standard setting
 The adoption of IAS 39 Financial Instruments – Recognition and
Measurement in the EU has been a highly political process
 The adoption of IAS 38 Intangible Assets in Australia illustrates
the role of politics in the standard setting process
The Regulatory Framework for
Financial Reporting
Environmental Setting for Preparing
Financial Statement
 Legal Setting
 Economic Setting
 Political Setting
 Social Setting
The Element of Regulatory Framework:
 Statutory Requirements
 Corporate Governance
 Auditors Oversight
 Independent enforcement bodies
Statutory Requirements
 Company law
 Accounting standards
 Taxation law
Corporate Governance

“the structures, processes and institutions within and around

organizations that allocate power and resource control among
participant”
Auditors Oversight

 Self-Regulation
 Statutory Regulation
Independent enforcement bodies

 EU Member
 Securities Market Regulator (AMF-France;Consob-
Italy;AFM-Netherland;SEC-USA;ASIC-Australia)
Institutional structure for setting
accounting and auditing standards
 Formation of IASC – 1973
 Aimed to develop accounting standards for use throughout
the world
 IOSCO’s support for a set of core standards
 IASC not independent so restructured in 2001 into the IASB
 In 2002 the EC decided to adopt IASB standards in 2005 in
the EU
 Australia adopted IFRS on 1 January 2005
The IASB and FASB convergence
program
 Convergence program commenced in 2002 called “Norwalk
agreement”
 IASB/FASB convergence program has generated considerable
work for both Boards. It complicated the process of
producing the 'stable platform' of standard for 2005
Accounting standards for the public
sector
 Individual countries must decide the extent to which IASB
standards will be followed by public sector entities
 Australia has pursued one set of standards that can be used by
both public and private sector entities
International auditing standards
 Historically auditing was self-regulated
 Best auditing practice has become enshrined in auditing
standards
 Governments have become involved due to market failure