Regulation of Financial Accounting

Question 1

what is regulation?

Answer 1

a rule or principle governing behaviour or practice.

Question 2

what is a regulator?

Answer 2

an official or agency responsible for the control and supervision of a particular industry, business activity area, area of public interest etc.

Question 3

what is accounting regulation?

Answer 3

rules (accounting standards) developed by an independent authoritative body that has been given the power to govern how we prepare financial statements.

Question 4

without government/market regulator backing…

Answer 4

accounting standards have no legal power by themselves

Question 5

‘Free Market’ perspective

Answer 5

accounting info should be treated like other goods, with demand and supply forces allowed to operate to generate an optimal supply.

Question 6

arguments supporting free market perspective

Answer 6

1. private economic based incentives
2. market for managers
3. market for corporate takeovers
4. market for lemons

Question 7

private economic based incentives

Answer 7

if managers do not provide credible information about company operations and performance to outsiders, assumed to operate the business for their personal benefit.

Question 8

PEBI: even if there is no regulations…

Answer 8

agents and principles will form their private contracting and associated financial reporting

Question 9

PEBI issues

Answer 9

• information costs will be high if too many people want different types of info
• may be too many parties for contracting to be feasible.

Question 10

market for managers

Answer 10

refers to the demand and supply of managerial positions across various industries. previous performance impacts remuneration managers command in future.

Question 11

mfm issues

Answer 11

• assumes info about past performance is known by prospective employers
• problems may arise if manager approaching retirement age.

Question 12

market for corporate takeovers

Answer 12

underperfoming organisations will be taken over by another entity with the existing management team being subsequently replaced - managers are motivated to maximise firm value.

Question 13

market for lemons

Answer 13

• no info = bad info
• reputational costs if companies try to hide bad news
• therefore managers motivated to share both good and bad news.

Question 14

lemon issues

Answer 14

not always a realistic assumption - e.g. Enron

Question 15

against regulation

Answer 15

• restricts available set of accounting methods
• might not reflect financial info users need so private contracting may be more appropriate
• can lead to oversupply of info

Question 16

for regulation

Answer 16

• individuals may have unequal access to info but regulation ensures equality
• promotes fairness; stakeholder confidence
• uniform methods enhance comparability

Question 17

theories of regulation

Answer 17

• public interest theory
• capture theory
• private interest theory

Question 18

public interest theory

Answer 18

accounting regulation is to maximise social welfare

Question 19

PIT criticisms

Answer 19

• question assumption that regulation is virtually costless
• argue that government is not neutral and will only legislate and lobby for regulation if it will increase their own wealth.

Question 20

Capture Theory

Answer 20

suggests regulatory agencies, which are supposed to act in the public interest, can be influenced and controlled by the industries or businesses they are meant to regulate.

Question 21

CT criticisms

Answer 21

• no reason to suggest that the regulated industry is the only interest group able to influence the regulator.

Question 22

Private interest theory

Answer 22

government are not neutral arbiter and will regulate based upon impacts to key voters and campaign finances.