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Chapter 3 - Accounting Regulation and politics

A. Free Market Perspective

It often provides a perspective that accounting information should be
treated like other goods, and demand and supply forces should be allowed
to operate so as to generate an optimal supply of information about an
Jensen and Meckling, Watts and Zimmerman, Smith and Watts are
ationale! "he argument by some advocates of the #free$market%
perspective is that in the absence of regulation there will be private
incentives to produce accounting information. &rgani'ations that do not
produce information will be penalised by higher cost of capital.
B. The Pro-regulation Perspective
(ccounting information is a )*ublic +oods% , once available, people can
use it without paying and can pass it on to others. *arties that use goods or
service without incurring some of the assoicated production costs are
referred to as #free$riders-. .ew people will hava an incentive to pay for te
goods or services and so does the producers of the particular goods or
services, which in turn leads to an underproduction of information.
"o alleviate this underproduction, regulation is argued to be necessary to
reduce the impacts of market failure.
C. The rationale or regulating inancial accounting practice
In most developed countries there is a multitude of accounting
standards covering a broad cross$section of issues , but do we really
need all this regulation/ "here are two broad schools of thought.
.or regulation , they don-t agree the free$market approach and support
the view that regulation could lead to uniform methods and so
enhancing comparability and protect from misleading information.
(gainst regulation , the free$market arguments concerns regulation will
lead to over$supply of information and would lead to an optimal supply
of information by entities. "hey support the Markets view as it is
efficient and the markets will provide incentives and penalties to
ensure that managers do as the market e0pect.
Chapter 3 - The Regulation o inancial accounting
!. Regulation " The Theor# or and against
Pu$lic %nterest theor# o regulation
"he theory proposes that regulation be introduced to protect the
"his theory assumes that the regulatory body is a neutral arbiter of the
#public interest- and does not let its own self$interest impact on its
rule$making processes.
Rationale& "he protection may be re1uired as a result of inefficient
Capture theor# o regulation
( contrary perspective of regulations is provided by captured theory
which argues that although regulation is often introduced to protect the
public, the regulatory mechanisms are often subse1uently controlled
2captured3 so as to protect the interests of particular self$interested
groups within society.
Rationale& "he #regulated% tend to capture the )regulator%. *osner
argues that )the original purposes of the regulatory program are later
th'arted through the efforts of the interest group.
(cono)ic interest theories o regulation
"he theory assumes that everybody acts in their own self$interest,
including regulators and those people that are regulated.
Rational& #egulators will only propose and support regulation which
leads to favorable outcomes for themselves, perhaps in terms of their
Chapte 3 " The Regulation o inancial accounting
Accounting regulation as an output o a political process
4. If we accept that the accounting standard$setting process is a
political process, then the view that financial accounting should be
6eutral and
is something that can be easily challenge .
Rational& 7ecause financial accounting affects the distribution of
wealth within society, it conse1uently will be political.
Standard$setting bodies typically encourage various affected parties to
make submissions on draft version of proposed accounting standards.
"his is deemed to be part of the normal #due process-.
8. If we accept that the standard$setters give due consideration to
the views e0pressed in the various submissions they receive, then we
must accept that accounting standards, and therefore financial
accounting reports, are the result of various social and economic
9ence they are very much standards are developed. "herefore it is
arguably very 1uestionable whether financial accounting should claim
to be )neutral% or )ob5ective%.
:. While it is accepted that accounting standards are developed
having regard to social and economic conse1uences, it is also a
re1uirement in many 5urisdictions that corporate financial statement be
)"rue and .air%.
Rational& *erhaps it is easier to say they are )fair%. It is doubtful to
say the financial statements are )true )when the standards are
determined depending on various economic and social conse1uences.