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THE REGULATION OF FINANCIAL ACCOUNTING - Coggle Diagram
THE REGULATION OF FINANCIAL ACCOUNTING
WHAT IS REGULATION?
Regulation is designed to control or govern conduct. :
Regulation relating to financial accounting - discussing rules that has been given the power to govern how are to prepare financial statements, and the actions of the authoritative body will have the effect of restricting the accounting options that would otherwise be available to an organization.
CAPTURE THEORY
HOW TO CAPTURE?
:black_small_square: Capture is said to occur if the regulated interest controls the regulation and the regulated agency, or
:black_small_square: If the regulated parties succeed in coordinatng the regulatory body's activities so that their private interest is satisfied. or,
:black_small_square: If the regulated party somehow manages to neutralize or ensure non-performance by the regulating body.
:black_small_square: Co-opting the regulators into seeing things from their own perspective and thus giving them the regulation they want.
:black_small_square: If quite independently of the formal or conscious desires of the regulators or the regulated parties, the basic structure of the reward system leads neither venal nor incompetent regulators inevitably to a community of interests with the regulated party.
:black_circle: In the process of introducing regulation, the organizations that are subject to the regulation will ultimately come to control the regulators.
:black_circle: The regulated industries will seek to gain control of the regulatory body because they know that the decisions made by the regulator will potentially have a significant impact on their industry.
ECONOMIC/PRIVATE INTEREST THEORY
:large_blue_diamond: Here, it is proposed that regulation is put in place to serve the private interests of particular parties, including politicians who seek re-election.
:large_blue_diamond: The regulator itself is an interest group- one that is motivated to embrace strategies to ensure re-election, or to ensure the maintenance of its position of power or privilege within the community
:large_blue_diamond: Assumes that group will form to protect particular economic interests.
THE PRO-REGULATION PERSPECTIVE
:large_blue_diamond: Accounting information is a public good. Once available, people can see it without paying and can pass it to the others-free riders.
:large_blue_diamond: In the absence of sufficient information about an organization then such an organization will be considered to be higher risk, and riskier organizations find it relatively more expensive to attract capital.
:large_blue_diamond: When other individuals can receive the goods without purchasing, the price system cannot function properly. So, market failure occurs.
:large_blue_diamond: This perspective assume that if information is not produced there will be greater uncertainty about the performance of the entity and this will translate into increased costs for organization.
ACCOUNTING REGULATION AS AN OUTPUT OF A POLITICAL PROCESS
:green_heart: If through due process, the views of various parties are not considered, the implication might be that the very existence of the regulatory body could be challenged.
:green_heart: if we accept that accounting standard setting is a political process, then the view that financial accounting should be objective, neutral and political is something that can be easily challenged.
:green_heart: Therefore, it is questionable whether financial accounting can claim to be neutral and objective
:green_heart: Compromise is essential.
:green_heart: When a decision making process depends for its success on the public confidence, the critical issues are not technical, they are political
:green_heart: Because financial accounting affects the distribution of wealth within a society, it consequently would be political
:green_heart: Accounting standards are results of various social and economic considerations
:green_heart: Hence, they are much tied to the values, norms and expectations of the society in which standards are developed.
THE 'FREE-MARKET' PERSPECTIVE
Market-related incentives
Market for managers
:black_medium_small_square: Managers' previous performance will impact upon how much remuneration they command in future period, either from their current employer or elsewhere.
:black_medium_small_square: Even in the absence of regulations, managers will be encouraged to adopt strategies to maximize the value of their organization and these strategies would include providing an optimal amount of financial accounting information.
Market for corporate takeovers
:eight_pointed_black_star: An underperforming organization will be taken over by another entity that will subsequently replace the existing management team.
:eight_pointed_black_star: Managers would be motivated to increase the firm value to minimize the likelihood that outsiders could seize control of the organization at low cost.
Market for lemons
:star: Even in the absence of regulation, organizations would still be motivated to disclose both good and bad news about their financial position and performance.
:star: The failure to provide information is viewed in the same light as providing bad information.
:star: The view being that in the absence of disclosure the capital market will assume that the organization is a 'lemon'.
:star: Provides an incentive for managers to release information in the absence of regulation, as failure to do o will have implications for the manager's wealth
FREE MARKET PERSPECTIVE
:deciduous_tree: In the absence of information about the organization's operations, other parties, including the owners of the firm who are not involved with the management of the organization, will assume that managers might be operating the business for their own benefit.
:deciduous_tree: To maximize the share value, managers will voluntarily enter into contracts with shareholders and lenders of giving optimal information.
:deciduous_tree: There will be conflict between external owners and internal managers and this conflict will be mitigated through audited financial reporting.
:deciduous_tree: These are called the private incentives to produce information
PUBLIC INTEREST THEORY
:red_circle: Regulation is deemed to be an instrument to create such confidence.
:red_circle: Society needs confidence that capital markets efficiently direct resources to productive assets.
:red_circle: The regulatory body is considered to be a neutral arbiter that represents the interests of the society in which it operates, rather than the private interests of the regulators.
:red_circle: Regulation is initially put in place to benefit society as a whole, rather than particular vested interests.
:red_circle: Regulation is supplied in response to the demand of the public for the correction of inefficient or inequitable market practices.