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It has been observed that the main role of Financial Accounting in many countries traditionally differs from the capital market based role. But due to increase in globalization and capital markets, the role of financial accounting is now largely focused on providing the information to the capital markets which results in growth of regulation over a long period of time. Accounting regulation identified various factors such as political, economic and social linked with the growth of accounting rules and scrutinizes the events that formed the different global regulatory frameworks. This process also creates the aim and rationale of accounting regulations in order to identify the requirements of these set of laws from many different perception. Accounting regulation mainly comprise of 3 parts as follow.
- An explanation of problem to be tackled
- A logical discussion or conduct of solving the problem
- In line of decision or theory, the given solution.
Interest in the theory of accounting and formulating of accounting rules has developed significantly over the modern years that reflects criticism expressed together internal and external the accounting profession of the procedures followed in drawing up the published financial statements of companies. In short accounting regulation build up the structure of accounting principles which expresses financial reporting practices. Over time financial statement and reports have come to be more strongly regulated by the accounting policy makers and tends to be heavily regulated in most countries with different accounting standards and regulation leading how particular transactions and events are to be predicted, measured and disclosed. Even though the financial reports are existed from around hundreds of years, the regulations of accounting in economies controlled by the capital market is a literally recent event. Accounting regulation generally became a subject after the crash of Wall Street stock market in 1920-30s. Also in the year 2001 it is observed that there is a chain of financial information fraud involving various large and reputed companies such as Enron, Arthur Anderson an auditing firm, WorldCom, Sunbeam, Quest and other corporations which arises the need to examine the usefulness of accounting standard and regulations.
Over the years there have been several argument and questions rose regarding the necessity and requirement of accounting regulation. Those believing in the efficient market argue that there is no necessity of regulation on the ground that market forces will operate allocation of resources. On the other side there are many who pointed out that the regulation is necessary as market will always operate in the best interests of societies. In countries with the huge number of external investors and with the developed capital markets there are large amount of accounting regulations casing a wide cross section of issues which arise an important question that whether the regulation for accounting is necessary? In the following section we will discuss the different perspective which dictates that whether the regulation for accounting is necessary or not.
Free market perspective
In considering accounting regulation we look at the arguments for eliminating or reducing regulation. Those who argue for unregulated market proposed that accounting information should be treated like other good and the forces of demand and supply should be allowed in order to produce optimal information .i.e. the supporter of free market approach stated that regulation of accounting should be according to laws of demand and supply rather than regulation. Also this perspective is supported by other authors such as etc. They use agency in the manner to question why incentives should exist for consistent and voluntary reporting to owners. In order to solve the conflict between managers and owners financial reporting is used to supervise employment contracts so as to judge and reward mangers. In addition, firms also have an incentive for reporting to the capital market voluntarily, because they have competition with other firms for resources in the capital market, and if the firms fail to report, it might be interpreted as bad news and will be punished by higher cost of capital and this will result in financial interest of managers who own shares in their organization will get damage. Thus according to 'Free market Perspective' regulation of accounting is not at all necessary.
Public Interest Theory
On the other side those who are in favor of regulated market use public interest argument. Supporters of public interest theory presented an explanation on why regulation is necessary to protect public rights. According to (Posner 1974) public interest theory holds that provision of accounting information is organized in reply to the improvement of inefficient and unfair market practices. Public interest theory assumes that usually there is government which acts as regulatory body in the best interest of public and not acts in its self interest in rule making process. Moreover applying these arguments to financial accounting and accepting of capital market existence, society assumes that capital markets will efficiently allocate resources to useful assets. Mostly, either market failures or the need for accomplishing social goals dictate the accounting regulation. Market failure as a suboptimal distribution of issuances may be the result of:
- A firm's unwillingness to disclose the information about itself, as it is monopoly supplier of information about itself;
- Due to incident of fraud like Enron, Parmalat, Satyam, Worldcom etc ;
- Underproduction of accounting information;
There is also another perspective 'pro-regulation' which dictates the necessity of accounting regulation. According to this perspective accounting is public good. I.e. once available people can use it without paying any cost and pass to others. Parties that use goods and services without paying any production cost are said to be 'free riders'. Only few people will have motivation to pay for goods and services and so does the manufacturer of particular goods and services which in turn go ahead to underproduction of information. Thus to improve this underproduction regulation of accounting is necessary to diminish the impacts of market failure.
As above we discussed significant perspectives describing both side of coin supporting and criticizing the accounting regulations. There are also different views and arguments of different authors in the favor of and against the accounting regulations as follows.
Arguments in favor of accounting regulation
In considering the necessity for accounting regulation the literature concern itself with various considerations such as:
A. Economic and Market Considerations for regulation
"According to Cohen and Cyret, accounting rules are necessary to regulate the economic consequences of resource allocation and provision for information in the market. In ideal and perfect condition market efficiency make certain the accessibility of accounting information under the accurate costs. However there are various factors inciting the failure of ideal perfectly competitive markets for e.g. tax rates, information asymmetry etc. This provides the basis for expecting some type of 'extra-market' regulation.
"According to Taylor and Turley (1986), necessity of accounting regulation arises to ensure this market efficiency. They argued that market may fail for a number of reasons.
- "The lack of regulations governing market behavior"
- A quality of achieving an efficient market is a supply of information at no cost about market factors and preferences. But in reality, information is not free and those transactions involving the provisions for information are also costly. Here Taylor and Turley argued that the cost of information may indicate that the individuals are wrongly informed about the current conditions or the effect of their decisions.
- "Market distortions" may also lead to the failure of markets.
B. Socio-Political Considerations for regulation
Tower (1993) highlighted two significant societal, intermediate goals for accounting as a social choice function such as efficiency and equity, and argued that corporate reports should consider these criteria clearly. He declared that accounting regulation plays an important role in encouraging the accountability and proposing the provision of superior amount of data in corporate reports and the addition of wider representation by stakeholders, including producers in order to enhance 'the acceptability of accounting rules' and thus to promote conformity with accounting regulations.
C. Other considerations for regulation
According to Baxter (1978) accounting standards raises the quality of accounts, make it more comparable and also make it more understandable, they drive out the doubts and bring harmony in principle. The need for accounting regulation was emphasized by scandals of 19th and 20th century like Enron, Satyam, Worldcom etc and various non-compliance activities of 1980s and 1990s.In addition one vial focus of accounting is the measurement of performance of business activities.
Arguments against accounting regulation
There are group of people who proposed that accounting regulations are not necessary, as market can make a decision that what accounting rules to demand. Bromwich (1985) aims to classify those conditions which states that regulation in any form unnecessary. He dictates that those who support that the provision of accounting information should be left to the free market disagree that the institutional structure does not match to the 'ideal' market settings. They also suggested that regulation of accounting in achieving its goals for accurate, consistent, and comparable financial reporting is ineffective and unproductive. Those who are not in favor of regulation suggest that the process of setting the standards is prejudiced in favor of setters. Hopwood and Page (1985) and tinker et al (1982) declared that inefficient regulation is result of difference between political and economic consideration of setting process.