Discuss the role of accounting practices in managing contemporary organisations

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In October 2009 the governor of the bank of England Mervin King called for the 'reform of the structure and regulation of the banking system'.

In the light of the above call, read the paper by Wahlstrom (2008) titled 'Risk management versus operational action: Basel II in a Swedish context', Management Accounting Research, Vol. 20, No 1, pp. 53 -68

Briefly review and discuss the main argument of the paper in relation to control and accountability.

Discuss the role of accountants and accounting practices in managing contemporary organisations. Propose a theoretical framework that could be used to support your argument / perspective.

Introduction

In these day and age, the issue of changing in banking system is debated widely. The speech of Mervyn King raised the issue of self interest of the agency in the society. The institutions "too important to fail" encourage banking to take risks that cause the problem of financial crisis.

However, economic failures led to a change in opinion of the world [1] . Alan Greenpan admit his mistake "in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms". The reason is their self-interests are conflict with the interest of shareholder and company when it comes to the implementation of control and accountability (Wahlstrom).

As the self-interest conflict, the agents' aim may increase the risk of management. This essay discusses the relationship between the self-interest and the risk associate with management by using agency theory.

The Basel II Review

As for reducing the risk of management, the Basel Committee with objective of developing the understanding of key management issues and enhancing the quality of banking supervision worldwide (Basel Committee, 2004a, 2006a,b), was introduced. In January 2001, the Basel Committee issued a proposal for a New Basel Capital Accord ("Basel II") that will replace the current 1988 Capital Accord.

According to the Basel Committee (1999) Basel II refined measurement which is based on three mutually reinforcing pillars that allow banks to evaluate properly the various risks can solve number of problem. These 3 pillars are: 

1. Minimum capital requirements which seek to refine the measurement framework set out in the 1988 Accord

2. Supervisory review of an institution's capital adequacy and internal assessment process, and 

3. Market discipline through effective disclosure to encourage safe and sound banking practices.

Theory

In the organisation, people who are working closely with implementing controls tend to have their own self-interest. By looking at the society as whole system that carried with it certain needs from various parts, different role has different interest that must be fulfilled (Émile Durkheim [2] ). Organisational functions are to promote integration, stability, consensus and balance.

In the organisation, all shareholders will agree that manager should do anything to maximize the shareholder wealth. [3] However, it also means that the principal needs to place trust in an agent to act in the principal's best interests.

"An agency theory suggests that principals have lack reasons to trust their agents. The owner will find to resolve these concerns by putting nontrivial monitoring costs to align the interests of agents with principals and to reduce the scope for information asymmetries and opportunistic behaviour". (ICAEW)

The managers have been given the power to control the company as the agency. 'Control is the process by which managers assure that resources are obtained and used effectively and efficiently in the accomplishment of the organization's objectives' Anthony [4] 

The agents are accountable for their decision as the one responsibility to perform a certain function. Accountability may be dictated or implied by law, regulation, or agreement or expectation. The agents obligated to bear the consequences for failure to perform as expected; accountableness. (Hoskin, K. 1996)

Methodology

By using secondary information collected from journal, article and book, this essay indicates the effect of agent self-interest on the management system. The advantage of this method is quick and collective of people idea from research. The disadvantage is the data might be bias.

The Role of Accountants

Previously, accountant is the role that including the preparation of collecting, analysing and communicating financial information. [5] Nowadays, accountants are involving progressively more in strategic management and decision support through the development and functioning of latest accounting models incorporating financial and non-financial information (Ezzamel, 1994). The role of Accountants describe the process in which identification, measurement, accumulation, analysis, preparation, interpretation and communication of information used by management to plan, evaluate and control within an entity and to assure appropriate use of and accountability for its resources. [6] 

Also chartered management accountants are taking part in areas of systems design.

Accountants and data

The constant change of the nature as well as the competitive of global business (Hayes and Whelwright, 1984; Schonberger 1986; Womack et al., 1991) makes a management accountant's role become more demanding than previously. Keeping up to date with various business areas and accounting rules, accounting evolutes to provide appropriate information to management.

Management accountants role are not only collecting data but also focusing on evaluating data and enhancing knowledge from that information. They are becoming decision support specialists who visualise their job as interpreting information, setting it out in a helpful format for different managers, and providing management decision making. The decisions that they make may be unfavourable, therefore they must take into account the effects of the information.

However, Principals hire agents and give them the rights and responsibilities in employment relationship such as compensation, information, allocation of duties, and allocation of ownership rights. Acting as agents, they are motivated by self-interest factors such as financial rewards, labour market opportunities, and relationships with other parties that are indirectly relevant to principals. Therefore, agents likely to be more optimistic about the economic performance of an entity or their performance under a contract than the reality would suggest. [7] 

As a result of these differing interests, agents may have an incentive to bias information flows. Principals may also express concerns about adverse selection where they can observe agents but does not have access to all information does not know if agent has shirked.

Accounting and risk

First of all, information asymmetries, where agents are in possession of information to which principals do not have access, also means that the risk for the principals may increase due to the hidden information. The accountants are responsible for the risk that they should take into account.

However, people argue that the risks of organisation contain the controllable risk as such the manager can control and the risk that uncontrollable. Chicken & Posner (1998) acknowledge this, and instead provide their interpretation of what a risk constituents:

Risk = Hazard x Exposure

They define hazard as "... the way in which a thing or situation can cause harm," and exposure as "... the extent to which the likely recipient of the harm can be influenced by the hazard".

Secondly, 'because risks are risks in knowledge, perceptions of risks are not different things, but one and the same' (Beck, 1992). In other words, risk can be measure by risk management such as RAROC (Basel II). Based on that they can avoid crises in own organization and other organizations, comply with corporate governance standards and avoid personal liability failure. In addition, they can understand full range of risk facing the organization, evaluate business strategy risks and achieve best practices. Therefore, the accountants must have full responsibility for the report of risks for organisation to manager.

On the other hand, according to argument of McGoun (1995) there are problems with the model of measuring risk which are still in use. The first problem that McGoun mentioned is historical experience base of prediction need sufficient level of similar condition. By other means, waiting for the history repeats itself is flawless. Wahlstrom strengthen that idea by addressing two striking example of using history as predictor: first, Russian financial crisis 1998; second, worldwide stock market crash 1987.Second problem was mentioned is the expected value with the standard deviation as risk will become obsolete. The assumption of estimation is other problem was pointed. Therefore, it is impossible to understand investors' reasoning and predict the level of risk.

Consequently, the outcome depends on the effort expended by agents and the environment factors. The accountants cannot avoid the risk entirely but can reduce the level of risk by doing properly measurement of risk and providing useful information to manager.

Besides, a person risk propensity plays a fundamental role in decision making and risk management procedures, (McGowen, 1999) that is why the more effort agents give to provide truthful data, the more correct measurement risk is (Young, 2006). Nevertheless, the principal usually cannot completely monitor the agents; therefore, agents may have an incentive to act inappropriately (Holmstrom, Moral hazard).

Related of fact:

In essence, what had happened was that banks, hedge funds and others had become over-confident as they all thought they had figured out how to take on risk and make money more effectively? As they initially made more money taking more risks, they reinforced their own view that they had it figured out. They thought they had spread all their risks effectively and yet when it really went wrong, it all went wrong.

The "too important to fail" problem of the bank encourage them to take the risks that allows them to get higher return when thing go well.

Holmstrom (1979) considers agency theory which the contract depend on the final outcome.

The design of the system that can reduce and control the risk.

The role of accountant/ system change in the organisation.

Accounting is important to manage the risk

Drawback of agency theory

In depth, the agency theory indicates that the agent act on their self interest that is conflict to the principle interest. However, the theory has lack of concern about the organisation behaviour, characteristic. Therefore, the assumption that agent act differently may reflect the culture of the role and the system of organisation.

Conclusions: the main findings of the case study

There is a genuine need for the project management profession to realise the potential impact of the individual risk propensities of management personnel if risk management methodologies are to have any future and be taken seriously (Hillson, 1999).

Bibiliography

Anthony, R. and Govindarajan, V., 2007 Management Control Systems, Chicago, Mc-Graw-Hill IRWIN.

Baiman, Agency Research in Managerial Accounting, Journal of Accounting Literature (1982)

Beck, Ulrich (1986) Risk Society: Towards a New Modernity. Sage Publications

Chicken, J C & Posner T (1998) The Philosophy of Risk. Thomas Telford

S P Shapiro, 'Agency theory', Annual Review of Sociology, Volume 31, pp263-84, August 2005.

Ezzamel, M. (1994), "The emergence of the 'accountant' in the institutions of Ancient Egypt", Management Accounting Research, Vol. 5 pp.221-46.

Greenspan - I was wrong about the economy. Sort of

http://www.guardian.co.uk/business/2008/oct/24/economics-creditcrunch-federal-reserve-greenspan

Greenspan, A., 1998. Statement before the Committee on Banking and Financial Services. Fed. Res. Bull. (December), 1046-1050.

Holmstrom, B., "Moral Hazard and Observability", Bell Journal of Economics, 1979, Vol.10, 74-91.

Holmstrom, B., and P. Milgrom, Ägreegation and Linearity in the Provision of Interetemporal Incentives", Econometrica, 1987, 303-328.

Hoskin, K. (1996), "The 'awful idea of accountability': inscribing people into the measurement of objects", in Munro, R., Mouritsen, J. (Eds), Accountability: Power, Ethos and the Technologies of Managing, pp.265-82

Hillson, D (1999) Project Risk Management: Future Developments. The International Journal of Project and Business Risk Management, Vol. 2, Issue 2, Pages 181 - 196

ICAEW Agency theory and the role of audit

http://www.icaew.com/index.cfm/route/139474/icaew_ga/Technical_and_Business_Topics/Thought_leadership/Audit_Quality_Forum/Agency_theory_and_the_role_of_audit/pdf

ICAEW October 2004

http://www.icaew.com/index.cfm/route/127769/icaew_ga/en/Faculties/Financial_Reporting/Information_for_better_markets/IFBM_reports/Sustainability_the_role_of_accountants

J Laffont and D Martimort, The theory of incentives: the principal-agent model, Princeton: Princeton University Press, 2002.

Markets rocket on US bailout package for struggling banks

http://www.guardian.co.uk/business/2008/sep/19/wallstreet.banking

http://www.guardian.co.uk/business/2008/oct/17/executivesalaries-banking

McGowen, C (1999) Elements of Risk: Attitude measurement and the implications for senior management. Research Essay, University of Otago, Dunedin, New Zealand

McGoun, E.G., 1992. TheCAPM: a Nobel failure. Crit. Perspect. Acc.4, 155-177

McGoun, E.G., 1995. The history of risk measurement. Crit. Perspect. Acc. 6,511-532

http://www.ft.com/cms/s/0/740495b6-cff4-11de-a36d-00144feabdc0.html?nclick_check=1

Peter Atrill, Eddie McLaney (2005) Financial Accounting for decision Makers

Speech by MERVYN KING GOVERNOR OF THE BANK OF ENGLAND to Scottish business organisations, Edinburgh on Tuesday 20 October 2009

Young, J., 1996. Instituitional thinking: the case of financial instruments. Acc. Organ. Soc 21, 579-600.

Young, J., 2001. Risk(ing) metaphors. Crit. Perspect. Acc.12, 607-625.

Young, J., 2003. Constructing, persuading and silencing: the rhetoric of accounting standards. Acc. Organ. Soc. 28, 621-638.

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