TAK: Applying Theory to Accounting Regulation


 * The Theories of Regulation Relevant to Accounting and Auditing
 * How the Theories of Regulation
 * Apply to Accounting and Auditing Practice

The Theories of Regulation Relevant to Accounting and Auditing
Managers have incentive to provide accounting Information.

Why do most countries have legal requirements to produce audited financial statements ?

Explanations are provided by:
 * Theory of Efficient Markets
 * Agency Theory
 * Theories of Regulation

Theory of Efficient Markets
This applies to the market for accounting information and should determine what accounting data should be supplied and what accounting practices should be used to prepare it.

The forces of supply and demand influence market behaviour and help keep markets efficient.


 * The market for accounting data is not efficient
 * The ‘free-rider’ problem distorts the market
 * Users cannot agree on what they want
 * Accountants cannot agree on procedures
 * Firms must produce comparable data
 * The government must therefore intervene

Agency Theory
A framework in which to study the relationship between those who provide accounting information - e.g. a manager - and those who use it – e.g. a shareholder or creditor

Demand for Accounting Information ; for stewardship and decision making


 * Because of Imbalance between data suppliers and data users, uncertainty and risk exit
 * Resources and Risk are likely to be misallocated between the parties
 * To the extent the market mechanism is inefficient, accounting regulation is required to reduce inefficient and inequitable outcomes

Theories of Regulation
Public Interest Theory

Public interest theory is based on the assumption that economic markets are subject to a series of market imperfections or transaction failures, which, if left uncorrected, will result in both inefficient and inequitable outcomes.

Based on three assumptions:
 * The interest of consumers is translated into legislative action through the operation of the internal marketplace.
 * There are agents (entrepreneurial politicians and public interest groups) who will seek regulation on behalf of the 'public interest'.
 * The government has no independent role to play in the development of regulations.

Regulatory Capture Theory

This theory maintains that although the 'purpose in fact' or origin of regulation is to protect the public interest.

Assumptions:
 * All members of society are economically rational.
 * The government has no independent role to play in the regulatory process, and that interest groups battle for control of the government's coercive powers to achieve their desired wealth distribution.

This purpose is not achieved because, in the process of regulation, the regulatee comes to control or dominate the regulator.

Private Interest Theory

Regulation comes into existence as a result of government response to public demands to rectify inefficient or inequitable practices by individuals and organisations, was strongly challenged in 1971 by George Stigle


 * Private interest theorists believe that there is a market for regulation with similar supply and demand forces operating as in the capital market.


 * This theory believe that regulation does not arise as a result of a government's response to public demands. Instead, regulation is sought by the 'producer' private interest group and is designed and operated mainly for its benefit.

Application of Public Interest Theory
Under public interest theory, governments intervene in the regulation of financial reporting in response to market failure and 'in the public interest'.

We can see the application of the theory in:
 * Sarbanes-Oxley Act
 * After the collapse of the Enron Corporation and the audit firm Arthur Andersen, SOX was introduced as a US law meant to protect investors from fraudulent accounting activities by corporations.


 * Accounting Standards Review Board
 * It is established by Australian government. This government’s intervention is seen as justified by failures in the market for accounting information, evidenced by the significant number of corporate collapses.

Application of Capture Theory
The accounting profession needed to legitimise accounting standards which could be achieved only by standards that had the ‘force of law’

Walker argues that ASRB (Accounting Standards Review Board) was introduced to capture the accounting profession, the regulated industry.

Example:

The ASX (Australian Securities Exchange) was a strong supporter of early adoption of international standards, presumably because it saw benefits for the ASX and listed companies flowing from the use of international standards.

Application of Private Interest Theory
We can see the application of the theory in the establishment of ASRB.
 * The Board was dependent on and susceptible to influence from several interest groups
 * The Board had to operate with the notion that its approved accounting standards were subject to political approval
 * Other parties secured important roles that enabled them to influence the Board's activities

Standard Setting as Political Process
It is viewed as a political process because of its potential to significantly affect the wellbeing of a wide variety of interest groups

In the presence of diverse and often conflicting interests,
 * The regulator must strike a balance between them by making political choices
 * The regulator must have a mandate to make social choices

Example of Standard Setting: Financial Instruments
 * The adoption of IAS 39 Financial Instruments - Recognition and Measurement in the EU has been a highly politicised process.
 * Standard setters have viewed fair value measurement as useful for providing relevant information for decision making.
 * The accounting change in the area of financial instrument was potentially dramatic.
 * GAAP → Used historical cost and only recorded gain when it realized
 * IAS 39 → Recorded unrealized gain and loss

The Regulatory Framework for Financial Reporting
Regulasi harus mengandung beberapa element

Elements:
 * Statutory Requirements, adalah peraturan yang mewajibkan entity untuk membuat dan menggunakan standar tertentu dalam laporan keuangan
 * Corporate Governance, the system yang ada di entity yang memastikan laporan keuangan yang dipublikasikan reliable. Misalnya, internal control
 * Auditors and Oversight, the person who verify financial statement published by the entity
 * Independent Enforcement Bodies, lembaga yang mempunyai kewenangan untuk memberikan saksi dan pengawasan kepada perusahaan yang melanggar regulasi yang ada.


 * The Institutional Structure for Setting Accounting and Auditing Standards

Five Theories - Theory of efficient market, discuss about demand and supply financial information about the entity - Public Interest Theory - R

QNA Session

 * Public Interest Theory, KPPU (Komisi Pengawas Persaingan Usaha) dan telah diregulasi dalam Undang-Undang Nomor 5/1999
 * Free rider issue. The entity memiliki kewajiban untuk mengungkapkan laporan keuangan. Hal ini harus diregulasi oleh lembaga pemerintah terkait untuk maintain the public interest, not the parties' interest.
 * IFRS 17 Insurance Company belum diadopsi di Indonesia hingga tahun 20215 (7 tahun lebih lama dari perilisan IFRS 17 secara global).
 * Injustice dalam financial industry salah satunya adalah ketidakadilan bagi investor/nasabah yang diakibatkan oleh perusahaan asuransi dan investasi yang tidak mengungkapkan secara penuh informasi keuangan, risiko, potential return and risk, financial condition of company, yang digunakan oleh perusahaan keuangan tersebut.