In theory, financial accounting and reporting should be objective and neutral. However, the standard setting process can be a challenge as it is influenced by external factors and groups with different interests (Gaffikin, 2005). In different countries, financial accounting tends to be heavily regulated, with laws governing how particular transactions and events are to be recognized, measured and disclosed (Gaffikin, 2005). As such, the accounting process leads to the generation of general purpose financial reports. There are two approaches to the accounting regulation process, the regulated and non-regulated approach (Hossain, 2011).
The non-regulated approach is also known as the Free Market approach. It states that the production of accounting information and regulation is determined by the market and its mechanisms according to its needs (Hossain, 2011). The Free Market approach argument is further supported by the Agency Theory in which managers and agencies are motivated by several self-interest reasons to reason and act a certain manner (Deegan, 2005). The free-market approach argues that regulation will lead to over-supply of information and would lead to an optimal supply of information by entities. They assume that markets will provide incentives and penalties to ensure that managers do as the market expect (Deegan, 2005).
On the other hand, are the pro-regulation approaches that fall under different regulatory theories which are: Public Interest Theory of Regulation and the Capture Theory of Regulation which is also known as Private Interest Theory of Regulation (Hossain, 2011). The basis of the Public Interest Theory is market inefficiencies, where the public needs to be protected from unfair economic practices. Public interest theory assumes that the regulatory body is a neutral defender of the ‘public interest’. Another theory based on public interest is the capture theory, which brings a twist in the public interest theory and argues that, while regulation might initially be introduced for the public’s benefit, eventually the group that is regulated will gain control of the regulation process. Typically those whose activities are most affected by the regulation are the ones who end up being favoured by the regulations. This implies that accounting regulations can have a different impact on different people or groups (Davianti, 2015).
The public interest assumption is not always the case as some regulators will seek to meet their interests first. The contradiction is supported by the private interest theories of regulation which is also referred to as the economic interest group theory, which proposes that the regulators introduce regulation that best serves the regulators’ own private interests. That is, regulators are motivated not by the public interest, but by their own self-interest (Hossain, 2011). For example, politicians will introduce regulation likely to generate enough support to ensure their re-election. A manager may want to cut down the costs of producing the accounting information whereas investors may require detailed information to use it in making informed decisions (Davianti, 2015).
Regulations play a role in creating uniformity in the society and in the process of formulating the rules; different factors are put into consideration. For the accounting process to be neutral and objective, it would imply that accounting reports are generated without consideration being given to the social and economic effects that the reports will produce (Davianti, 2015). However, if the rules upon which the accounting reports are generated have been developed through a process in which many compromises and trade-offs are made, it is difficult to consider that accounting reports can be neutral and objective.
References
Davianti, A. (2015). Applying Theory to Accounting Regulation. [online] Slideshare.net. Available at: http://www.slideshare.net/ArthikDavianti/l3-applying-theory-to-accounting-regulation [Accessed 17 Jan. 2017].
Deegan, C. (2005). The Financial Reporting Environment. 1st ed. pp.33-52.
Gaffikin, M. (2005). Regulation as Accounting Theory. Accounting and Finance, [online] 1(2), pp.1-21. Available at: http://ro.uow.edu.au/cgi/viewcontent.cgi?article=1049&context=accfinwp [Accessed 17 Jan. 2017].
Hossain, D. (2011). Accounting theory 5. [online] Slideshare.net. Available at: http://www.slideshare.net/khosru94/accounting-theory-5?next_slideshow=1 [Accessed 17 Jan. 2017].
