Accounting & Auditing: Interaction in the regulation and research domains

Accounting & Auditing:

Interaction in the regulation

and research domains

Wolfgang Ballwieser

Munich University

Contents

• Research domain: Theories

• Accounting theories

• Auditing theories

• Interaction

Theories 1

• Theories are systems of sentences

about subjects of scientific interest

which

– contain no contradictions

– can be proven false on logical and/or empirical level

Theories 2

• Theories can be

– normative in the sense of prescriptive: if your aim is x and the conditions are y, then you reach your aim by doing z

– positive in the sense of explaining or reconstructing some aspects of reality

– analytical in the sense of using logic and giving definitions

Accounting theories

Financial accounting theories income measurement financial reporting Management accounting theories Beaver/Demski 1979: The nature of income measurement Beaver 1998: FR: An Accounting Revolution Lev 1988: Theory of

Equitable and Efficient Accounting Policy Watts/Zimmerman 1986: PAT regulation regulation normative positive

Normative regulation theory 1

• Regulatory aims are

– improving allocational efficiency

– guaranteeing fairness for investors, protecting them against fraud and exploitation (SEC)

Normative regulation theory 2

• Regulation avoids market failure

• Unregulated financial reporting leads to

– free rider problem and underinvestment in

reporting (public good argument)

– low network effects and high transaction costs

– information asymmetry and abstaining from market transactions

Normative regulation theory 3

• Regulation supports network effects

because of

– increasing returns for accumulated information – learning effects

– comparability of financial statements – economies of scale

– large and cheap supply of complementary

Normative regulation theory 4

• FASB/IASB/GASB ... follow the concept of

decision usefulness for unidentified users

• It is theoretically not clear what this means

(Demski 1973)

• It is practically not clear; think of

– segmental reporting (SFAS 131, IAS 14, GAS 3) – goodwill amortization (history of SFAS 141&142!) – consolidation of special purpose entities

Auditing theories

Theories on auditing financial reporting

Internal control theories

auditing auditing &

auditing firms regulation regulation normative positive Sampling approach System approach Corporate Governance Independency Influence of peer review Independency Qualified opinions Auditor change Risk analysis

Normative regulation theory 1

• Regulatory aims are

– enforcement of accounting rules – improving allocational efficiency

– guaranteeing fairness for investors (SEC) – guaranteeing equality of opportunity (Lev)

Normative regulation theory 2

• Regulation avoids market failure

• Same arguments as above

Interaction 1

• Accounting and auditing regulation

must be combined because auditing shall

enforce accouting rules

– Accounting rules have to be auditable: what about fair value measurement or impairment test of good will?

– Auditing techniques must be problem solving (effective) and efficient

Interaction 2

• The auditor creats a new agency

problem (risk of moral hazard and

collusion); therefore

– the enforcement of accounting rules by auditors has to be supervised

– incentives have to be given in order to support the independence of auditors, e.g. by liability

Interaction 3

• Experience shows that audit regulation

reacts on damages in the accounting

and/or auditing sector

Deficits in Theory 1

• Empirical research in auditing has many

objections:

– What is the governance structure in audit firms? What is the role of committees?

– How competitive is the audit market?

– What signals quality to whom: client, investor, regulatory body?

– What are the institutional devices to support auditor independence? Public commission /

Deficits in theory 2

• Theoretical research has many open

questions:

– How can efficient audit tools be developed in a dynamic world of accounting?

– What are the consequences of a separation of auditing and consulting, e.g. with respect to

recruiting good personell and risk assessment of audit clients?

– What are the consequences of the globalization of audit firms on management and risk?

Deficits in theory 3

• Recommendations on policy are

restricted by the mentioned deficits :

– What kind of recommendations can be given with respect to regulatory aims, bodies,

institutions, supervisions etc. in the case of further globalization of accounting rules? – What shall be tought at universities and

colleges in order to prepare students for the auditing sector?

Literature

• Ballwieser, Wolfgang, Entwicklung der Theorie der Rechnungslegung in den USA, in: Wagner, Franz W. (ed.), Ökonomische Analyse des Bilanzrechts, Sonderheft 32/93 der zfbf, Düsseldorf, Frankfurt a.M. 1993, pp. 107-108.

• Beaver, William H., Financial Reporting: An Accounting Revolution. 3. ed., Upper Saddle River 1998.

• Beaver, William H./Demski, Joel S., The Nature of Income Measurement, AR 54 (1979), pp. 38-46.

• Demski, Joel S., The General Impossibility of Normative Accounting Standards, AR 48 (1973), pp. 718-723.

• Lev, Baruch, Towards a Theory of Equitable and Efficient Accounting Policy, AR 63 (1988), pp. 1-22.

• Währisch, Mark, The Evolution of International Accounting Systems, Frankfurt a.M. (Peter Lang), 2001.

• Watts, Ross L./Zimmerman, Jerold L., Positive Accounting Theory. Englewood Cliffs, N.J. 1986.