CHAPTER 2: THE

FINANCIAL By Lecturer : Ahmad Anabtawi

REPORTING
ENVIRONMENT
AHMAD ANABTAWI ACCOUNTING THEORY CH2 1
• TABLE OF CONTENTS:
In this chapter you will be introduced to:
 financial reporting and regulations

 The early history of accounting

 the history of the accounting profession and of regulation

 some of the arguments for and against the existence of accounting regulation

 some of the theoretical perspectives used to explain the existence of regulation

• AHMAD ANABTAWI ACCOUNTING THEORY CH2 • 2

FINANCIAL ACCOUNTING
VERSUS MANAGEMENT
ACCOUNTING
Financial Accounting: Process of collection and processing of information of a
financial nature for the purpose of assisting various decisions to be made by external
parties to the organization.
includes : Income statement, statement of change in equity, balance sheet and statement of
cash flows.

Management Accounting: provides information for decision making by parties

within the organization (internal parties)
Includes: cash flows projections, sales budgets, production and etc.

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USERS OF FINANCIAL
REPORTING
users have different information needs so it is not possible to generate reports to
meet individual needs

‘general purpose financial statements’

users include:
 present and potential investors; lenders; suppliers; employees; customers; government and other
parties performing a review or oversight function; media

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ACCOUNTING KNOWLEDGE
REQUIRED OR EXPECTED BY
USERS
changes to accounting standards or new standards affect the accounting numbers
within financial reports (profits, net assets)

users should ideally have sufficient knowledge to assess effect of changes to

regulations

Financial Reports are designed for users who have a reasonable knowledge of
business and accounting and a willingness to study the information with reasonable
diligence.
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DEVELOPMENT OF
ACCOUNTING PRACTICE:
FIRST DOCUMENTED USE
early systems of double entry accounting traced back to 13th and 14th century in
Northern Italy
Franciscan monk named Pacioli first to document double entry accounting practice
(1494)
included debits and credits and used ledgers and journals
Debit means the left side of the account
Credit means the right side of the account
Luca Pacioli uses debit and credit because at that time their was no Minus (which
found in 1700s)

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FORMATION OF
PROFESSIONAL
ASSOCIATIONS
 1854: Society of Accountants (Edinburgh)

 1880: Institute of Chartered Accountants in England and Wales

 1887: American Association of Public Accountants

although members required to prepare and audit reports pursuant to company laws and
stock exchange requirements, no regulation about content of reports and how numbers
compiled existed, that is there was effectively a ‘free market’ approach to accounting
regulation
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HISTORY OF ACCOUNTING
REGULATION
1920s: there was a limited work to codify accounting principles and rules (like:
conservatism, Materiality, consistency and matching principle)
1930: US profession and New York Stock Exchange (NYSE) developed a list of
broadly used accounting principles.
1934: US security exchange act by (SEC) required a specific disclosure of firms
seeking to trade securities.
1938: SEC just accepted financial statements prepared in accordance with GAAP.
This gave a great power of accounting profession.
1939: Committee on accounting procedures commenced issuing statements on
accounting principles: issue 12 accounting research bulletins during 1939.

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DEVELOPMENT OF
MANDATORY ACCOUNTING
STANDARDS
Accounting Standards Steering Committee established in UK
in 1970 (later Accounting Standards Committee) that
mandatory standards developed

US Financial Accounting Standards Board (FASB) formed in

1973
 later produced mandatory standards
 from 1965 departures from principles had to be disclosed in footnotes

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ARGUMENTS IN FAVOUR OF
REGULATION
1- markets for information not efficient
2- ‘on average’ market efficiency arguments ignore the rights of individuals
3- those able to demand information can often do so as a result of power over scarce
resources, while those with limited power are generally unable to secure information
without regulation (even though the organisation may impact their existence)
4- investors need protection from fraudulent organisations producing misleading
information
5- regulation leads to uniform methods thus enhancing comparability

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ARGUMENTS AGAINST
REGULATION
1- people will be prepared to pay for information to the extent that it has use
2- capital markets act to punish organisations that fail to provide information
 no news deemed to imply bad news

3- regulation will lead to oversupply of information as users who do not bear the cost
of supply tend to overstate their needs
4- regulation restricts the accounting methods able to be used so organisations may
be prohibited from using methods which most efficiently reflect their particular
performance and position

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THEORIES USED TO DESCRIBE
BENEFITS OF REGULATION
public-interest theory of regulation
 regulation introduced to protect the public as a result of inefficient
markets.

capture theory of regulation

 although regulation introduced to protect the public, regulatory
mechanisms often controlled by groups most affected by regulation

private interest theory of regulation

 government not neutral arbiter and will regulate based upon impacts to
key voters and campaign finances
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PRIVATE VERSUS PUBLIC
SECTOR REGULATION
private sector regulation
 accounting profession best able to develop accounting standards because of expertise and greater
likelihood rules will be accepted by business

public sector regulation

 government has greater enforcement powers, hence rules more likely to be followed, may be less
responsive to pressure from business and more likely to consider public interest

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