CHAPTER 1 (1) – ACCOUNTING: THEORIES AND EMERGING 5.

Mythology
ISSUES - Accoun/ng system supports the concept of
“professionalism” - used to jus/fy, ra/onalize and
AICPA defines accoun/ng as: legi/mize decisions that are made.
the art of recording, classifying, and summarizing in a - The mythical accountant iden/fies areas of imbalance,
significant manner and in terms of money, transac/ons and recommends solu/ons, and makes sure that financial
event which are in part at least, of a financial character and choices are ethically acceptable.
interpre/ng the results of thereof
6. Communica/on-Decision Informa/on
ROLE OF ACCCOUNTING Accoun/ng reports prepared (by internal n external) to
1. Historical record support strategic decision making.
- Provides a history of the managers’ stewardship of the
owners’ resources. 7. Magic (tricks)
- Measurement of the stewardship concept has evolved - Seen as a means of misleading report users
over /me, in the following periods: - An accountant can perform sleight-of-hand accoun/ng
a) Pure custodial period Do as instructed(rules) – the tricks which can be compared to magician’s tricks
direc3on of how assets should be
b) Tradi/onal custodial period used is determined by the owners. - Able to make the financial statements appear to be
c) Asset-u/liza/on period – pakai formula something they are not
(ini/a/ve in using the assets) - Managers/agents use to - Ex: Enron used accoun/ng techniques to disguise its loss-
provide ini/a/ve and insight on how the assets should be making investments
used to meet the objec/ve to maximize the value of the
assets. 8. Economic goods
Ex: The turnover ra/os, such as inventory turnover and - Part of a wider informa/on set which includes
accounts receivable turnover macroeconomic, poli/cal, taxa/on and other specific
informa/on that affects the performance of the firm
2. Language. - Managers will o_en argue for accoun/ng standards that
Accoun/ng is perceived as the language of business. decrease informa/on costs because they are associated
Accoun/ng has 2 components: with the produc/on of accoun/ng informa/on.
a) Symbols - Numerals and words. Ex: DR. Bank 75,000 - Shareholders and creditors will lobby for accoun/ng rules
b) Gramma/cal rules - set of procedures used to create that enhance their ability or right to control and monitor
financial data. Ex: DR n CR the conducts of the management
- Translate economic events and transac/ons into words
and numbers that can be communicated and understood 9. Social commodity
by users of accoun/ng reports - accoun/ng serves as a social commodity by providing
- Convey its financial performance, u/liza/on of resources informa/on that goes beyond individual or organiza/onal
provided by various par/es and also details of past interests. (demand n supply – free market)
transac/ons that had been entered into - Accoun/ng exists because specialized informa/on is in
demand and accountants are willing and capable of
3. Intra-Corporate poli/cs. producing it
- Reflects and supports the values and needs of special - Choice of accoun/ng informa/on may have an impact on
interest group the welfare of various group in society
- Informa/on is created as a tool to help shape business
policies 10. Ideology and exploita/on
- used in decision-making to improve and further - Seen as ideological, serving to maintain and legi/mize the
management goals. exis/ng social, poli/cal, and economic structures.
- Ex: Use accoun/ng reports to convince the management - Perceived as a myth, symbol and ritual that permits the
to increase resource crea/on of a symbolic order within which social agents
interact
4. Poli/cal process - As both a tool of the capitalist system and an instrument
- involves the use of financial informa/on and repor/ng to of economic logic.
influence or respond to poli/cal decisions, policies, and
regula/ons.
- O_en argue for accoun/ng standards to further their own
objec/ves and choose accoun/ng methods that maximize
their own benefits. Example: Managers support standards
that lower taxes, reduce poli/cal and bookkeeping costs
and increase management compensa/on
Overview of AccounBng theory. 1800 – 1955: pragma/c theories/general scien/fic period
Hendriksen’s defini/on: - The theories during the period were mainly concerned
“logical reasoning in the form of a set of broad principles that about the explanaBons of pracBce and the development
provide a general framework of reference by which accoun/ng of explanatory framework.
prac/ce can be evaluated and guide the development of new - Theories developed based on real-world observa/ons
prac/ces and procedures.” rather than solely on logic. However, developments were
sporadic.
- Was developed to resolve problems as they
- Ad-hoc approach - a way of tackling a problem in an 1956 – 1970: norma/ve theories
informal or spontaneous manner. - The theories were concerned about developing
- Led to inconsistencies in prac/ce statements of the best accoun/ng prac/ce.
- e.g. different deprecia/on methods - Researchers were less concerned about what actually
happen in prac/ce and more concerned about developing
Accoun/ng theory is a set of assump/ons, frameworks, and theories that prescribed what should happen.
methodologies used in the study and applica/on of financial - However, norma/ve period drew to an end in early 1970s
repor/ng principles. due to the following factors:
a) Norma/ve theories were based on subjec/ve opinion,
Basic elements to accoun/ng theory: usefulness, relevance, which varied between individuals. Dissa/sfac/on
reliability, comparability, and consistency. arises because these theories did not resolve the
differences in opinion
Whether a theory is accepted depends on how: b) Norma/ve theories could not be empirically testes
a) well it explains and predicts reality because it was impossible to demonstrate empirically
b) well it is constructed both theore/cally and empirically what ought to be. thus, it was unclear whether the
c) acceptable its implica/ons are theories had any strong founda/on.

Development in AccounBng theory. 1970 – 2000: posi/ve theories/specific scien/fic theory.

before 1400s - Posi/ve accoun/ng theories were developed to explain
Very liile was wriien about the theory underlying the and predict accoun/ng prac/ces.
accoun/ng prac/ce. Main emphasis was on prac/ces. - The benefit of posi/ve accoun/ng theories is that they
enable regulators to assess the economic consequences
1494 of various accounBng pracBces they are considering.
Luca Pacioli, a Franciscan monk, is generally associated with - Hypotheses about reality were developed and
the introducBon of double-entry bookkeeping. He published a subsequently tested through observaBons of the reality.
book describing the prac/ce in Venice at the /me with the - However, the problem with these theories is that for
purpose of “giving the trader without delay informa/on as to posi/ve theorists, wealth maximisa/on became the
his assets and liabili/es." Pacioli's book was subsequently answer to every ques/on - whatever the observed
translated into several languages contribu/ng to the spread of prac/ce, it could be construed as a means of maximising
the double-entry method throughout Europe. wealth.
- This has airacted cri/cisms regarding the biased fashion
1450 – 1750: pre theory period in which the posi/ve theorists dismiss alterna/ve
- Development in accoun/ng were concentrated on refining viewpoints.
prac/ces but not on systema/c basis. - For example, the "bonus plan hypothesis" states that
- Thus, developments were random and ill defined, evolving managers maximize wealth, even at the expense of the
as they were needed to jus/fy par/cular prac/ces. interests of shareholders. A manager will have an
incen/ve to start accoun/ng procedures that maximize
1750 - 1920 reported profits in periods when he is likely to get bonuses
This period saw the formalisa/on of exis/ng in textbooks and if his compensa/on is par/ally based on reported
teaching methods due to: accoun/ng profits. According to this argument, managers
a) Rapid expansion in technology, growth of business sectors who receive bonus payments are more likely to use profit-
and the construc/on of railroad networks in US and UK. These increasing accoun/ng techniques than managers who do
increased the demand for detailed accoun/ng informa/on, for not receive bonus payments.
improved techniques and for accoun/ng prac/ces such as
deprecia/on of long-term assets and new finance.
b) Taxa/on and government legisla/ons regarding repor/ng
requirements.
c) government and corporate economic policy decisions based
on accoun/ng numbers.
1980 – present: behavioural period 20th century: development of accoun/ng methods for
- Behavioural accoun/ng theories focus on psychological complex issues:
and sociological influence on individuals in their - Computa/on of earnings per share
prepara/on of accoun/ng. For example, it is expected that - Accoun/ng for business combina/ons
a bank loan manager with exper/se in lending to - Accoun/ng for infla/on
businesses that failed on their debt agreements due to - Accoun/ng for long-term leases
poor cash flow would rely more on cash flow data when - Accoun/ng for pensions
determining the "credit risk" of the company. However, it - Accoun/ng for new products of financial engineering
is expected that the manager will put a higher value on
the stated profit or loss and possible earnings of the
poten/al borrowers if the bank loan manager has
experience with loans to companies that failed due to
unproduc/ve opera/ons. Surprisingly posi/ve accoun/ng
con/nues to rule the accoun/ng research literature, even
if it is becoming more and more popular in behavioural
research.

WHO IS LUCA PACIOLI

Introduced the double entry bookkeeping
- He did not invent double-entry bookkeeping but rather
made a record of what was happening in Italy at the /me
- His books were translated into several languages and so
the Italian Method spread throughout Europe
- The terms Debit and Credit were used.
- He said, ‘All entries have to be double entries, that is, if
you make one creditor, you must make someone debtor.’
- He advised the computa/on of periodic profits and the
closing of the books. ‘It is always good to close the books
each year, especially if you are in a partnership with
others. Frequent accoun/ng makes for long friendship’.

EVOLUTION OF DOUBLE-ENTRY BOOKEEPING

16th century:
- The introduc/on of specific journals
- The prac/ce of periodic financial statement

17th century:
- Con/nuing development of the prac/ce of periodic
financial statement
- The use of separate inventory accounts for different types
of goods
- Growth of the corpora/on and the Industrial Revolu/on
and, as a result, accoun/ng acquires a beier status.

18th century:
- Three methods of trea/ng fixed assets:
a) Asset is carried forward at original cost.
b) Asset account is closed at balancing date.
c) Revalua/on of fixed assets

19th Century
- Deprecia/ng property was accounted.
- Cost accoun/ng emerged.
- Techniques of accoun/ng for prepayments and accruals
- Development of funds’ statements
CHAPTER 1 (2) 1993 Securi/es Commission was established. Public
listed companies are required to show full
OVERVIEW OF FINANCIAL REPORTING ENVIRONMENT. disclosure requirements as required by SC's
1. Companies Act 1965 1997 Financial Repor/ng Founda/on (FRF) and
2. Security Industry Act 1983 Malaysian Accoun/ng Standards Board (MASB)
3. Securi/es Commissions Act 1992 was established under the Financial Repor/ng Act
4. An/-Money Laundering Act 2001 1997
5. Banking and Financial Ins/tu/on Act 1989 31/1/ The Companies Act 1965 was established by the
2017 Companies Commission of Malaysia (SSM) to
USERS OF FINANCIAL REPORTING ENVIRONMENT replace the Companies Act 1965, with several key
1. Corporate/ Preparers of Financial Statements: updates to benefit SMEs greatly such as lowering
Purpose: Public and investor rela/ons (communica/ng the minimum requirements for the company
financial and opera/ng performance) incorpora/on of a Sdn Bhd and simplifying the
Concern: Maintenance, Legal risks, Confiden/ality mandatory.

2. Regulators bodies and Enforcement Authori/es: THE CURRENT FINANCIAL REPORTING REGIME
Purpose – Reducing informa/on disparity, Protec/ng Financial Repor/ng MASB
public interest. Founda/on (FRF) S7(1) of the FRA 1997
Concerns – Standards seong, Monitoring and S4(1) of the FRA 1997
Enforcement (Through Companies Act and through its 1. To provide its views to 1. To issue new accoun/ng
prescribed schedules. Compliance with stock exchange the MASB on any standards as approved
authori/es etc.) maiers which the accoun/ng standards.
MASB seeks to 2. To review, revise or adapt
3. Users/Capital Markets: (Internal & External) undertake or as approved accoun/ng
Purpose - Decision Making implement in rela/on standards, exis/ng
Concerns - Relevance and Reliability to the MASB’s accoun/ng standards.
func/ons of issuing, 3. To issue statements of
ACCOUNTING DEVELOPMENT IN MALAYSIA reviewing, or principles for financial
Prior to Companies Ordinances (and amendments) of developing approved repor/ng.
1957 1940, 1946, 1956 accoun/ng standards. 4. To sponsor or undertake
1958 The Malayan Associa/on of Cer/fied Public 2. To review the the development of
Accountants was formed performance of possible accoun/ng
1964 The Associa/on became The Malaysian MASB. standards.
Associa/on of Cer/fied Public Accountants 3. To be responsible for 5. To conduct such public
(MACPA) on July 6 (finally renamed The all the financing consulta/on as may be
Malaysian Ins/tute of Cer/fied Public arrangements for the necessary to determine
Accountants (MICPA) on January 29, 2002) opera/ons of the the contents of
1965 - Establishment of Companies Act 1965 MASB, including accoun/ng concepts,
- Companies Ordinances were then repealed. approving the budget principles, and standards.
Contained Ninth Schedule (disclosure of the MASB. 6. To develop a conceptual
requirements) 4. To perform such other framework for the
1967 The Malaysian Ins/tute of Accountants (MIA) was func/on as the purpose of evalua/ng
established under the Accountants Act 1967 Minister of Finance proposed accoun/ng
1968 MACPA issued first accoun/ng guidance which may prescribe by standards.
dealt with specimen company accounts order published in the 7. To make such changes to
1978 MACP was admiied as a member of Interna/onal gazeie. the form and content of
Accoun/ng Standards Commiiee (IASC) and proposed accoun/ng
began adop/ng IAS standards as it considers
1984 MACPA issued the first Malaysian Accoun/ng necessary.
Standard 8. To perform such other
1985 Companies Act 1965 was amended. New Ninth func/ons as the Minister
Schedule with more comprehensive disclosure of Finance may prescribe
requirements that includes the prepara/on of by order published in the
statement of source and applica/on of funds. gazeie.
1987 Opera/on of MIA were ac/vated. MIA began
issuing accoun/ng standards.
 CHAPTER 2: FORMULATION AND PRAGMATIC THEORIES
VERIFICATION OF ACCOUNTING THEORY
Definition: An approach that emphasize the
(PART 1)
practical usefulness of ideas and concept.
WHAT IS THEORY?
• Happen during general scientific period.
A theory is defined as a set of interrelated
constructs (concepts), definitions, and Descriptive Pragmatic Criticism Descriptive
propositions that present a systematic view of Approach Pragmatic Approach
phenomena by specifying relations among • Based on observed • Does not consider the
variables, with the purpose of explaining and behavior of accountants quality of an accountant’s
predicting the phenomena (Kerlinger, 1964) • Theory developed from action
how accountants act in • Does not provide for
CHARACTERISTICS OF A THEORY certain situations accounting practices to be
• Tested by observing challenged
• Widely accepted
whether accountants do • Focuses on accountants’
• Descriptive approach in general and a normative act in the way the behaviour not on
(prescriptive) approach in particular theory suggests measuring the attributes of
• Is an inductive approach the firm
• Having the quality of authenticity and also
authoritative Keywords: Observe accountants’ behavior
• The ability to evaluate and explain current (perangai)
events correctly
Psychological Pragmatic Criticism Psychological
• The ability to analyse past events and forecast Approach Pragmatic Approach
future events • Theory depends on • Does not consider the
observation of quality of an accountant’s
• The ability to solve problems created by the the reactions of users to action
occurrence of an event the accountants’ outputs • Does not provide for
accounting practices to be
• Verifiable through testing of hypothesis
• A reaction is taken as challenged
*Prescriptive = What should do & how something evidence that the outputs • Focuses on accountants’
should be done are useful and contain behaviour not on
relevant information measuring the attributes of
*Descriptive = Observing & measuring without
the firm
manipulating results
(Meaning to say, kalau
CLASSIFYING THEORIES: THE UNDERLYING Keywords: Observe
accounting standards/policies
ASSUMPTIONS accountants’ reaction tu diterima baik dan boleh
membantu accountants in
• Theories are classified based on: decision-making, theory tu
boleh proceed)
(1) The assumptions they rely on

(2) How they are formulated and their approaches NORMATIVE THEORIES (what should be done)
in explaining and predicting actual events
Definition:
• Pragmatic (General Scientific Period)
1. Concerned with establishing what should be
• Normative (Normative Period) the proper or ideal behaviour or decision-
making in a given situation based on a set of
• Positive (Specific Scientific Period) ethical, moral or legal principles.
• Behavioral (Behavioural Period) 2. Observe how things should be or what is
considered right or wrong in the context of
* Formulation of theories need to go through all ethics and morality.
four phases without missing a single one. 3. Normative theories in accounting are
concerned with prescribing how accounting
 practices should be carried out rather than - Regard the provision of information for
describing how they are currently practiced decision making as the main function of
financial statements.
Normative approach is based on value judgments
or opinion and these value judgments cannot be POSITIVE THEORIES
verified or tested.
Roughly defined as observe how things are in real
- Happen in 1950s and 1960s world. (To explain reasons for current practices)

- Policy recommendations • Positivism or empiricism means testing or

relating accounting hypothesis based on
- What should be (financial statements should
‘experiences’ or ‘facts’ of the real world.
mean what they say) This approach involves gathering data, conducting
- Concentrated on: experiments, or analyzing real financial
information to confirm or reject accounting
a) Deriving true income (profit) hypotheses.

• The term "true income" signifies the • Explain the reasons for current practice.
desire for an accurate representation of • Predicting the role of accounting information
the financial results of an organization's in decision making
operations, free from biases, errors, or • Test theories that assume that accounting
misleading information. information is an economic and political
b) Practices that enhance decision commodity.
usefulness • People act in their own self-interest.

• Normative theories aim to cater to the Contohnya, investor act

needs of various users (such as BEHAVIOURAL THEORIES
in self-interest bila buat
investors, creditors, managers, etc.) by investment decisions.
providing financial information that aids in Definition: Mereka akan guna
accounting information
their decision-making processes. This
Behavioral theories in accounting untuk buat keputusan
involves considering different users'
focus on understanding how tentang investment
information requirements and tailoring mereka yang maximize
psychological and behavioral factors
accounting practices to meet those return and minimize
influence decision-making,
needs. risk.
judgment, and behavior within the
- Based on analytic and empirical propositions realm of accounting practices and
financial reporting.
*Analytic = Logical Assessment
These theories draw from insights in psychology,
*Empirical = Observation Data sociology, and behavioral economics to explain
Features: why individuals, including managers, investors,
auditors, and other stakeholders, may deviate
- Market-based theories which use methods (menyimpang/drift away) from purely rational
other than historical cost method. and objective decision-making assumptions.
- Respective concepts of true income and
financial position
Market-based methods, like Focuses on
• Normative theories aim to develop methods that fair value accounting, involve understanding and
provide a faithful representation of these concepts in valuing assets and liabilities at explaining accountants
financial reporting. their current market prices. and non-accountants’
This approach is favored in behaviour.
- Assume profit maximization as the primary certain normative theories
goal of management. because it potentially reflects Compare the decisions
more current economic they made and
- Constructed based on Deductive reasoning starts
realities than historical cost, improve.
deductive reasoning. from general principles and
enhancing the relevance of
uses logical steps to derive
financial information.
specific conclusions.
- Derived from disciplines such as psychology, • The harnessing and recording of the expertise
sociology, and organizational theories. and skills of experienced accountants using
the behavioral research methods.
- Objective is to discover why people behave as
• This system will then be used to train
they do.
inexperienced practitioners.
- According to Hofstedt and Kinard (1970), • Some auditors have also used behavioral
behavioral accounting research is defined as: research methods to develop an expert
system to conduct risk assessment of
“The study of the behavior of accountants or the potential audit clients
behavior of non-accountants as they are
influenced by accounting functions and reports.” NORMATIVE vs. POSITIVE

Importance of behavioral accounting NORMATIVE POSITIVE

research: THEORY THEORY

a) Identifies how people use and process Focus Normative theories Positive theories aim
accounting information. prescribe how to describe, explain,
accounting should be and predict
• Specifically, it examines the decision-making conducted. They are accounting
activities of the preparers, users, and auditors concerned with phenomena as they
of accounting information. establishing are, based on
b) Provides valuable insight into the ways of how principles, guidelines, empirical evidence
different decisions are produced, processed and and standards that and observations of
how people react to items of accounting guide ideal actual behaviors and
information and communication methods. accounting practices. practices.

• By improving the decision-making process, Objectivity The primary objective ather than prescribing
users of financial information can avoid of normative theories what should be done,
making bad decisions that lead to losses, and is to determine what positive theories seek
preparers and auditors of financial information accounting principles to understand and
can avoid being sued. and practices ought describe current
to be, based on ideal accounting practices
c) It can lead to training and increase in standards of and behaviors,
knowledge for accountants to improve their skills relevance, reliability, exploring the reasons
in information gathering, processing, and and usefulness of behind them.
communication. financial information.
d) It can provide useful information to accounting Methodology Normative theories Positive theories rely
regulators, particularly in the aspect of providing use deductive on empirical
decision-useful information to the users of reasoning and ethical evidence,
financial statements. considerations to observations, and
develop accounting scientific
• Can directly study specific accounting options
standards and methodologies. They
and then report to standard setters on which
principles. They use methods like
methods or disclosures improve users’
emphasize how statistical analysis,
decision.
accounting practices experiments, and
e) It can lead to efficiency in the work of should ideally empirical research to
accountants and other professionals. operate, often test hypotheses and
drawing from moral understand the
• For example, a computerized expert system and ethical ideals. behavior of
for decision making can be developed individuals within
through. accounting settings.
 FORMULATION OF ACCOUNTING THEORY: COMPARING DEDUCTIVE AND INDUCTIVE
APPROACHES
1. Deductive Approach
• In the deductive approach, the truth or falsity of
2. Inductive Approach
the propositions does not depend on other
3. Ethical Approach propositions, but must be empirically verified
4. Sociological Approach • In the inductive approach, the truth of the
5. Economic Approach propositions depends on the observation of
sufficient instances of recurring relationships
6. Eclectic Approach
• Accounting propositions that result from
DEDUCTIVE INDUCTIVE inductive inference imply special accounting
APPROACH APPROACH techniques only with high probability
The approach moves Begins with observation • Accounting propositions that result from
from the general to and moves toward deductive inference, on the other hand, lead to
derive logical conclusion generalized conclusion specific accounting techniques with certainty
General statements to Particular statements to 3. Ethical Approach:
specific statements general statements
Focus: The ethical approach in accounting theory
Based on normative Based on positive theory emphasizes moral principles, values, and ethical
theory considerations in formulating accounting
standards and practices.
Steps Steps:
Objective: It aims to ensure that accounting
1. Specify the objectives 1. Record all
practices align with ethical norms and principles,
of financial statements observations
emphasizing honesty, integrity, transparency, and
2. Select the postulates 2. Analyze and classify accountability.
of accounting and explain these
Example: One example is the development of
(assumption) observations to detect
ethical codes of conduct for accountants by
recurring relationships
3. Derive the principles professional bodies like the International
of accounting 3. Generalize the Federation of Accountants (IFAC) or the American
principles of accounting Institute of Certified Public Accountants (AICPA).
4. Develop the These codes establish ethical guidelines for
from observations that
techniques of accountants to promote integrity, objectivity, and
depict recurring
accounting professional behavior.
relationships (making
conclusion)

4. Test the
• The basis derived from the concepts of
generalizations fairness, justice, equity and truth

• In general, the concept of fairness implies that

accounting statements have not been subject to
MINI SUMMARY:
undue influence or bias

• Normative Theory • Positive Theory • The committee on auditing procedures refers

• Deductive • Inductive fairness of presentation to conformity with
• GAAP, disclosure, consistency, and
General -> Specific • Do research (to
• What should be comparability
explain) & to
done analyze
• Comparison
• Explain reasons
for current
practices
• Menjelaskan
tindakan
individu
4. Sociological Approach: Example: The application of cost-benefit analysis
in accounting standard-setting processes, where
Focus: The sociological approach considers the
the benefits of implementing a new accounting
influence of social structures, cultural values, and
standard are weighed against the costs involved,
societal norms on accounting practices.
reflects the economic approach.
Objective: It aims to understand how accounting
6. Eclectic Approach:
practices are shaped by social factors, including
culture, politics, power structures, and the roles of Focus: The eclectic approach integrates multiple
various stakeholders in the accounting process. perspectives, theories, or methodologies to
formulate accounting theories.
Example: Research exploring how cultural
differences impact financial reporting practices in Objective: It aims to draw on various approaches
different countries or how power dynamics within (such as ethical, sociological, economic, etc.) to
organizations affect decision-making related to develop a more comprehensive and flexible
financial disclosure reflects the sociological framework for understanding accounting
approach. practices.

Example: Using a combination of economic

• Emphasizes the social effects of accounting
principles, ethical considerations, and social
techniques
context to design a framework for financial
• According to this approach, a given reporting that considers both economic rationality
accounting principle or technique is evaluated and societal values represents the eclectic
for acceptance on the basis of its reporting approach.
effects on all groups in society

• Implies that accounting data will be useful in • In general, the formulation of accounting
making social welfare judgments. theory and the development of accounting
principles have followed an eclectic approach (a
combination of approaches), rather than just
one school of thought.
5. Economic Approach:
• This approach is mainly the result of various
attempts made by professionals and
• Emphasizes controlling the behavior of
government to participate in the establishment
macroeconomic indicators that result from the
of concepts and principles in accounting.
adoption of various accounting techniques

• The choice of different accounting techniques

depends on their impact on the national
economic good

• Accounting policies and techniques should

reflect ‘economic reality’ and the choice of

accounting techniques should be based on

‘economic consequences.

Focus: The economic approach in accounting

theory centers on economic principles, incentives,
and rational decision-making in accounting
practices.

Objective: It seeks to explain accounting

behaviors and practices based on economic
incentives, market forces, and rational choices
made by individuals within organizations.
 CHAPTER 2: FORMULATION AND ▪ Does not incorporate notions of loyalty or
VERIFICATION OF ACCOUNTING THEORY morality
(PART 2)
ORIGIN OF POSITIVE ACCOUNTING THEORY
POSITIVE THEORIES VERSUS NORMATIVE
THEORIES Positive accounting theory (PAT) emerged in the
1960s and 1970s as a response to the limitations
• A positive theory seeks to explain and predict of normative accounting theories.
particular phenomena
PAT was developed to understand and explain
▪ Positive Accounting Theory (PAT), which we existing accounting practices by studying the
explore in this lecture, is one example of a behaviors and motivations of various stakeholders
positive theory of accounting. involved in the accounting process, such as
managers, shareholders, creditors, and
▪ Other examples are covered in the next lecture regulators.
(when we consider theories such as legitimacy
theory and institutional theory which are positive The key premise of PAT is to explain and predict
theories that can be applied to explain the accounting practices by examining the self-
practice of accounting) interested behaviors of different parties within an
organization. It assumes that individuals act
• By contrast, normative theories (which will be rationally and in their own best interests. This
considered in CF topic) prescribe how a particular theory contends that accounting choices are
practice should be undertaken influenced by factors like economic incentives,
contracts, political costs, and the information
▪ The prescription might depart from existing
needs of users.
practice.
PAT explores how managers might manipulate
POSITIVE ACCOUNTING THEORY
accounting policies to serve their interests, such
DEFINITION as maximizing their compensation or portraying
the company in a favorable light to stakeholders.
• PAT ‘… is concerned with explaining accounting It acknowledges that accounting standards and
practice. It is designed to explain and predict practices might not always reflect the ideal but are
which firms will and which firms will not use a influenced by the economic and social
particular method … but it says nothing as to environment in which they operate.
which method a firm should use.’ (Watts and
Zimmerman 1986, p. 7) The theory also highlights the importance of
empirical research and uses data analysis to test
• Again, positive theories do not prescribe what hypotheses and validate theories, aiming to
should occur – they focus on explaining or provide a more realistic understanding of
predicting what does occur accounting practices as they exist in the real
PAT focuses on relationships between various world.
individuals and explains how accounting is used Overall, PAT provides a framework to analyze and
to assist in the functioning of these relationships. understand the motivations behind accounting
For example, relationships: choices and practices, acknowledging that these
decisions are influenced by various factors and
▪ between owners and managers stakeholders' self-interest.
▪ between managers and the firm’s debt providers
• Started coming to prominence in mid-1960s
ASSUMPTIONS UNDERLYING PAT • Paradigm shift from normative theories
• PAT became the dominant research paradigm in
• All individuals’ action is driven by self-interest
1970s and 1980s
and individuals will act in an opportunistic manner
• shift resulted from US reports on business
to the extent that the actions will increase their education and improved computing facilities
wealth. enabling large-scale statistical analysis – something
common in positive research
 ORIGINS OF PAT— CAPITAL MARKETS Positive accounting theory (PAT) stepped in to
RESEARCH tackle this issue by shifting the focus from how
accounting should be done to understanding why
• Development of Efficient Markets Hypothesis
specific accounting methods were chosen in
(EMH) by Fama and others provided an
practice. It posited that accounting methods were
environment suitable for PAT research
not solely determined by their informational
▪ Capital content but were influenced by various factors,
We will focus on EMH theory
markets react including economic incentives and the self-
on PAT during Chap 5 –
in an efficient Creative Accounting interest of parties involved (like managers,
and unbiased shareholders, etc.).
manner to publicly available information
PAT recognized that managers, being self-
• Ball and Brown (1968) paper was crucial to the interested individuals, might choose accounting
acceptance of the positive research paradigm methods that align with their goals, such as
maximizing bonuses, meeting performance
▪ Investigated stock market reaction to accounting targets, or presenting the company in a favorable
earnings announcements light to stakeholders. This behavior could lead to
the selection of accounting methods that might
▪ Sought to explain market reactions
not necessarily reflect economic reality but serve
• Price of a security based on beliefs about
the interests of the individuals or groups involved.
present value of future cash flows
FIRMS AND CONTRACTS
• Ball and Brown found that earnings
• Firms can be characterized as a nexus of
announcements impacted share prices
contracts between consumers of products and the
▪ Evidence that historical cost information is suppliers of factors of production
useful to the market
• Firms exist because they reduce contracting
• But the literature was unable to explain why costs:
particular accounting methods were selected –
if the market was efficient as commonly • firms provide an efficient means of
assumed by researchers, and could understand organizing economic activity
how different accounting methods affect
• consider the alternative, an individual
accounting numbers, then why does it
organizing the production of a good:
matterwhat accounting method was selected?
PAT addresses this issue. acquiring the raw materials organizing
various people to make the good]
EXPLAINATION:
• Contracts include all types of agreements
The idea that security prices are based on between two or more parties (not necessarily
expectations about the present value of future written contracts)
cash flows aligns with the efficient markets
AGENCY THEORY
hypothesis, suggesting that all publicly available
information is reflected in asset prices. However, • Agency theory was crucial to the development of
the empirical findings, such as those by Ball and PAT
Brown showing that earnings announcements
impact stock prices, indicated that historical • Agency theory explained why the selection of
accounting information, specifically earnings, particular accounting methods might matter
influenced market perceptions. • Focused on the relationships between principals
This created a conundrum/confusing question: If (shareholder) and agent (manager, auditor)
markets were truly efficient and could understand
how different accounting methods affect financial The principal is the individual seeking out
numbers, why did the choice of accounting the service or advice of a professional,
while the agent is the professional
method matter? This was a pivotal question that
performing the work.
normative theories struggled to address.
• Information asymmetries create much 2. Granting managers stock options or
uncertainty equity in the company, making them
shareholders to a certain extent.
When one party in a transaction possesses
more information than the other, it creates AGENCY PROBLEM
uncertainty for the less informed party. For
instance, in the context of financial markets, if The agency problem refers to conflicts of
managers possess detailed knowledge about a interest and diverging goals that arise
company's financial health while shareholders between two parties involved in a principal-
have limited access to this information, it agent relationship.
creates uncertainty among shareholders about
the true value of their investments. This WHY?
uncertainty can lead to market inefficiencies.
1. The principal (such as shareholders)
▪ Transaction costs and information costs exist expects the agent (such as managers or
employees) to act in a manner that
maximizes the principal's interests.
Principals may incur Principals might need to invest in 2. Agents often possess more detailed
transaction costs in the obtaining relevant information to information about day-to-day operations,
form of monitoring bridge the information gap between market conditions, or specific decisions
expenses, auditing, themselves and the agents. This than principals.
setting up incentive investment can involve expenses 3. Misalignment of goals between principals
structures, or related to acquiring, processing, and and agents can lead to actions that
establishing control analysing information that is critical
prioritize short-term gains or personal
mechanisms to reduce for making informed decisions and
for effective monitoring of the
interests over the long-term sustainable
the adverse effects of
information agents' actions. growth and success of the organization.
asymmetry.
AGENCY COSTS

AGENCY RELATIONSHIP Agency costs refer to the expenses incurred

by a principal (like shareholders) in monitoring
• The ‘agency relationship’ is a central focus of
and controlling agents (such as managers or
agency theory
employees) to ensure that they act in the best
• Defined by Jensen and Meckling (1976): “a interests of the principal. These costs arise
contract under which one or more (principals) due to the inherent conflicts of interest and
engage another person (the agent) to perform information asymmetry between principals
some service on their behalf which involves and agents in a typical agency relationship.
delegating some decision-making authority to the
1. Monitoring Costs: These are expenses
agent.”
incurred by principals to supervise, monitor,
• Agency theory key assumptions from the and evaluate the actions and decisions of
economics literature, such as: agents. Monitoring costs include activities
- assumptions of self-interest and wealth such as conducting audits, implementing
maximisation internal controls, hiring external consultants,
or establishing reporting systems to track
PRICE PROTECTION agent performance.
Definition: A mechanism or provision designed to 2. Bonding Costs: Bonding costs refer to
safeguard the interests of shareholders or expenses associated with creating
principals against potential losses that may arise mechanisms or arrangements to align the
due to actions taken by agents or managers. interests of agents with those of principals.
These costs involve implementing incentives,
Example:
contracts, or structures that encourage agents
1. Structuring compensation or incentive to act in ways that benefit the principal.
schemes for managers based on the Examples include performance-based
company's performance or stock price. compensation, stock options, or contractual
agreements that align agent incentives with Debt Hypothesis:
the long-term goals of the principal.
The debt hypothesis focuses on the influence
3. Residual Loss: Residual loss represents of debt contracts on accounting choices. It
the potential loss or decrease in value posits that firms with higher levels of debt are
suffered by the principal despite incurring inclined to use accounting methods that
monitoring and bonding costs. It arises when portray a more stable or favorable financial
agents' actions, despite efforts to align their position to creditors. When firms have
interests, do not fully maximize the principal's significant debt, they might prefer accounting
interests. This loss can occur due to methods that decrease reported volatility in
information asymmetry, unforeseen earnings or assets to reduce the risk of
circumstances, or limitations in the default or breach of debt covenants. As a
effectiveness of control mechanisms. result, managers may opt for conservative
Residual loss reflects the gap between the accounting practices to maintain good
ideal outcome (maximizing principal's wealth) relationships with creditors and to safeguard
and the actual outcome. against potential financial distress.

ROLE OF ACCOUNTING IN CONTRACTS *volatility = kebarangkalian untuk berubah ke

arah yang teruk/the likely to change and
• Accounting information is used to address
becoming worse.
the agency problem and to reduce agency
costs. • The higher the firm’s debt/equity ratio, the
more likely managers use accounting methods
• Accounting is used as a monitoring and
that increase income
bonding mechanism to control the efforts of
self-interested agents (managers). ▪ Also called debt/equity hypothesis

KEY HYPOTHESIS ▪ The higher the debt/equity ratio, the closer the
firm is to the constraints in debt covenants
Bonus Plan Hypothesis:
▪ Covenant violation results in costs of technical
This hypothesis suggests that managers default
have an incentive to manipulate accounting
Political Cost Hypothesis:
numbers to maximize their compensation or
bonuses. Under bonus plans tied to The political cost hypothesis suggests that
accounting performance measures (like firms consider the potential costs associated
meeting specific earnings targets), managers with negative perceptions from governmental
might be motivated to engage in earnings or regulatory bodies when making accounting
management. For instance, they may choices. Managers may use accounting
selectively time certain transactions, defer methods that minimize reported profits or
expenses, or manipulate revenue recognition asset values to lower tax liabilities or to avoid
to meet these targets and secure higher regulatory scrutiny. By presenting a less
bonuses. This hypothesis implies that prosperous financial picture, firms might
managerial compensation structures can reduce their exposure to increased taxes or
influence accounting choices and practices. regulatory interventions. This hypothesis
implies that firms factor in the political
• Managers of firms with bonus plans are more implications of their financial reporting
likely to use accounting methods that increase decisions. *scrutiny = insepection
current period reported income

▪ Also called management compensation • Large firms rather than small firms are more likely to
use accounting choices that reduce reported profits
hypothesis
▪ Size is a proxy variable for political attention
▪ Choose actions that increase the present
value of bonuses paid to management ▪ Reduction of reported income is hypothesised to
reduce the possibility that people will argue that the
organisation is exploiting other parties
 TWO PERSPECTIVES ADOPTED BY PAT Implications: Accounting choices are seen
RESEARCH as reflecting opportunistic behavior where
individuals might select accounting methods
• Efficiency perspective
that serve their own interests rather than
• Opportunistic perspective accurately representing the underlying
economic reality. For example, managers
EFFICIENCY PERSPECTIVE might choose accounting methods that inflate
short-term performance metrics to secure
Focus: This perspective assumes that
bonuses or influence stock prices.
accounting practices are designed to
maximize the efficiency of an organization's • Seeks to explain managers’ actions once
operations. contracts are already in place

Assumptions: It posits that managers, • That is, particular accounting methods might
shareholders, and other stakeholders act initially be selected for efficiency reasons, but
rationally and seek to maximize their own once they have been negotiated/agreed, then
interests within the bounds of legal and managers will aim to utilise accounting choices
regulatory frameworks. in a way that best serves their own interest

• Not possible to write complete contracts, so

Implications: Under this perspective,
managers are assumed to opportunistically act
accounting choices are made to enhance the to maximise own wealth
efficiency of resource allocation. For instance,
managers might employ accounting methods • Known as ex-post perspective
that accurately reflect the economic reality of ▪ Considers opportunistic actions after the fact
transactions, thereby providing information
that aids in efficient decision-making by OWNER/MANAGER CONTRACTING
stakeholders.
• Assuming self-interest, owners expect
• Researchers explain how contracting managers (agent) to undertake activities not
mechanisms minimise agency costs of the firm always in the interest of owners (principal)
• Known as ex-ante perspective • Managers have access to information not
▪ Mechanisms put in place up front to minimise always available to principals
future agency and contracting costs
• Information asymmetry
• Managers select accounting methods which • Further increases managers’ ability to
most efficiently reflect underlying firm undertake activities beneficial to
performance themselves
• PAT theorists argue that regulation forcing firms • Costs of divergent behaviour (as a result of
to use a particular accounting method imposes
conflict of interests) are known as agency
unwarranted costs and introduces inefficiencies
costs
OPPORTUNISTIC PERSPECTIVE • In the absence of controls to reduce
Focus: This perspective assumes that opportunistic behaviour, agents (managers)
individuals within an organization pursue self- are expected to undertake activities
interest and may exploit information disadvantageous to the value of the firm
asymmetry and agency conflicts to serve their • Principals price this into the amounts they
own interests. are prepared to pay the manager
Assumptions: It suggests that managers and • Managers may contract themselves not to
other stakeholders may engage in consume perks so that they will receive higher
opportunistic behaviors, such as earnings salary (This is known as bonding)
management, to manipulate accounting
information for personal gain or to influence
contractual outcomes.
 METHODS OF REWARDING MANAGERS • Contracts relying on accounting numbers
may rely on ‘floating’ GAAP
• Fixed basis—salary independent of
performance
'Floating' Generally Accepted Accounting
▪ Managers may not take great risks and do Principles (GAAP) refers to contracts that
specify the use of whatever accounting
not share in potential gains
principles are generally accepted at the
• Salary plus remuneration is, in part, tied to time of assessment rather than fixed to a
specific accounting standard.
firm performance.

BONUS SCHEMES INCENTIVES TO MANIPULATE

ACCOUNTING NUMBERS
▪ This is known as bonus schemes
• The decision to reward managers on the
• Remuneration can be tied to: basis of accounting profits might initially be
introduced for efficiency reasons (it motivates
• profits of the firm
them to work in a way that also benefits the
• sales of the firm
principals), but it may subsequently induce
• return on assets
them to manipulate accounting numbers (the
• All based on output from the accounting opportunistic perspective)
system
At the outset, rewarding managers based on
• May also be rewarded in line with market accounting profits is often introduced with the
price of the firm’s shares aim of aligning their interests with those of the
organization's owners (principals). This
ACCOUNTING-BASED BONUS PLANS alignment is assumed to encourage managers
to make decisions that enhance the company's
• Any changes in accounting methods will financial performance, boosting efficiency and
affect the bonuses paid maximizing overall benefit for both parties.

Accounting-based bonus plans often tie Over time, the focus on accounting profits as a
bonuses to specific accounting metrics basis for managerial rewards can potentially
or financial performance indicators. If lead to opportunistic behavior. Managers might
there's a change in the accounting feel pressured to manipulate accounting
method used to calculate these metrics, numbers to meet or exceed performance
it can significantly impact the reported targets, thereby securing their bonuses or
numbers. meeting market expectations.
▪ May occur as a result of a new Example: Managers might resort to tactics like
accounting standard applied aggressive revenue recognition, altering
depreciation methods, or deferring expenses to
• Contracts in some circumstances may be inflate short-term profits artificially. These
based on the old method in place so changes actions might not necessarily reflect the true
will not affect bonuses economic health of the company but are aimed
at meeting the bonus criteria.
In certain cases, employment contracts or
bonus agreements might specify a ▪ A change in accounting numbers will affect
particular accounting method or financial their rewards
metric for bonus calculations. If these
contracts are based on the old method, • Bonuses based on profits cause short-term
changes in accounting methods won't rather than long-term focus
impact the bonuses until the contract
▪ May affect investment in positive NPV
terms are renegotiated or updated.
projects if returns not expected to be
consistent

▪ TO BE DISCUSSED FURTHER IN TOPIC 5

CREATIVE ACCOUNTING
 CRITICISMS OF PAT

• Does not provide prescription

PAT primarily focuses on explaining and

predicting accounting practices based on
assumptions about human behavior and
incentives. However, it's criticized for not
offering normative guidelines or
recommendations about what accounting
practices should be. It explains behavior
without necessarily suggesting what
actions should be taken or what practices
should be followed.

• PAT is not value free as it asserts

assumption that all actions are driven by self
interest

PAT assumes that managers always seek to

maximize their own utility or wealth,
disregarding other potential motivations
like ethical considerations or societal
welfare that might also influence decision-
making.

• Argued to be too negative and simplistic

perspective of humankind

• Issues have not shown great development

Some critics argue that PAT hasn't evolved

significantly to address emerging issues or
incorporate a broader understanding of
organizational behavior. It's accused of
lacking adaptation to changing contexts,
technologies, or socio-economic
landscapes.

• In undertaking large-scale empirical

research, researchers ignore organisational-
specific relationships

Without taking into consideration the

subtleties or distinctive features of various
businesses, PAT may generalize actions or
decision-making patterns across industries,
potentially leading to oversights or
misinterpretations in its predictions or
explanations.
STATUTORY REGULATIONS ON FINANCIAL ACCOUNTING AND InsBtuBon ContribuBon phase
REPORTING. The crea/on & the increasing role of ins/tu/ons on the
1. The Financial Repor/ng Act 1997 - Deals with development of accoun/ng principles
compliance with approved accoun/ng standards of In US the development includes:
the MASB. a) The establishment profession a standard-seong of the
2. The Income Tax Act - Mainly concerned with SecuriBes Exchange Commission (SEC) in 1934 to regulate
ascertaining of chargeable income and tax payable. the trading of securi/es develop accoun/ng principles.
3. The Companies Act 2016 – Compliance with approved b) The approval by the American InsBtute of Accountants
accoun/ng standards and with other laws or (AIA) of 6 rules:
authori/es. 1. Income a/c should not include unrealized profit.
4. Securi/es Commission Act 1993 – To regulate all 2. Capital surplus (addi/onal paid-in capital) should not be
maiers rela/ng to the capital market. charged with the amounts chargeable ordinarily to
5. The Audit Oversight Board - to assist Securi/es income.
Commission in overseeing the auditors of public 3. Retained earnings of subsidiary co. before the
interest en//es and to protect the interest of acquisi/on was not part of consolidated earned surplus
investors by promo/ng confidence in the quality and of the parent.
reliability of audited financial statements of public 4. Dividend on treasury stock may not be credited to
interest en//es. company's income.
6. Bursa Malaysia - Does not have legal power to enforce 5. Amount receivable from officers, employees and
compliance but has power to delist, suspend or affiliated companies should be shown separately.
publicly reprimand errant listed companies for any c) The new role of the CommiZee on AccounBng
non-compliance with its regula/ons. Procedures (CAP): (research)
7. Bank Negara Malaysia - a) Engage in accoun/ng research.
b) Issue accoun/ng pronouncements.
DEVELOPMENT OF ACCOUNTING CONCEPTS AND PRINCIPLES. c) Eliminate ques/onable accoun/ng prac/ces focus on
1. Management Contribu/on Phase (1900-1933) repor/ng problem.
2. Ins/tu/on Contribu/on Phase (1933 – 1959)
3. Professional Contribu/on Phase (1959 – 1973) PROFESSIONAL CONTRIBUTION PHASE
4. Overt Poli/ciza/on Phase (1973 – Present) Dissa/sfac/on with the Commiiee on Accoun/ng Procedure
(CAP) was expressed by the president of the AICPA.
Management ContribuBon Phase (normaBve period) “How successful we have been in narrowing areas of
- Management had complete control over the selec/on of difference and inconsistency in the prepara/on & presenta/on
financial informa/on. of financial informa/on."
- Disclosed in annual reports. - A Special Commiiee on Research Program was set up and
- Impact: gave management complete control over the proposed the dissolu/on of the CAP and its research
format or content of accoun/ng disclosure department.
- The AICPA accepted the recommenda/ons of the
There are 5 consequences of the dependence on management Commiiee and established the Accoun/ng Principles
ini/a/ve: Board (APB) and the Accoun/ng Research Division (ARD)
1. Prac/ces lacked theore/cal support.
2. The focus was on the determina/on of taxable income Cri/cized and dissa/sfac/on?
and minimiza/on of income. + interest cost - no established theore/cal framework,
3. There was a desire to smooth earnings -the act of using - no authority on statement issued and
accoun/ng methods to level out fluctua/ons in net - the flexibility of alterna/ve accoun/ng treatments.
income from different repor/ng periods. - Abuses of annual repor/ng were also noted in this phase.
4. They avoided complex problems and adopted expedient (no regula/ons)
(prac/cal) solu/ons.
5. There were no consistency as different firms adopted OVERT (OPEN) POLITICIZATION PHASE
different accoun/ng techniques for the same problem. - Adop/on of a more deducBve approach (normaBve
theory) as well as an ever-increasing poli/ciza/on of the
Some of the issues debated: standard-seong process.
1. Improvement un standards of financial repor/ng - Generally accepted view: accoun/ng numbers affect
2. Protec/on of investors economic behavior and, consequently. accoun/ng rules
3. Agree to publish annual financial statements. should be established in the poli/cal arena.
4. Ques/on of accoun/ng for interest cost - The FASB's and IASB's conduct are to develop a theore/cal
5. Calcula/on of taxable income based on cash receipts and framework and the general acceptance of new standards.
disbursements.
- A deduc/ve approach is concerned with developing a The Importance of AccounBng History.
hypothesis (or hypotheses) based on exis/ng theory, and 1. Accoun/ng Pedagogy
then designing a research strategy to test the hypothesis. - to a beier understanding and apprecia/on of the field of
- The process of formula/ng accoun/ng standards is accoun/ng and its evolu/on as a social science.
becoming poli/cal, for instance, - Access to analyses and interpreta/ons of historical
- The US Senate Subcommiiee released a report en/tled development in accoun/ng thoughts and prac/ces allows
The Accoun/ng Establishment. Known as the Metcalf development of current and future research.
Report, it charged that the United States' 'big eight' 2. Accoun/ng policy.
accoun/ng firms’ monopolies the audi/ng of large to a beier understanding of the accoun/ng problems and
corpora/ons and control the standard-seong process. their ins/tu/onal contexts as well as the formula/on of public.
- The passing of the Sarbanes-Oxley Act in 2002, also known
as the Public Company Accoun/ng Reform and Investor 3. Accoun/ng prac/ce.
Protec/on Act of 2002, Sarbox, or SOX. (to protect provide a beier assessment of the exis/ng prac/ces by a
investor, globally) comparison with the methods used in the past.
- *MCCG – protect Malaysian investor
Relevance of accounBng history
Recent Development in AccounBng Theory - Accoun/ng has a history which is usually discussed in
- Academic and professional developments in accoun/ng terms of one seminal (important) event, the inven/on and
theory have tended to take different approaches. dissemina/on of the double-entry bookkeeping processes.
- Academic research focuses on capital markets, agency - The historical evolu/on of accoun/ng provides clues and
theory and behavioral aspects. explana/ons of double-entry bookkeeping and the
- The profession has sought a more norma/ve approach- development of modern accoun/ng.
what accoun/ng prac/ces should be adopted? - The history of accoun/ng allows us to relate the past to
- Norma/ve theory approach is a theory that is not based what is prac/ced and to what ought to be prac/ced.
on observa/on. It is based on how things in the - It helps us to make a link between the historical state and
accoun/ng process should be done. both posi/ve and norma/ve states.
- The link supports the view within the full context of social,
The Conceptual Framework poli/cal, economic, and temporal environments.
- Conceptual framework-resurrected (revived) in 1980s.
- States the nature and purpose of financial repor/ng. LimitaBons of AccounBng History
- Establishes criteria for deciding between alterna/ve - Historical inquiry could either be narra/ve or
accoun/ngs prac/ces. interpreta/ve and is condi/onal and not defini/ve.
- Statement of Accoun/ng Concepts (SACs) 1-4 - It may be incomplete.
- Conceptual framework-Recent Developments - History may not reveal cause of an event as a certainty but
- Joint project between IASB & FASB can indicate probable factors affec/ng the event.
- Interna/onal harmoniza/on of accoun/ng prac/ces - Historians 'explana/on and causal analysis' begin with
through a single consistent set of interna/onal financial searches for paierns of development.
repor/ng standards (IFRS) - Aiempts to proceed from determina/on (what
- The conceptual framework underpinning the IFRS favors a happened) to a con/ngency (how it happened) basis-
move toward: judgmental process constrained by /me.
a) accoun/ng prac/ces that provide informa/on for
enhancing decision making by investors and others
b) recognizing all gains and losses in the accoun/ng periods
in which they occur
c) measurement using exit value.
 CHAP3: REGULATORY APPROACH OF AN 1. Accoun ng-based management
ACCOUNTING THEORY bonus schemes
2. Accoun ng-based debt covenants
What is Regula on?
Private economic-based incen ves are based
Defini on:
on the idea that individuals and firms will
 A rule of order, as for conduct, prescribed by make choices that maximize their own
authority: a governing direc on or law economic self-interest.
 designed to control or govern conduct
 Organiza on not producing informa on
Against regula on: FREE MARKET @ E.M @ will be penalised by higher cost of capital.
PRIVATE ECO.BASED (People avoid inves ng in the company
that lack of informa on)
Pro/Support regula on:  Organisa ons to determine what
 PUBLIC INTEREST THEORY, informa on should be produced depends
 CAPTURE THEORY, on par es involved and assets in place
 ECONOMIC INTEREST GROUP THEORY (PRIVATE  Imposing regula ons will restrict the
INTEREST THEORY) available set of accoun ng methods,
hence decreases efficiency of contrac ng
FREE MARKET PERSPECTIVE (Against) (Too many rules will affect the company to
generate profit)
Reason:
 Also, assumed that audi ng will take place
• We do not need all the regula ons we in the absence of regula on—reduces risk
currently have to external stakeholders which allows
• Accoun ng informa on should be treated like organisa ons to a ract funds at a lower
other goods, with demand and supply forces cost
allowed to operate to generate an op mal  Agency theory can fulfil the absence of
supply regula ons!!
Arguments Suppor ng Free-market Perspec ve Problems in Presence of Many Different
Par es (Bank, Supplier, Gov)
1. Private economic-based incen ves
• The contrac ng argument might be good
2. Market for managers
in principle but tends to have problems in
Manager will do
3. Market for corporate takeovers the presence of many owners or
their best so no
debtholders
4. Market for lemons need guideline.
• May be too many par es for contrac ng
1.Private Economic-based Incen ves to be feasible
• Prohibi ve cost of nego a on if different
• Assumed that managers will operate the business investors want different informa on
for their own benefit, and this will always be • Costly to nego ate single contract with all
expected by shareholders and debtholders investors as they need to agree on
 So, if managers’ self-interested behaviour is not informa on provided
controlled, then they will be paid a lower salary. • Is it realis c that every party will assume
Therefore, it is in the interests of management to every other party is driven by self-
enter into contracts with shareholders and interest?
debtholders to constrain their ac ons

 Contracts o en based on TWO (2) accoun ng

informa on
 2. Market for Managers 4. Market for lemons

Argument: Argument:

• In the absence of regula on, manager will s ll  No informa on is viewed in the same light
do the right thing because of the ‘market for as bad informa on.
managers’  Market may make the assessment that
silence implies the organisa on has bad
• Managers’ previous performance impacts on
news to disclose.
remunera on they can command in future
 Therefore, managers are mo vated to
• In the absence of regula on, it is assumed disclose both good and bad news
managers will be encouraged to adopt strategies  Evidence that both good and bad news are
to maximise value of firm (provides favourable disclosed voluntarily (Skinner, 1994).
view of own performance and includes providing  Assumes the market knows that managers
op mal amount of accoun ng informa on have news to disclose
 May not always be a realis c assump on,
• If regula ons exist, managers cannot make
for example, consider high profile cases like
strategies!
Enron
Assump ons Underlying ‘Market for Managers’
If knowledge of non-disclosure becomes
Argument
available later, market expected to react at that
• Managerial labour market operates efficiently stage.
(there is no corrup on in managers)
Pro-regula on Perspec ve
• Informa on about past performance is known by
Free market approach will not be able to achieve
prospec ve employers and will be impounded in
a socially ideal equilibrium price for accoun ng
future salaries (salary will be increase, if
informa on.
manager’s performance is good)
• Accoun ng informa on is a public or ‘free’
• Capital market is efficient (no corrup on)
good
• Effec ve managerial strategies are reflected in • It should not be treated the same as other
posi ve share price movements ‘goods’
• In the presence of free rider, true demand is
 However, problems arise if the manager is
understated
approaching re rement
*Pricing system does not func on properly
3. ‘Market for Corporate Takeovers’
since not all users can be charged for the
Argument: informa on, suppliers will have li le incen ve
to provide it. Thus, regulatory interven on can
• Underperforming organiza ons will be taken persuade companies to produce necessary
over by another en ty with the exis ng of the informa on to meet real demand and ensure
management team subsequently replaced an efficient capital market.
• Therefore, managers are mo vated to
maximise firm value. Results in insufficient informa on produc on
• Informa on produced to minimise cost of - When a company monopolizes informa on
capital, thereby increasing firm value. about itself, it tends to produce less and sell at
• Assumes managers know marginal cost and a higher price. Mandatory reporting will
marginal benefit of informa on. result in more information at a lower cost

Underperform company will be taken over

by another company, hence mo vate
managers to do be er.
 • Regula on necessary to reduce impacts
of market failure
THEORIES THAT SUPPORT REGULATION (PRO)
Should Supply of ‘Free’ Goods be Regulated?
Gov has no interest
• Some people argue that free goods are o en @ act neutral
Public Interest Theory (Gov)
overproduced as a result of regula on
• The public, knowing they do not have to pay, • Regula on is put in place to benefit society
will overstate their need for the good or as a whole rather than vested interests
service. E.g., investment analysts • Regulatory bodies/poli cians (government)
• Could lead to ‘accoun ng standards overload’ are considered to represent the interests of
the society in which they operate, rather
Role of Adam Smith’s ‘Invisible Hand’ than the private interests of the
the Invisible Hand represents the idea that by regulators/poli cians.
pursuing their own self-interest, individuals and • The enactment of regula on is a balancing
firms can contribute to the overall well-being of act between the perceived social benefits
society without even realizing it. ‘Invisible hand’ and the perceived social costs of the
no on used as argument in favor of free market. regula on
• Without regulatory involvement, as if by an • Assumes that government is a neutral
invisible hand, produc ve resources will find arbiter/3rd party
their way to most produc ve uses
• Some (for example, Milton Friedman) went to Examples of Public Interest Theory
argue that leaving ac vi es to the control of 1. Securi es Commission Malaysia (SC): The SC
market mechanisms will actually protect was established to regulate the capital markets
market par cipants in Malaysia and promote the development of a
• to describe the self-regula ng nature of a free fair and efficient securi es market in the public
market economy. The term "invisible hand" is interest.
meant to convey the idea that there is an
unseen force or mechanism that guides 2. Malaysian Ins tute of Accountants (MIA): The
individual ac ons and choices in the market, MIA was established to regulate and develop
without the need for centralized direc on or the accountancy profession in Malaysia in the
control. public interest. It sets accoun ng and audi ng
• Assump on - The free-market argument standards and oversees the conduct of
ignores market failures and uneven professional accountants to ensure that they
distribu on of power meet ethical and professional standards.
• Smith was concerned where monopolis c 3. Accoun ng regula on: Public interest theory
powers were created by government suggests that accoun ng regula on is needed
interven on to protect the public interest by ensuring that
• But Smith advocated regulatory interven on financial informa on is accurate and reliable.
in some instances For example, in Malaysia, the Audi ng
• Where in the public interest to protect the Oversight Board was established to regulate
more vulnerable and oversee the audi ng profession in the
*Smith himself acknowledged that some degree of public interest.
regula on is necessary to ensure a fair and
efficient market.
 Company wants to survive in
which they influence gov for
their own interest.
Capture Theory (Company) - control gov • No reason why regulated industries only able
to capture exis ng agencies rather than
• The regulated party or industry will seek to take
procure the crea on of an agency
charge of CAPTURE the regulator.
• No reason why regulated industry could not
• Once the regulator is ‘captured’, the industry
prevent crea on of the regulatory agency
representa ves will seek to ensure that the rules
subsequently released are advantageous to the
par es subject to regula on
Economic Interest Group Theory @ Private
• Although regula ng ini ally in the public
interest Theory (PVIT)
interest, difficult for regulator to remain
independent • The economic interest group theory of
• Companies with large amounts of money will regula on assumes that every group will form
influence government regulators so they can to protect par cular interest
con nue their business prac ces without being • Groups are o en in conflict with each other and
held accountable for poten al harm done to will lobby government to put in place
consumers or society as a whole legisla on which will benefit them at the
expense of others
Examples of Capture Theory
• No no on of public interest inherent in the
The banking industry theory
• Regulators/poli cians are assumed to have
• The banking industry in Malaysia is both heavily
self-interest.
regulated and closely connected to government
• The regulator is not a neutral arbiter but is seen
officials. They argue that this allows the industry
as an interest group itself /Gov has its own
to have too much influence on regulatory
interest
decisions, leading to weaker oversight and more
• The regulator is mo vated to ensure re-
risk-taking.
elec on or maintenance of its posi on of
The telecommunica ons industry power
• Regula on serves the private interests of
• The telecommunica ons industry in Malaysia poli cally effec ve groups
has also been accused of regulatory capture, • Those groups with insufficient power will not
with cri cs arguing that regulators have been too be able to effec vely lobby for regula on to
easy-going on companies, resul ng in poor protect their own interests
service quality and high prices for consumers.
Examples of Private interest theory
The palm oil industry
*Consumer might lobby government for price
• The palm oil industry in Malaysia has been protec on or regulated firms lobby for tariff
accused of exer ng undue influence over protec on
regulatory decisions, par cularly with regards to
environmental regula ons. Cri cs argue that this Crony capitalism
has led to a situa on where the industry is able
A phenomenon where businesses benefit from
to engage in environmentally damaging prac ces
close rela onships with poli cians and
with li le consequence.
government officials, o en at the expense of the
Cri cisms of Capture Theory public interest. In Malaysia, there have been
allega ons of crony capitalism in the awarding of
• No reason to suggest that regulated industry government contracts and the alloca on of
the only interest group able to influence the licenses for various industries.
regulator
 Poli cal financing • Ethical and professional behavior of
individuals and organiza ons in the industry.
Private interest theory suggests that businesses
and wealthy individuals may donate to poli cal Regulatory Capture Theory:
par es in exchange for favors or preferen al
• Independent oversight and monitoring of
treatment. In Malaysia, there have been concerns
regulatory agencies to prevent capture.
about the influence of poli cal dona ons on
• Strict enforcement of conflict-of-interest rules
government policies and decision-making.
and regula ons.
Corrup on • Transparency and disclosure of all interac ons
between regulators and industry stakeholders.
Private interest theory suggests that individuals
• Strong and vocal civil society groups and media
may engage in corrupt ac vi es to benefit
to hold regulators accountable.
themselves or their private interests. Malaysia has
been rocked by several high-profile corrup on Private Interest Theory
scandals in recent years, including the 1MDB
• Effec ve regulatory oversight that balances the
scandal, which involved the alleged
interests of all stakeholders, including
misappropria on of billions of dollars from a state
consumers and the public.
investment fund.
• Compe on and market forces that incen vize
Examples of Applica on to Accoun ng Standard- companies to act in the best interests of
se ng (Impact) consumers and the public.
• Effec ve an -monopoly and an -trust laws
• The release of new or revised accoun ng
that prevent market domina on and abuse of
standards have real economic and social
market power.
consequences. For example, consider how the
• Transparency and accountability in the
adop on of AASB 138 Intangibles might have
regulatory process, including clear and
created real economic impacts within Australia or
objec ve standards that are based on empirical
consider the new accoun ng standard for leasing
evidence and public input.
that is being developed
• Industry groups may lobby to accept or reject a Accoun ng Regula on as an Output of a Poli cal
par cular accoun ng standard. E.g., European Process (every group take part to discuss rules and
Banks in rela on to IASB 39 regula ons)
• Large poli cally sensi ve firms found to lobby in
• The view that financial accoun ng should be
favour of general price level accoun ng in the US
objec ve, neutral and apoli cal can be
(led to reduced profits)
challenged
• Accoun ng firms lobbying to protect their own
• Will inevitably be poli cal as it affects wealth
interests
distribu on within society
Mi ga ng factors (reduce nega ve impact) • Standard-se ers encourage affected par es to
make submissions on dra s of proposed
Public Interest Theory:
standards
• Strong and independent regulatory bodies with • If standard-se ers give considera on to views
adequate resources and authority to enforce in submissions, accoun ng standards, and
regula ons in the public interest. therefore financial reports are the result of
• Transparency and accountability in the regulatory various social and environmental
process, including public consulta on and considera ons
stakeholder engagement. • Tied to the values, norms and expecta ons of
• Clear and objec ve standards that are based on the society in which standards are developed
empirical evidence and public input.
• Ques onable whether financial accoun ng can 7. Bank Negara Malaysia
claim to be neutral and objec ve
• Compliance with accoun ng standards is usually
seen to indicate financial statements are ‘true Financial Repor ng Act 1997
and fair’
• Can or should financial statements that have • Financial Repor ng Founda on (FRF) is
been prepared on the basis of accoun ng established under the Financial Repor ng Act
standards (with such standards having been 1997
developed a er taking into account various • FRF – A trustee body has responsibility for the
economic and social consequences) be oversight of MASB’s performance, financial,
deemed to be ‘true and fair’? fund arrangements
• Users may not be aware that financial reports are • FRF as an ini al source of views for the MASB on
the outcome of various poli cal pressures proposed standards and pronouncements
• Should regulators consider preparers’ views • Sec on 27 of FRA 1997 – stated that all
given that standards are designed to limit what companies incorporated under CA 1965 will
preparers do? need to comply with MASB approved
• It’s important for regulators to consider the accoun ng standards
views of preparers during the standard-se ng • Under FRA 1997, MASB approved accoun ng
process. This is because preparers are the ones standards have force of law on the statutory
who will be responsible for implemen ng and duty of directors and management of repor ng
complying with the standards, and their input companies and other business, industrial or
can provide valuable insights into the prac cal commercial enterprises to ensure financial
implica ons of the standards. statements of their respec ve companies or
• Preparers can provide feedback on the poten al enterprises comply with MASB approved
costs and benefits of specific accoun ng accoun ng standards
standards, as well as on any challenges or
difficul es they may encounter in implemen ng Func ons/Responsibility of Financial Repor ng
them. By considering preparers' views, Founda on (FRF)
regulators can be er understand the real-world
impact of the standards they are developing and • To provide its view to the MASB on any ma ers
can work to ensure that the standards are which the MASB seeks to undertake or
effec ve, feasible, and prac cal. implement with respect to the development
and issue of accoun ng standards and
PART 2: REGULATORY BODIES AND ITS FUNCTION conceptual framework
Malaysia’s Financial Repor ng Regime for listed • To review the performance of the MASB
companies to comply: • To be responsible for the financing
arrangements and opera ons of the MASB
1. Financial Repor ng Act 1997
• To approve the MASB budget
2. Financial Repor ng (Amendment) Act 2004
• To engage or to employ persons and determine
3. Companies Act 2016
4. Income Tax Act 1967 the condi ons of such appointment as
5. Guidelines of the Securi es Commission necessary to assist the FRF and MASB perform
1995 (Corporate disclosure, Post-lis ng their func ons under the FRA 1997
obliga ons & Accoun ng standards and • To administer the fund established to finance
valua on/revalua on of assets) the ongoing opera ons of FRF and MASB
6. Bursa Malaysia Lis ng Requirements including management of funds not expanded
(Submission of reports & Addi onal on opera ons during the period
disclosures)
• To maintain proper accounts and prepare an annual Security Commission (SC)
statement of accounts of the FRF
• Set up under the Securi es Commission Act 1993 to
• To appoint an auditor to audit the annual statement
protect investor.
of accounts
• Func on: To promote strong and healthy securi es
• To forward the annual statement of accounts and
market and to maintain confidence of investors in
audit report to the Minister of Finance, and report
line with provisions of the Securi es Act 1993 and
on ac vi es of the FRF and MASB at the end of
Securi es Industries Act 1983
each financial year
• Is a self-funding statutory body with inves ga ve
• To perform such other func ons as the Minister of
and enforcement powers
Finance may prescribe
• Reports to Ministry of Finance and accounts tabled
in Parliament annually
Companies Commission of Malaysia
• Also enforces Capital Markets and Services Act 2007
• Member of Interna onal Organiza on of Securi es
• Established to combine the roles of the previous
Commission (IOSCO)
Registrar of Companies (ROC) and Registrar of
• A public company has obliga on to fully disclose to
Business (ROB).
public informa on necessary to make informed
• Purpose: Make sure that the rules and laws are
investment decisions
followed and enforced properly.
• If listed, it must immediately release informa on
• Companies Act 1965 Sec on 169(4):
which are expected to have material effect on
Every company under this Act must have its profit &
market ac vity in, and prices of, its listed securi es
loss (P/L) and balance sheet (B/S) audited before
• Appropriate ac ons shall be taken against the
showing them at the Annual General Mee ng-AGM.
improper use of price-sensi ve informa on
• Compliance with Accoun ng Standards:
Companies must follow approved accoun ng Regulatory Outcomes
standards when preparing their accounts.
• Supported by two pillars: Propor onality and
• Collabora on with Accoun ng Profession & MASB
Transparency
Working together with the accoun ng profession &
MASB to find and address issues affec ng the financial Propor onality
and repor ng environment. • To achieve a balanced, efficient and effec ve
regulatory environment
• The degree to which SC regulates markets, products,
services, market par cipants and ac vi es should be
commensurate with risks posed, standards of conduct
prac ced and outcomes they are seeking to achieve

Transparency

1. Supports accountability to public and stakeholders,

and help to design propor onate regula ons
2. Disclose relevant informa on and not disclose those
may harm public interest
3. Prac ce an open-door policy in receiving feedback
 Audi ng Oversight Board (Supervising audit firm) • For instance, AOB has acknowledged auditors from
countries like the United States, United Kingdom,
• AOB is created as per Part IIIA of the Securi es
Australia, and Singapore. These foreign auditors can
Commission Act 1993, which was added through
audit companies listed on the Malaysian stock
the Securi es Commission Amendment Act 2010.
exchange as long as they follow the rules and
This amendment came into effect on April 1, 2010.
regula ons set by the AOB.
• The AOB's main goal is to support the Securi es
Commission (SC) in overseeing auditors of public
AOB - Inspec on
interest en es.
• According to Sec on 31E(1)(d) of the Securi es
• It aims to safeguard the interests of investors by
Commission Act 1993, one of AOB's main du es is to
enhancing confidence in the quality and reliability
inspect and monitor auditors to check how well they
of FS audited for public interest en es.
follow audi ng and ethical standards.
• In fulfilling these responsibili es, AOB can inspect a
Mission:
‘Fostering high quality independent audi ng on public interest en es' (PIEs) audit firm through a
financial statements of public-interest en es and regular or special inspec on program.
schedule funds in Malaysia” • Whether it's a regular or special program, AOB
The AOB will achieve this by monitor ac vi es like: inspec ons can happen at the overall firm level, the
 Registra on specific engagement level, or both.
 Recogni on • A firm review looks into an audit firm's quality
 Inspec on control systems and prac ces, assessing how well
 Enforcement they meet the requirements of the Interna onal
 Revoca on and Suspension of Registra on Standards of Quality Control 1 ("ISQC 1").
• An engagement review aims to evaluate how well an
AOB - Resgistra on auditor complies with audi ng and ethical standards
during a specific audit engagement.
• The AOB is responsible for the registra on of auditor
of public interest en es or schedule funds under Part AOB - Enforcement
IIIA of the Securi es Commission Malaysia Act 1993.
• The AOB follows a strategic enforcement approach
The public interest en es and schedule funds are
based on principles of propor onality, efficiency, and
defined in Schedule 1 of the Act
achieving the desired outcomes.
• Registering auditors for public interest en es or
• When deciding on sanc ons/sekatan (threatened
scheduled funds ensures that only competent and
penal es for rule viola ons), the AOB considers the
suitable auditors are engaged in audi ng the FS of
nature and seriousness of the offenses, the
these en es.
individual's regulatory history, and other factors that
• This aligns with one of AOB's strategic themes in its
make the situa on be er or worse.
strategic framework, which aims to encourage
• They also assess the impact on the profession's
high-quality audit prac ces.
integrity, the overall capital market, and the
confidence in audited financial statements of the
Recogni on of AOB
involved public interest en ty (PIE).
• AOB's enforcement focuses on ensuring auditors
• The Securi es Commission Malaysia Act 1993, through
adhere to recognized audi ng and ethical standards.
Part IIIA, sets up a system that allows the AOB to
Such ac on does not necessarily mean the audited
acknowledge foreign auditors responsible for audi ng
financial statement is inaccurate.
the financial statements of foreign companies listed
• Possible sanc ons, as outlined in the Act, include:
on Bursa Malaysia.
• Reprimand (teguran); • MASB with FRF make up framework for
financial repor ng in Malaysia
• Requiring professional educa on to be undertaken

• Assigning a reviewer to oversee an audit that is The aims of the MASB

undertaken by the auditor concerned
 To implement an efficient, effec ve structure
• Financial penalty of not exceeding RM500,000 and ‘due process’ for the development of
MASB standards, a conceptual framework and
• Prohibit the person concerned from accep ng any other forms of authorita ve guidance
public interest en ty or schedule fund as its clients or
 To purse the development of MASB standards,
preparing reports in rela on to financial informa on of
a conceptual framework and other
any public interest en ty or schedule fund, as may be authorita ve guidance on a basis that
required under the securi es laws or guidelines issued recognizes that users of financial statements
by the Commission, for a period not exceeding twelve are the primary customers, so that those users
months; and are be er able to make economic decisions
• Prohibit the person concerned from audi ng financial
 Composi on of the Board – The members are
statements or preparing reports in rela on to financial
appointed by the Minister of Finance as
informa on of a public interest en ty or schedule fund, as
follows:
may be required under the securi es laws or guidelines
issued by the Commission, for a period not exceeding • A Chairman
twelve months or permanently. • The accountant -General
• Six other members who possess
Background of Malaysian Accoun ng Standard Board knowledge and experience in ma ers of
(MASB) financial accoun ng and repor ng and in
one or more of the following fields –
accountancy, law, business and finance.
At least five of these members should be
members of the MIA
• Three advisors represen ng the Bank
Negara Malaysia, the Securi es
Commission Malaysia and the Registrar of
Companies

Issues Commi ee:

• In May 2002, MASB formed the Issues

Commi ee to take over from the Interpreta on
Commi ee.
• Financial Repor ng Act 1997 establishes Financial • The change reflects the broader role of the
Repor ng Founda on (FRF) & Malaysian Accoun ng commi ee, which not only addresses
Standards Board (MASB) interpreta ons of approved standards but also
handles other accoun ng issues where there
• Main func ons of FRF are to provide financing
are no exis ng standards.
arrangements for MASB’s opera ons and to review
• It reviews accoun ng ma ers with differing
its performance
interpreta ons and provides recommenda ons
• MASB as an independent authority to develop and to the Board for decisions.
issue accoun ng and financial repor ng standards in • The commi ee currently comprises (3)
Malaysia representa ves from the Big Four, (1)
 medium prac ce, (1) corporate sector, (1) MASB’s Other Roles
academic analyst, and
1. Approved accoun ng standards especially from
(1) solicitor-legal representa ve
the Interna onal Accoun ng Standards Board
Due Process in the Issuance of MASB Standards 2. Other technical pronouncements/guideline such
as Statements of Principles, Urgent Issues
Abstracts and Technical Releases which are
developed with due regard to both local and
interna onal treatments. The purpose of
technical pronouncement is to provide guidance
on the applica on of GAAP to the resolu on of a
par cular accoun ng issue
3. Development of Islamic Accoun ng Framework
4. Par cipa on in interna onal standard-se ng
process
5. Movement towards accoun ng standards
convergence

The Issue of Accoun ng Standards Overload

MASB’s Working Group • Standards overload = amount of informa on
required to be supplied by repor ng en ty >
1. Appointed by MASB to debate the issues
amount reasonably required by users in making
2. Chaired by a member of the MASB economic decision
• Situa on been iden fied with accoun ng
3. Comprises a project manager
standards overload:
• Representa ves from/amongst: • Too many standards
• Too detailed standards
 Industry
• No rigid standards, making selec vity of
 Auditors applica on difficult
• General purpose standards failing to provide for
 Regulatory bodies
differences in the needs of preparers, users and
 Academia CPAs
• General-purpose standards failing to provide for
Exposure Dra
differences between:
• Dra of exposure dra s are prepared by MASB • Public and non-public en es
WGs and refined through discussion • Annual and interim F/S
• Large and small enterprises
• The dra document is presented to the MASB for • Audited and non-audited F/S
4review and then to the FRF for comment-14 days
Several factors have contributed to the issue of
• The dra pronouncement is then published as an standards overload:
exposure dra by MASB, which invites comment
from all interested par es, usually over a • Accountants started issuing a higher volume of
certain period standards with the aim of minimizing judgment and
decreasing li ga on related to accoun ng
principles. This approach is in response to
 numerous queries about what informa on to
disclose.
• To protect the public interest and to assist the
individual investors generated various &
numerous governmental & professional
regula ons and disclosures
• To sa sfy the needs of many users, required
more detailed standards and disclosures

Effects of Accoun ng Standards Overload

1. Accountants may lose sight of real jobs because of
the excessive data required when complying
with exis ng standards
2. Audit failures may occur when compliance is
the focus rather than basic audit procedures
3. Implica ons for legal liability, erosion of
professional ethics, loss of public support
and dissonance within the accoun ng profession

Solving the Standards Overload problems

• Not all standards are relevant to everyone, like IFRS 6 for

or property development @ FRS 204 for accoun ng in
Aquaculture.
• Small and medium-sized enterprises (SMEs), lacking
public accountability, have separate accoun ng
standards developed by the IASB in 2009.
• Considera ons of cost benefit are taken into account.
• The op mal informa on for one user may not be
suitable for another.
• Therefore, the Board must try to cater to many
different users while considering the burdens placed
on those who have to provide informa on,
constantly treads a fine line between requiring
disclosure of too much informa on or requiring too
li le.
CHAPTER 4: DISCUSSION ON CONCEPTUAL 1989
FRAMEWORK IASC issued Framework for the Preparation
and Presentation of financial Statement
Part 1 (A) Development, theories & accounting
postulates
2001-CURRENT
❖ Accounting conceptual framework: - IASB replaced IASC and adopt framework (for
A set of rules and guidelines for recording guide IASB in develop acc. standard and
resolve issues.
financial transactions and reporting financial
activities.
❖ Developing conceptual framework: -
❖ Development of a Conceptual Framework
for Financial Reporting: -
1. Principle-based v rules-based approaches
1959-1969
AICPA reorganized and established APB and IFRS (worldwide) GAAP (US based)
ARD. Objective: IASB mostly produce FASB traditionally
1. set up basic accounting postulates consistent principle rule based. increase
2. establish set of broad principle based standard comparability &
3. formulate rules (guide principle to verifiability. reduce
real situation) earning management
4. base entire program on research

2. Information for Decision Making and the

1970-1972 Decision-Theory Approach
Creation of US accounting profession’s first Accounting data essential purposes:
conceptual framework.
- Decision-making
- Accountability
1973-1986
APB replaced by FASB (board independent of For decision-making, accounting
accounting profession). Objective: information is considered input for users'
1. develop new conceptual framework prediction models. This focusing on both
for FR past achievements (stewardship) and future
projections.
1987-2000 i. External users rely on historical events
FASB issue 7 concept statement: for assessing stewardship
1. The objective of general-purpose ii. Decision-making involves anticipating
financial reporting. future outcomes.
2. Qualitative characteristics of useful
Question arise when decision making: is
financial information.
3. Financial statements and the historical cost or current value more relevant?
reporting entity. ❖ Debates (agree & against CF)
4. The elements of financial statements.
5. Recognition and derecognition.
Agree for CF
6. Measurement.
1. Technical benefit (provide guidance
7. Presentation and disclosure.
& answer for acc. problems)
8. Concepts of capital and capital
2. Political benefit (reduce political
maintenance (additional)
interference)
3. Professional benefit (professional
status of accountant maintained)
 Against CF
1. Framework does not work in practice (too subjective, inconsistent)
2. Framework too descriptive (potentially influence by politics and accountant self-interest)
3. Risk of mechanical decision (one size fit all, ignoring specific consideration)

❖ Formulating the Objective of Accounting - Conflict of Interests

1. Firms interacting
2. Users
for FS
3. Accounting profession
fundamental
principle that
❖ The Accounting Postulates forms basis
acc. practices
1. The entity postulates
- Treating business as separate entity from owner.

2. The going-concern postulate

- Assume that business will continue its operation.

3. The unit-of-measure postulate

- Measure in monetary term.

4. The accounting period postulate

- FS show changes in firm wealth disclosed periodically.

❖ The theoretical concept

1. The proprietary theory
- The entity is the ‘agent, representative, or arrangement through which the individual
entrepreneurs (proprietaries) or shareholders operate.

2. The entity theory

- The entity as something separate and distinct from those who provide capital to the
entity.

3. The fund theory

- The basis of accounting is neither the proprietor nor the entity, but a group of assets and
related obligations and restrictions called a ‘fund’.
Part 1 (B) THE ACCOUNTING PRINCIPLE the enterprise and someone external to
it.
❖ Accounting principle
▪ It must be the result of a legal sale or
The rules and guidelines that companies and similar process.
other bodies must follow when reporting ▪ It must be severed from capital.
financial data. ▪ It must be in the form of liquid assets.
basis valuation ▪ Both its gross and net effects on
❖ Basic accounting principle (8) utk recognize cost shareholder’s equity must be estimable
1. Cost Principle sesuatu barang with a high degree of reliability.
The acquisition cost or historical cost is the
appropriate valuation basis for recognition of 3. Matching Principle
the acquisition of all goods and services, Expenses should be recognized in the same
expenses, costs, and equities. period as the associated revenues.
• Justify both objectivity (can show • association between revenues and expenses
justification) and going concern postulate depends on one of the following 4 criteria:
(business will continue operation) i. Direct matching of expired costs with a
record revenue when revenue.
2. Revenue Principle it is earned instead of ii. Direct matching of expired costs with
when it is collected
Specifies: the period.
iii. Allocation of costs over periods
i. The nature and components of revenue benefited.
- An inflow of net assets resulting iv. Expensing all other costs in the period
from the sale of goods or services. incurred, unless they have future benefit
- An outflow of goods or services from
can show
the firm to its customers. 4. Objectivity Principle justification
- A product of the firm resulting from
the mere creation of goods or usefulness of financial information depends on
services by an enterprise during a the reliability of the measurement procedure
given period of time. used.
ii. The measurement of revenue
• interpretations of this objectivity:
- Measured in terms of the value of i. An objective measurement is an
the goods and services exchanged in
impersonal measure.
an arm’s-length transaction.
ii. An objective measurement is a very
- Two interpretations:
viable measurement.
▪ Cash discounts and any reductions in iii. An objective measurement is the result
the fixed prices should be deducted of consensus among a given group of
when computing revenue.
observers.
▪ For non-cash transactions, the
iv. The size of the dispersion of the
exchange value is set equal to the fair measurement distribution may be used
market value of the consideration given as an indicator of the degree of
or received. objectivity.
iii. the timing of revenue recognition
▪ It must be earned in one sense or 5. Consistency Principle
another.
▪ It must be in distributable form similar economic event should be recorded and
▪ It must be the result of a conversion reported in consistent manner from period to
brought about in a transaction between period (exp: dep. method, close account)
 need to disclose
6. Full Disclosure Principle all information ❖ Principle Supports for Uniformity
• Diversification
no information of substance or of interest to the
reduces the diverse use of accounting
average investor will be omitted or concealed.
procedures and the inadequacies of
This principle is enforced by various disclosure accounting practices
requirements within the national and
international accounting standards setters. •Comparability
allows meaningful comparisons of the
exp: contingent liability – kena saman financial statements of different firms
guide how to
7. Conservatism Principle record uncertain
event • Confidence
when choosing between two or more acceptable restores the confidence of users in the
accounting techniques, some preference is financial statements
shown for the option that has the least favorable
impact on shareholders’ equity. • Regulation
At present, the emphasis on objective and fair leads to governmental intervention and the
presentation has lessened the reliance on regulation of accounting practices.
conservatism.

‘trying to take cautious when reporting FE when

there is uncertainty’

8. Materiality Principle

Transactions and events having insignificant

economic effects need not be disclosed.

An item of information is material ‘if its

omission, non-disclosure or misstatement would
cause the financial statements to mislead users
when making evaluations or decisions’ (AAS 5)

• criteria determine materiality:

1. size approach (size of an item to another
relevant variable such as net income)
2. change criterion approach (e impact of
an item on trends or changes between
accounting periods)

❖ Uniformity and Comparability Principles

uniformity: the use of the same procedures by

different firms.

This approach is to achieve comparability of

financial statements by reducing the diversity
created by the use of different accounting
procedures by different firms.
Part 2 THE DEFINITION AND THE DEVELOPMENT ❖ Malaysian Accounting Standard Board

❖ Need for Conceptual Framework (reason)

Established under Financial Reporting Act 1997
1. Assists accounting standards setter in
standard setting
2. Provides a basis for selection of alternative Develops and issues accounting and financial
principles reporting standards in Malaysia
3. Provides a basis for reconciling any
differences
Takes over the accounting standards setting
4. Assists preparers in absence of standards
responsibility from the local accounting
5. Assists auditors in forming opinions professional bodies
6. Assists users in interpreting financial
statements
7. Provides transparency in standards setting ❖ Standard-setting Due Process
8. Facilitates communication

❖ Need for Conceptual Framework (situation)

1. Two or more methods of accounting are
accepted for the same facts
2. Less conservative accounting methods are
used rather than more conservative ones
3. Reserves are used to artificially smooth
earnings fluctuation
4. Financial statements fail to warn of
impending liquidity crunches
5. Deferrals are followed by ‘big bath’ write-
offs
6. There is unadjusted optimism in estimates of
recoverability
7. Off-balance sheet financing is common
8. An unwarranted assertion of immateriality
has been used to justify non-disclosure of
unfavourable information or departures
from standards
9. Form is relevant over substance

❖ Malaysia’s Conceptual Framework

Developed by MASB in November 2011

Similar to Conceptual Framework for Financial

Reporting as issued by IASB

Modified to suit Malaysian economic

environment and needs
❖ Accounting Standard Pronouncements in ❖ International Accounting Standards Board
Malaysia (IASB) responsibilities
1. Develops and approves IFRS
Due process of the MASB after 2003 2. Operates under the oversight of the IFRS
Stage 1 foundation
The MASB seeks public comment on IASB's 3. Formed in 2001 to replace IASC
draft technical pronouncements 4. Guided by IASB Framework
The IASB creates draft documents, and the
MASB shares them on its website and with local ❖ Important Findings on Malaysia’s
groups, asking for comments. People can submit Conceptual Framework
feedback to the MASB about a month before the 1) Objective of general-purpose financial
IASB's deadline. The MASB reviews the
reporting
comments and then submits its feedback to the
IASB. If there are big changes, they might hold objective
public forums.
qualitative elements
characteristic
Stage 2
Deliberation (discussion) at the WG level on
IASB's draft pronouncements recognition
assumptions
The MASB's working group (WG) discusses the
IASB's draft pronouncements and public measurement
comments. After careful consideration, the WG constraints
gives feedback and recommendations to the
MASB for further review. • Objective, Usefulness, and Limitations of
General-Purpose Financial Reporting
Stage 3 & 4 (outline):
Deliberation by the MASB 1. To provide financial information about the
The MASB reviews all public comments, the reporting entity that is useful to existing and
working group's input, and recommendations. potential investors.
After thorough consideration, the MASB 2. To assess an entity’s prospects for future net
discusses these points and prepares a comment cash inflows, existing and potential investors,
letter to submit to the IASB. lenders, and other creditors.
3. To help assess the prospects for future net
Stage 5, 6 & 7 cash inflows to an entity.
Issuance of Standard by the IASB 4. Decisions by existing and potential lenders and
After the IASB publishes new or updated IFRS, other creditors about providing or settling
the working group (WG) reviews the changes loans and other forms of credit depend on the
made. The WG then shares recommendations, principal and interest payments or other
including any potential issues or implications of returns that they expect.
the IFRS, with the MASB for consideration.
• Material Elements to be Considered:
Stage 8,9 & 10 1. Economic resources and claims
Issuance of standard by the MASB 2. Changes in economic resources and claims
After careful consideration by the MASB, a 3. Financial performance reflected by accruals
copy of the MFRS (which mirrors the IFRS) is accounting
shared with FRF members for their comments. 4. Financial performance reflected by past cash
Once approved, it becomes the official flows
accounting standard in Malaysia. 5. Changes in economic resources and claim not
resulting from financial performance (as
presented in SOCIE)
2) Qualitative characteristics of useful financial 3) Definition, recognition, and measurement of
information the elements from which financial
statements are constructed
1.Types of information that are most useful
a) Relevance asset Cash and cash
Relevant financial information is capable of equivalent
making a difference in the decisions made by
the users if it has:
- predictive value (predict future SOFP liability Giving up
outcomes) resources
- Confirmatory value (provides
feedback of previous evaluations) equity Sub-
b) Faithfully representation
classification
Characteristic:
- complete
- neutral comparable
- free from error
verifiable
PERFORMANCE
timely
2.The usefulness of information
a. comparable
- Involves choosing between understandable
alternatives
recognition: process of incorporating in the
- More useful if it can be compared
- Enables users to identify and balance sheet or income statement an item that
understand similarities and meets the definition of an element and satisfies
differences the criteria for recognition. can be recognized if
- Comparability - consistency probable any future economic benefit and value
b. verifiable can be measure reliably
- Different knowledgeable and
independent observers could reach measurement: process of determining the
consensus monetary amounts at which the elements of the
- Two types: financial statements are to be recognized and
Direct - direct observations carried in the balance sheet and income
Indirect - checking the inputs through statement. 1) historical cost, 2) current cost
methods (NRV, PV)
c. timely
- The information is available to 4) Concept of capital and capital maintenance
decision-makers in time to be able to capital capital maintenance
influence their decisions Financial concept:
- older the information, the less useful Invested money / Profit= FVNA at the end of
it is purchasing power a period is higher than at
d. understandable the beginning, excluding
- Classifying, characterizing, and owner contribs
presenting information clearly and Physical concept:
concisely Operating capability Profit= entity's ability to
- Even well-informed and diligent users Capital regarded as produce goods or services
may have trouble to understand the productive increases from the
capacity of the entity beginning to the end of a
information about complex economic
period, excluding any
phenomenon
owner distributions
during that time.
Part 3 MEASUREMENT AND RECOGNITION > Criticism of Historical Cost Accounting:

Measurement = process of determining the (a) Objectivity

monetary amounts at which the elements of the
HCA's focus on stewardship may not show the
financial statements are to be recognized and
true value of assets, potentially affecting
carried in the balance sheet and income
investments and transparency. Critics want a
statement
more forward-looking approach.
❖ capital measurement systems
(b) Decision Making
1. Historical cost accounting HCA isn't great for evaluating current business
o (beli asset, bayar gaji, bill) decisions as historical costs become less relevant
over time.
well-accepted measuring system in published (c) Basis of Historical Cost
financial statements
HCA assumes a company lasts forever, using
> assumption: historical costs for matching revenues. Critics say
we should focus on how assets are used, not
(a) flow of cost
potential buying or selling.
• Track costs associated with goods and
services as they move through the business. (d) Matching
• Determine which costs have been used up
There's no consistent way to match costs,
(expired) and should be matched with
leading to arbitrary decisions and confusion in
revenues in the profit and loss statement.
evaluating a company's financial position.
• Identify costs that are still valid (unexpired)
and should be listed on the balance sheet as (e) Investor Needs
assets.
(b) stewardship Some investors care more about short-term
market trends than long-term profits.
• HCA focuses on the contractual relationship Conventional accounting's focus on current
between a firm and those who provide returns may encourage misleading financial
resources (separation of ownership and information.
control).
• Management, as stewards, are responsible 2. Current cost accounting
for the proper use of assets in operations o (market price utk beli)
and their impact on the net value of assets
over time.
> Reason for dominance: based on the entity concept of maintaining
intact the ability of the firm to continue to
deliver the same amount of goods and services -
firm’s operating capacity
> Valuation Principles: 3. Exit price accounting
o (fair value untuk jual)

amount a seller would receive from selling an

asset either to a market for new commodity or
to a secondary market

> Support of EPA:

a) Providing useful information

Show profits, losses, and values based on current
market conditions.
b) Relevant and reliable information
c) Adaptive decision making
Companies adjust to the business environment.
> Valuation Principles: d) Additivity (results in meaningful financial
statements)
a. A fixed asset's value lies in its service make sense by using current values
potential, not in its market (exchangeable)
e) Allocation free
value.
b. Current cost is subjective in determining the Asset values and profits don't rely on complex
amount of increase in cost. allocations.
c. Critics believe that if the firm intends to use f) Reality real-world reference
an asset instead of selling it, changes in its Use actual market prices
market price are irrelevant. g) Objectivity
d. Current cost accounting anticipates profit, Exit values are clearer and more comparable
which may never be realised.
than traditional methods.
e. They reject current cost accounting because
it violates the traditional realisation h) A measure of risk
principle. exit prices show how risky it is to buy an asset.

> Concept of Capital Maintenance: ➢ Criticisms of EPA:

(a) Profit Concept
- Exit price (opportunity cost) doesn't match
well with revenues, making it less relevant
for measuring a firm's performance.
- EPA is criticized for being forward-looking
and decision-focused rather than focusing
on past events (stewardship objective).
- Relevant only if the company plans to
liquidate assets; not useful for ongoing
businesses.
(b) Value-in-Use vs. Value-in-Exchange
- Ignores the concept of value-in-use,
emphasizing value-in-exchange (market
value).
 - Value-in-exchange is objective and COST VS VALUE
determined by the market, while value-in-
COST VALUE
use is subjective and personal to the owner.
Cost= FV + incidental Value= consumer’s
- Assets are often held for their use in cost to the acquisition willingness to give up
generating revenue, not just for selling, something to obtain it
making exit prices less relevant. (preference by people)
(c) Additivity 1) historical cost 1) exit price
cost incurred at the amount a seller would
- Evaluating a firm's operating efficiency is time the asset is receive from selling an
challenging with EPA. acquired asset either to a
- Anticipatory calculations and current example: FIFO, LIFO, market for new
weighted average cost commodity or to a
figures can't be easily combined.
secondary market
- EPA doesn't consider the possibility of 2) current cost 2) net realizable value
selling assets as a package, leading to amount that would be expected selling price
limitations in assessing efficiency. paid now to acquire the less expected cost of
best asset available disposition

Edward and Bell (1961) preferred current cost

accounting (CCA) over exit price accounting
(EPA) for the following reasons:
BUYER SELLER
(a) Anomalous Revaluation on Acquisition:
OBJECTIVE RECEIVED SUBJECTIVE
PAID
Exit prices result in abnormal revaluation during (masa beli (FV) (egreement
(COST) between
acquisition, considering additional costs like asset, ada
tertera two entity)
transportation, installation, and removal
dkt resit)
charges, as well as challenges in accessing the
market.

(b) Short-Term Business Approach:

Exit prices suggest a short-term business focus as

they emphasize disposition and liquidation
values, possibly neglecting long-term
operational considerations.

(c) Anticipation of Operating Profit:

Using exit prices for finished goods inventory

could lead to anticipating operating profit before
actual sales occur. This is because the inventory
is valued higher than the current cost.
CHAPTER 5-CREATIVE ACCOUNTING - concerns raised by auditors, particularly in relation to
going concern considerations (unless anticipated by the
part 1 (motives and related theories)
market) (from auditor report)
❖ creative accounting: - industry-wide changes, such as the implications
associated with the introduction of particular legislations
consists of accounting practices that follow required laws and (such as the Sarbanes-Oxley Act in the US) (kalau ada
regulations but deviate (depart) from what those standards pengenalan kpd rules baru, affect SP)
intend to accomplish.
❖ Incentives to Manipulate Accounting Numbers (evidence):
❖ capital market research (CMR):
Healy (1985): Lewellen, Loderer, and
accounting research investigates the association between
Managers adopt accounting Martin (1987):
accounting information and key capital market variables, such
methods to maximise bonus US managers approaching
as the subject company's share price, or the rate of return on
if contract rewarded retirement are less likely to
its shares over some time period, or their systematic risk. managers after a pre- undertake R&D expenditure
(Going to be use for justification) specified level of earnings if rewards based on
reached accounting-based
❖ Reasons for Capital Market Research:
performance measures.
- explores the market’s (investors in aggregate) reaction to
If income not expected to
various releases of information including accounting reach pre-specified Short-term focus.
information and therefore capital markets research minimum, managers shift
should be of interest to the accounting profession. earnings to future period
- CMR relies on the assumption that equity markets are (‘take a bath’)
efficient (according to EMH)

❖ Three Forms of Market Efficiency:

❖ Use of Conservative Accounting Method in Managing
Bonus Scheme (3 hypothesis of CA theory):
Semi-strong form
1. Conservative accounting methods (historical cost)-
Weak form Strong form
prices reflect all publicly security
naikkan revenue, kurangkan expenses/ to delay the
information available prices reflect recognition of income, accelerate the recognition of
about past information is all expenses,
prices and rapidly and fully information 2. Asset and income recognition based on assessments of
trading impounded into (public and fair value would not be considered a ‘conservative’
volumes
share prices in an private) accounting approach -Fair value accounting, by contrast,
(lihat bursa
unbiased manner (maklumat may result in recognizing unrealized gains in the value of
Malaysia)
when released orang dalam)
assets before they are realized or converted into cash,
(lihat bursa&news)
potentially overstating the financial position or
performance of a company.
3. Potential conflicts of interest between agents and
principals are better managed when conservative
❖ Assumptions About Market Efficiency:
accounting methods are used as they restrict the ability of
i) models or theories will not always fully reflect what
managers to opportunistically use income and net asset
actually happens in the ‘real world’
increasing accounting methods Apart from accounting-
ii) many researchers rejected claims that securities
based bonus schemes,
markets are efficient.
❖ Market-based Bonus Schemes: managers are provided
with capital market-
❖ Share Prices React to Information from Various Sources: more appropriate to based bonuses
- news about senior executive resignations (well known remunerate managers in exp: mining/ high
executive) terms of market value of technology R&D firms/
- takeover rumors posted to internet discussion sites which firm’s securities (shares) when managers
raises possible issues about the regulation of information where accounting earnings approach retirement
provided on such sites (rumor-SP fluctuate) fluctuate greatly
methods: cash bonus based on share price increase, shares, option to
buy shares
 From miss: ❖ Political Actions of Individuals:
Bonus- upah to managers. (Ways for individuals participate & contribute to political process)
Accounting based bonus = profit ^, bonus ^ (based on profit) - Limited expected ‘pay-off’ results from the actions of
Market based bonus = share price ^, bonus ^ (based on SP) individuals
How to increase share price? - Results in formation of interest groups
Do activity that make company well known. - Information costs shared, ability to investigate
government and business action increases
- Given self-interest, representatives of interest groups
❖ Debt Contracting — Agency Costs of Debt: predicted to maximise own welfare as constituents have
- excessive dividend payments, which leave fewer assets to limited motivation or means to be fully informed
service debt
- the organisation may take on additional debt, with new ❖ Actions of Politicians:
debtholders competing with original debtholders for - Politicians know that highly profitable companies could be
repayment (claim dilution) unpopular with members of their constituency
- investment in high-risk projects may not be beneficial to - Politicians (who are assumed to be driven by self-interest
debt holders as they have a fixed claim (asset substitution) like everybody else) could win votes by taking actions
- underinvestment against the companies
- May rely on reported profits to justify actions
❖ Use of Debt Contracts:
- prices protect ❖ Relevance of PAT-based Research to Current Efforts of
- If firms contract not to pay excess dividends, take on high IASB to Promote the Use of Fair Values
levels of debt, invest in risky projects, or under-invest,
then they can attract debt at lower cost (Conservative acctg method lead to)
- it is efficient to enter into contracts that restrict the ability
of managers to adversely affect the wealth of debtholders • relatively lower revenue recognition
• faster expense recognition main reason
fraud is
❖ Role of Conservative Accounting Methods in Reducing • higher liability recognition happening
the Agency Costs of Debt: • lower asset recognition
- it allows them to attract debt at a lower price
Conservative accounting methods, such as historical
costs, reduce the ability of managers to manipulate
❖ Role of External Auditors:
accounting numbers compared to fair value accounting

❖ Do the ongoing efforts of the IASB to embrace fair values

make sense from an efficient contracting perspective?

The IASB is pushing for fair value accounting, but some

argue that traditional conservative methods, which
reduce the risk of manipulation, have their own benefits.

Conservative methods can attract capital at a lower cost

due to perceived lower risk. While fair values provide
useful information, conservative accounting methods also
control behavior in contracts.

In essence, there's a trade-off between having relevant

❖ Political Costs Hypothesis want to maintain
normal/not outstand to information and the benefits of conservative accounting.
avoid capture
Political costs are costs resulting from
political attention from government, pemilihan method perlu
lobby groups ambil kira intervation of
gov. & authorities

Commonly indication of result in increased

directed at market taxes, increased
larger firms power wage claims,
product boycotts
TOPIC 5: CREATIVE ACCOUNTING PART 2 (a) To prevent shareholders from withdrawing capital
(EARNING MANAGEMENT) (b) To show good stewardship and performance

What is Grey Area? GOOD SIDE OF CREATIVE ACCOUNTING

A situation that is not clear or where the rules are not ‘Good’ earnings management or creative accounting
known. occurs when:

Grey Areas in Accounting • management knows that the long-term earnings

prospects of the firm are better than the current non-
Revenue Firms record a sale when it is made, managed earnings would imply
Recognition not when the customer actually pays;
however, the date of sale is not • management wants to improve the predictability of
always obvious. earnings by reporting a stream of smooth and growing
Cookie-Jar Imagine saving some extra money earnings over time
Reserves when business is good to use during
tougher times. In accounting, this is BAD SIDE OF CREATIVE ACCOUNTING
like putting aside extra profits during
profitable periods to show steadier Management may use earnings management or
earnings later, even if the company creative accounting to avoid:
isn’t doing as well.
Off-balance These are things a company owns or • negative stock price reaction that follows, if
sheet assets owes that don't show up on the usual investors’ expectations are not met
and liabilities financial statements. It's like having • reputational damage
hidden assets (things owned) or • negative consequences on executive compensation
liabilities (things owed), making it
harder to see the full financial picture. IMPLICATIONS
Mark-to- This is when a company updates the POSITIVE NEGATIVE
market value of things it owns to match their • Creative accounting • Creative
accounting current market value. For assets that helps to smoothen up accounting can mislead
might change in value (like stocks or income patterns of investors by untruthfully
property), this method shows their large corporations so reporting financial
worth right now, not just what they as to avoid scrutiny and information of the firm in a
were originally bought for. attention from favourable light -
authorities and lobby manipulative practice is
MECHANISTIC OR BEHAVIORAL EFFECT OF groups with political often called “cooking the
ACCOUNTING INFORMATION agenda books”

1. Mechanistic Effect • Companies dealing If overdone, creative

It's about how this data is used for specific purposes with volatile markets - accounting brings
like financial reporting, compliance, and decision- oil companies might negative impacts to the:
making based on predefined rules and regulations. use creative accounting
to flatten erratic results • Company - reported a
2. Behavioral Effect so as to prevent higher profit/greater
This refers to the influence that accounting information alarming their investors wealth at the expense
of long-run
can have on the behavior and decision-making of
• Companies that need sustainability
people within the company. It's about how this
financial support might
information shapes or guides actions, choices, and
use accounting policies • Capital market - the
attitudes of individuals or groups within the to achieve good debt overnight collapsed of
organization. ratios and high corporate giant like
profitability margin Enron affected the
WHAT IS CREATIVE ACCOUNTING? investors’ confidence
towards the capital
A process that constantly needs one to make market
judgment, and to resolve conflicts between competing
approaches to the presentation of the results of • Financial reporting
financial events. system - the public
began to question the
Two reasons why firm uses creative accounting: credibility of the
 financial reporting FIRMS AND MANAGERS OFTEN HAVE MOTIVES
system TO MISSTATE EARNINGS BECAUSE:

• Accounting profession (a) Contracting incentives:

- the profession lost
its reputation in the • Avoid violating contracts
public’s eye • Maximize bonus (managers)
• Avoid regulatory/government/union intervention
• Avoid detection of managerial shirking
WHAT IS EARNING MANAGEMENT?
(b) Stock market incentives:
Earnings management is the potential accrual
management with the intent of obtaining some private • Meet analysts’ targets
gain.
(c) Political incentives:

• Avoid political scrutiny

COMMON FEATURES OF EARNINGS

MANAGEMENT

1. Purposeful and deliberate actions taken by

management with the ultimate goal to alter reported
earnings

▪ Thus, earnings management is different from

unintentional errors, such as accountant mistakenly
entering incorrect numbers

2.Accounting-based earnings management. The

reported earnings is artificially affected

▪ using estimates or judgments allowed by accounting

regulation, such as expected lives and salvaging
values of long-term assets, obligations for pension
benefits and other post-employment benefits, deferred
taxes, and losses from bad debt and asset
impairments

▪ making changes between acceptable accounting

methods, such as the opportunity to affect changes
from the LIFO to FIFO, or weighted-average for
inventory valuation

3. Real earnings management as it attempts to

manage cash flows, and thus the revenues and
expenses associated with operations. This involves
manipulating real transactions to alter reported
earnings by designing them in such a way that the
desired result can be obtained

▪ Examples of this techniques include reducing prices,

changing production, discretionary expenditures,
including R&D and SGA (Selling, General, and
Administrative expenses), and debt-equity swaps

FRAUDULENT FINANCIAL REPORTING

Manipulation that falls outside the law and standards

constitutes fraud, whilst activities covered by the
terms 'earnings management’ (income smoothing, big
bath accounting), or generally 'creative accounting' WINDOW DRESSING
normally remain within the law.
• Involves making cosmetic adjustments to financial
The most common financial fraud techniques: statements or financial ratios to present a more
favorable or misleading picture of the company's
• Improper revenue recognition (recording fictitious financial position or performance, typically at the
revenues, or recording revenues prematurely) end of a reporting period. The objective is to
• Overstatement of assets (excluding accounts create a positive impression for investors, lenders,
receivable) or other stakeholders.
• Understatement of expenses/liabilities
• Insider trading Examples of window dressing include:
• Disguised use of related-party transactions
• Temporarily paying off short-term debt to reduce
• Other miscellaneous techniques (acquisition, joint
the company's leverage ratios.
ventures, etc.)
• Selling off underperforming assets or transferring
WHY FRAUD HAPPEN IN FINANCIAL REPORTS? liabilities off the balance sheet near the reporting
date.
• Meet external earnings expectation of analysts • Timing or manipulating transactions to achieve
and others specific financial targets or ratios.
• Meet internally-set financial targets, or make the • Engaging in aggressive revenue recognition
company looks better practices or offering unsustainable discounts or
• Conceal the company’s deteriorating financial incentives to boost sales figures.
condition
• Increase the stock price
• Bolster financial position for pending equity, or
debt financing
• Increase management compensation through
achievement of bonus targets, and through
enhanced stock appreciation
• Cover up assets misappropriated for personal
gain

INCOME SMOOTHING

Income smoothing is the deliberate normalization of

income in order to reach a desired trend or level

Ways to do it:

▪ Changing accounting policies

• Managing discretionary accruals (Non-

discretionary expenses refer to expenses that the
business is obligated to pay.Both utility bills and
wages to be paid to employees count as non-
discretionary accrued. Discretionary accrued
expenses are expenses that the business is not
obligated to pay but considers to have been
incurred and not yet paid. Examples of
discretionary accrued expenses are rare, but
bonuses to be paid to management are an
excellent example)
• Timing of adoption of new accounting standards
• Changing real variables: R&D, advertising, repairs
& maintenance
• Structured transactions like SPEs, e.g., Enron
• Fraud like WorldCom -capitalizing operating
expenses