Free Market Proponents That Oppose Regulation Argue That Even in the Absence of Regulation, Organisation Will Provide Optimal Amounts of Accounting Information

Question 1

a) Free market proponents that oppose regulation argue that even in the absence of regulation, organisation will provide optimal amounts of accounting information.

Provide two (2) incentives for organisations to produce optimal amounts of accounting information despite the absence of regulations. (5 marks)

Two incentives for organisations to produce optimal amounts of accounting information despite the absence of regulation is the role of manager and the volatility of market economy.

The manager itself will have to cope the responsibility to make sure all the information related to accounting or non-accounting is sufficient for analysis before taking of any decision for company’s future plan. Managers will have incentives to provide information, as failure to do so might mean that no funds can be attracted or, if they can, only at high cost. The managers are assumed to be able to determine what methods of accounting best reflect the performance of their entity, rather than leaving it to regulators to impose particular methods which in certain cases may be unsuitable. Hence, in the absence of regulation there will be private incentives to produce accounting information where only internal user only able to use it.

The high volatility of market economy also help the organization in gathering the accounting information. The huge demand, production and supply will resulting more information related to company performance whether the company doing well or not. For example, in the production stage, when there a high volume of production, the management able to see what problem that lead to high of cost production, how to solve it, and what corrective that should taking to reduce the cost of production. Here, the management team able to get the information that can be used for producing the accounting information. Thee information from the volatility of market economy not limited to internal information, it can be expend to external information such as information related the company’s competitor that can be used for sake of the company.

b) Discuss the free market approach to standard setting. (10 marks)

The standard setting is viewed as the political process due to of its potentials to significantly affect the wellbeing of a wide variety of interest group such a consumer, company, and government itself. It refer to interest theory where the public will seeking the leader who will protect and give them benefits in changing the regulation and it involve regulatory capture theory. Different groups are affected differently by any of accounting regulations. For example, the doubtful debts expense might be welcomed by the company who borrow heavily and close to their borrowing agreement leverage. Other example is the large bank with high public profiles may be averse to the standard because it causes their profit to increase, understates their risk and increases their apparent exploitation of their customers.To make the decision to accepted by the people affected, the regulatory agency needs a mandate to make social choices through political legitimacy. The government in many countries have to set up independent standard setters in attempt to produce high quality standard which meet decision making needs of financial statement user. The standard setting allow the stakeholders to contribute to standard setting but also prevent any one party, such as the accounting profession from dominating the process. The independent national standard setters have had mixed success in producing conceptually sound accounting standard that achieved the decision usefulness objective.

c) Advocates of regulatory approach argue that the free market approach will not be able to achieve a socially ideal equilibrium price for accounting information

Discuss three (3) reasons in support of the above argument (10 marks)

Public Goods
Accounting information cannot be considered in the same way as other products because it is a public goods. Once the information is released by the company, it is available to everyone. Although the information may be sold by to certain people only, others who did not pay for it cannot be easily excluded from using the information. It refer to free-rider problem and the example is potential investor and financial analyst. The company have to produce the accounting information request by the regulator and at the same time, the other user such financial analyst and potential investors will also try to get those information for their own benefits.

Monopoly of supply information
A company has a monopoly on the supply of information about itself and therefore the tendency will be for the company under produce and sell at high price. For example information related to profit earn by the company will be sell to high price and it very valuable to existing and potential investor.

The need of regulator
Even if a free market existed for accounting information, a regulatory board would still needed due to the users are unable to agree on what they want and accountants will not agree on the procedure to derive the desired information. For example, the user want details information about company position and the producer of the information refuse to produce it while the accountant might have to incur additional cost for gathering all information before that able to produce accounting information. Further, the value of information provided by the companies to users is greatly enhance if it can be compared with information from other companies.

Question 2

1. Explain the main difference between the concepts of financial capital and physical capital.         (5 marks)

Under the financial capital concept, capital is synonymous with the net assets or equity of the entity, measured either in terms of the actual amount of dollars by subtracting the total of liabilities from assets, or in terms of the purchasing power of the dollar amount recorded as equity. Profit exists only after the entity has maintained its capital, measured as either the dollar value of equity at the beginning of the period, or the purchasing power of those dollars in the equity at the beginning of the period.

Under the physical capital concept, capital is seen not so much as the equity recorded by the entity but as the operating capability of the entity’s assets. Profit exists only after the entity has set aside enough capital to maintain the operating capability of its assets.

1. Identify two reasons why holding in gains are a component of accounting profit. (5 marks)

• Because a firm benefits from the increase of the value of its assets
• The company needs to invest more in the assets if they intend to buy it now.
• The cash saving from the previous purchase is thus a real benefit and should be included in income.

1. Discuss the difference between the ‘value in use’ and ‘value in exchange’ approaches to asset valuation. (10 marks)

Answer:

Value in use is an asset that is own and brings more benefits or worth to the owner rather than be sold. And the act of not selling does not directly cause its owner to suffer in economic terms after a price fall. This is especially true in the case of nonmarketable fixed assets. They are usually highly specific to a particular business and might be also excellent investment for the firm. However, since no alternative use exists for the assets outside their business, their resale value may effectively be zero. A firm can consider an asset to have value because of its use in the business rather than its sale and the synergistic value added by combining with other assets.