CHAPTER TWO
THE REGULATION OF
FINANCIAL ACCOUNTING
What is regulation?
the act of regulating or state of being regulated
an authoritative rule: a rule or order issued by a
government agency and often having the force of law
a rule or directive made and maintained by an
authority.
regulation, in government, a rule or mechanism that limits,
steers, or otherwise controls social behaviour.
Regulation consists of requirements the government
imposes on private firms and individuals to achieve
government's purposes
Accounting regulation consists of a legal framework,
standards, education, and licensure.
An overview of the ‘free-market’
perspective
The free market is an economic system based on
competition, with little or no government
interference.
It is a system in which economic decisions and
pricing are guided by the interactions of citizens
and businesses.
Nobody is forced to do anything and transactions
are entered into voluntarily.
Arguments in favor of regulation
Unregulated markets may fail – a misallocation
of resources
Regulation has done much to improve the
quality of life for consumers and employees
and give them more rights. Products are
generally safe.
Competition provides goods and services at
lower prices, increasing standards of living
and wellbeing.
Regulation defends small businesses and
defeats monoposonies
Arguments against government
regulation
Adds to costs and pushes up prices.
Compliance with regulation can cause delays.
Regulation is often ineffective and misguided –
with gov failure adding to market failure.
Not being able to collude with one another may
force them to compete on price.
There is a trade-off between employee
protection regulations and the level of
employment/job creation.
Theories of regulation
Three major theories of economic regulation:
public good theory, capture theory, and
special interest theory
The public interest theory of regulation
claims that government regulation acts to
protect and benefit the public.
The public interest is "the welfare or well-
being of the general public" and society.
Regulation means the employment of legal
instruments for the implementation of
policy objectives
Regulatory capture is an economic theory that
regulatory agencies may come to be dominated by the
interests they regulate and not by the public interest.
The result is that the agency instead acts in ways that
benefit the interests it is supposed to be regulating.
Private interest theory acknowledges that individuals
form into groups to pursue their self interest.
This theory proposes that private interests rather than
public interests dominate the regulatory process.
Regulatory outcomes reflect the interests of the most
powerful group.
What are arguments for pro regulation
perspective?
Accounting information is a free good.
Everyone has the right to access these kind of
information
Regulators see a need to reduce the
impact of market failure
There are free-riders that understate true
demand --> Pricing system will not work
properly --> Leads to underproduction of
information
Economic and social impacts of
accounting regulation
The economic consequences are basically dealing with
the economic cost and benefits of the company as
well as the industry in which that standard is applicable
(a) standard-setters must give first priority to ensuring
that companies do not suffer any adverse effect as a
result of a new standard. (b) standard-setters must
ensure that no new costs are incurred when a new
standard is issued.
Accounting standards are critical for ensuring that
investors aren't led astray by misleading financial
statements
The process of setting accounting standards
is considered a political process because
modification in standards can result in a
substantial redistribution of wealth within
the country's economy, congress or
political party votes on the introduction of
a new accounting standard