Accounting & Auditing: Interaction in the regulation and research ...

Accounting & Auditing:
Interaction in the regulation
and research domains
Wolfgang Ballwieser
Munich University
W. Ballwieser: Accounting and Auditing 1

Contents
• Research domain: Theories
• Accounting theories
• Auditing theories
• Interaction
• Deficits in theory
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Theories 1
• Theories are systems of sentences
about subjects of scientific interest
which
– contain no contradictions
– can be proven false on logical and/or
empirical level
– have some kind of generality
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Theories 2
• Theories can be
– normative in the sense of prescriptive: if
your aim is x and the conditions are y, then
you reach your aim by doing z
– positive in the sense of explaining or
reconstructing some aspects of reality
– analytical in the sense of using logic and
giving definitions
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Accounting theories
Financial accounting
theories
Management
accounting theories
normative
positive
income
measurement
regulation
regulation
financial
reporting
Beaver/Demski
1979: The nature
of income
measurement
Lev 1988: Theory of
Equitable and Efficient
Accounting Policy
Watts/Zimmerman
1986: PAT
Beaver 1998: FR:
An Accounting
Revolution
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Normative regulation theory 1
• Regulatory aims are
– improving allocational efficiency
– guaranteeing fairness for investors, protecting
them against fraud and exploitation (SEC)
– guaranteeing equality of opportunity (Lev)
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Normative regulation theory 2
• Regulation avoids market failure
• Unregulated financial reporting leads to
– free rider problem and underinvestment in
reporting (public good argument)
– low network effects and high transaction
costs
– information asymmetry and abstaining from
market transactions
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Normative regulation theory 3
• Regulation supports network effects
because of
– increasing returns for accumulated information
– learning effects
– comparability of financial statements
– economies of scale
– large and cheap supply of complementary
goods, e.g. auditing services & techniques
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Normative regulation theory 4
• FASB/IASB/GASB ... follow the concept of
decision usefulness for unidentified users
• It is theoretically not clear what this means
(Demski 1973)
• It is practically not clear; think of
– segmental reporting (SFAS 131, IAS 14, GAS 3)
– goodwill amortization (history of SFAS 141&142!)
– consolidation of special purpose entities
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Auditing theories
Theories on auditing
financial reporting
Internal control
theories
normative
positive
auditing
regulation
regulation
auditing &
auditing firms
Sampling
approach
System approach
Risk approach
Quality approach
Corporate
Governance
Independency
Influence of peer
review
Independency
Qualified opinions
Auditor change
Risk analysis
Concentration
process
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Normative regulation theory 1
• Regulatory aims are
– enforcement of accounting rules
– improving allocational efficiency
– guaranteeing fairness for investors (SEC)
– guaranteeing equality of opportunity (Lev)
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Normative regulation theory 2
• Regulation avoids market failure
• Same arguments as above
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Interaction 1
• Accounting and auditing regulation
must be combined because auditing shall
enforce accouting rules
– Accounting rules have to be auditable: what
about fair value measurement or impairment
test of good will?
– Auditing techniques must be problem solving
(effective) and efficient
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Interaction 2
• The auditor creats a new agency
problem (risk of moral hazard and
collusion); therefore
– the enforcement of accounting rules by
auditors has to be supervised
– incentives have to be given in order to support
the independence of auditors, e.g. by liability
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Interaction 3
• Experience shows that audit regulation
reacts on damages in the accounting
and/or auditing sector
• Audit regulation should be pro-active
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Deficits in Theory 1
• Empirical research in auditing has many
objections:
– What is the governance structure in audit
firms? What is the role of committees?
– How competitive is the audit market?
– What signals quality to whom: client, investor,
regulatory body?
– What are the institutional devices to support
auditor independence? Public commission /
peer review?
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Deficits in theory 2
• Theoretical research has many open
questions:
– How can efficient audit tools be developed in a
dynamic world of accounting?
– What are the consequences of a separation of
auditing and consulting, e.g. with respect to
recruiting good personell and risk assessment
of audit clients?
– What are the consequences of the globalization
of audit firms on management and risk?
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Deficits in theory 3
• Recommendations on policy are
restricted by the mentioned deficits :
– What kind of recommendations can be given
with respect to regulatory aims, bodies,
institutions, supervisions etc. in the case of
further globalization of accounting rules?
– What shall be tought at universities and
colleges in order to prepare students for the
auditing sector?
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Literature
• Ballwieser, Wolfgang, Entwicklung der Theorie der Rechnungslegung in den USA, in:
Wagner, Franz W. (ed.), Ökonomische Analyse des Bilanzrechts, Sonderheft 32/93
der zfbf, Düsseldorf, Frankfurt a.M. 1993, pp. 107-108.
• Beaver, William H., Financial Reporting: An Accounting Revolution. 3. ed., Upper
Saddle River 1998.
• Beaver, William H./Demski, Joel S., The Nature of Income Measurement, AR 54
(1979), pp. 38-46.
• Demski, Joel S., The General Impossibility of Normative Accounting Standards, AR 48
(1973), pp. 718-723.
• Lev, Baruch, Towards a Theory of Equitable and Efficient Accounting Policy, AR 63
(1988), pp. 1-22.
• Währisch, Mark, The Evolution of International Accounting Systems, Frankfurt a.M.
(Peter Lang), 2001.
• Watts, Ross L./Zimmerman, Jerold L., Positive Accounting Theory. Englewood Cliffs,
N.J. 1986.
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