The Case for Accounting Regulation

Accounting

A Theoretical Approach
Dr. Elie Menassa*
DBA CFE FAIA (Acad)

The literature of accounting regulation identified the economic, social and political factors associated with the development of accounting rules and examined
the events that shaped the different international regulatory frameworks. It has
also established the aim and purpose of accounting regulation and identified
the needs for these rules from many different perspectives, in particular, the

30 OdG ` ` 2007 dG dG ` ` RG SG

economic, social and professional viewpoints, and the conditions which render

THE CERTIFIED ACCOUNTANT 2nd Quarter 2007 Issue #30

61

them unnecessary.

The present study attempts to gather and to contrast in one place these different views. Nevertheless, only reference papers, those which have established
the theory of accounting regulation, are included and consequently the list of
works discussed herein is neither exhaustive nor necessarily represents the last
research dealing with these issues.
The relevance of such analysis springs from the fact that many Middle-Eastern
countries are trying to develop their accounting systems to respond to the ever
growing requirements of global accountancy bodies and international business.
Therefore, this analysis could provide these countries with the theoretical foundation needed to understand the importance of such rules and later to buildup, restructure or improve their current accounting frameworks.
From a different angle, this study serves as a basis for future analyses by Arab
faculty and researchers, as well as business and accounting students, to
improve their understanding of the subject matter, and to take further the ideas
contained there in and attempts to test them empirically in the Arab world.

* Dr. Elie Menassa is a Certified Fraud Examiner and the coordinator of the Accounting and Auditing concentration at the University of Balamand. He is
also an Academic Fellow of the Association of International Accountants and a member of many international research bodies, in particular, the European
Accounting Association and the British Accounting Association. elie.menassa@balamand.edu.lb

Accounting

The first line of examination is of importance for this analysis because there exist currently different views related to
what mainly considers accounting rules. The second line
examines the importance of accounting regulations and
3. The Need for Accounting Regulation
their purpose and aims. It attempts to justify the need for
In considering the need for accounting regulation, the literthese rules, in particular, to regulate the economic conseature concerns itself with many considerations such as ecoquences of resource allocation and information provision in
nomic, socio-political, professional and cultural factors.
the market, to achieve the welfare of the society, to promote
a high level of professional practice in the public interest,
3.1.Economic and Market Considerations
and to secure a safe business environment and achieve the
Accounting rules are needed to regulate the economic conobjectives for corporate reporting. The last section looks at
sequences of resource allocation and
the reasons put forward by many
information provision in the market. In
researchers justifying why it is not necesan ideal and perfect situation, market
sary, from their angle, to have accountefficiency ensures the availability of
ing regulation.
In considering the need for
accounting information under the right
accounting regulation, the literacosts. However, there are factors provok2. Defining the Boundaries of
ture concerns itself with many
ing the failure of ideal perfectly competiAccounting Regulation
considerations such as economtive markets (information asymmetry, tax
It is crucial at this stage to start this
ic, socio-political, professional
rates, etc.). This provides reasons for
investigation by defining the boundaries
and cultural factors.
expecting some type of extra-market
of accounting regulation. Therefore, for
regulation (Cohen and Cyret, 1965).
the purpose of this research, accounting
regulations are taken to refer to the difOvercoming difficulties attributed to market imperfection
ferent GAAPs (mainly US and UK Generally Accepted
and the lack of well-functioning markets for accounting
Accounting Principles and Practices (UK GAAP). GAAP are
information and achieving the most efficient allocation of
mainly the norms governing financial reporting. However,
resources are reasons highlighted by several other writers,
UK GAAP does not have any statutory definition as elsesuch as May and Sundem (1976), Bromwich (1985) and
where i.e. USA and Canada. It is a dynamic concept that
Taylor and Turley (1986).
changes over time in reaction to changing circumstances. It
goes beyond principles and encompasses practice. This
Bromwich (1985: 57) argued that these problems of marresearch acknowledges that the boundaries of GAAP extend
ket imperfections and the lack of complete markets seem to
far beyond accounting standards and adopts the definition
plague the provision of external accounting information. He
devised by Davies et al. (1997: 35) in describing UK
added, such problems may not require regulation. For this
GAAP: UK GAAP incorporates the requirements of
to be the case necessitates that the results of such regulaaccounting standards and UITF, of the Companies Act and
tion are demonstrably better than the results of a more
of the Stock Exchange, together with other accounting pracfreely functioning, but imperfect market mechanism.
tices which are generally accepted by the accounting profession to be permissible.
According to Taylor and Turley (1986), accounting regulation is necessary to ensure this market efficiency. They
On a more practical level, accounting regulation (financial
argued that markets may fail for several reasons, and in parreporting) is seen as the imposition of constraints upon the
ticular:
preparation, content and form of external financial reports
by bodies (governments, regulatory agencies established by
The lack of rules governing market behaviour (p.7)
governments, trade and other associations in the private

30 OdG ` ` 2007 dG dG ` ` RG SG

A definition of accounting regulations and their boundaries.

Bringing to light the purpose and the aims of accounting
regulation.
An identification of those conditions which render regulation in any form unnecessary.

sector, loose industrial groups which pursue collusive activities) other than the preparers of the reports, on the organisations and individuals for which the reports are prepared
(Taylor and Turley, 1986: 1). Reporting requirements are
therefore influenced by environmental factors such as those
identified by May and Sundem (1976) who examined the
environment in which financial reporting is conducted. They
argued that there are four inter-linked elements affecting
this environment: the production of these reports is influenced by accounting and auditing regulations imposed by
public and private agencies, influenced in their turn by the
preferences of users and the related costs-benefits emerging
as consequences of their decision choices.

60
THE CERTIFIED ACCOUNTANT 2nd Quarter 2007 Issue #30

or that purpose, this examination covers the following three main headings:

Accounting
30 OdG ` ` 2007 dG dG ` ` RG SG
THE CERTIFIED ACCOUNTANT 2nd Quarter 2007 Issue #30

59

which must state the nature and the means commodities

(including accounting information) may be allocated
together with the form of contracts governing these allocations and the ways for settling disputes and enforcing
rules.
A characteristic of achieving an efficient market is the
supply of free information about market factors and preferences. In reality, information is not free and transactions involving information provision are costly. Taylor
and Turley (1986: 8) argued that the costs of information may mean that individuals are imperfectly informed
about present conditions or the outcomes of their decisions.
In addition to transactions costs, there may be incentives
to obtain private information through insider trading
(Hirshleifer, 1971). Therefore, and from a general perspective, accounting information may affect the level and
distribution of risks among individuals, since risk is a
reflection of the supply of information, and the economic
aggregate (consumption, interest rates) and hence market players decisions through the terms of lending agreements, debt covenants, and dividend restrictions (Taylor
and Turley, 1986: 8).
Markets may also fail because of market distortions. In
the absence of controls on the pricing system, a divergence of prices between producers and consumers of
accounting information may occur where producers could
act as monopolists and hence the need for procedures

guaranteeing the provision of information.

In addition to the above points, accounting information,
which may be considered to have the characteristics of
public good, should be available to all market players
without any discrimination. Moreover, Taylor and Turley
(1986: 10-11) stated that accounting information can
be thought of as giving rise to externalities. They
argued that rational persons would not buy information
unless exclusion could be applied to its consumption.
Exclusion might be practised by allowing full property
rights over accounting information argued Gonedes and
Dopuch (1974). Insider trading is an example: an individual who has acquired additional accounting information may use it to make trading decisions; others
observing his actions may draw inferences about the
unknown information (Taylor and Turley, 1986: 11).
Therefore this leak of information may reduce the value
of the information and generate externalities (Grossman,
1977).
3.2. Socio-Political Considerations
Considerable attention has been given to the application of
economic ideas to the provision of accounting information
(Bromwich, 1985). The economic perspective has been
focusing primarily on accounting policy making as a vehicle
for achieving the most efficient allocation of resources.
However, it fails to take into consideration the non-economic criteria, such as social, psychological and political factors, which in their turn exert major influence on accounting regulation and need explanation. Therefore, another
focus must be considered to incorporate the social view, in

 The relaxation of the assumption of complete heterogeneity of tastes and beliefs among financial statement users,
which he described as an assumption with no systematic
empirical support, and may not be appropriate at all times.
The possibility of replacing the requirement for complete
accounting regulations.
and the importance of concentrating on the mechanism of
social choice.

In fact, activities of regulatory bodies may have consequences

for wealth and income distribution. Their competence for
making such re-distributive judgements is one item which
needs to be included when considering accounting regulation,
argued Bromwich (1985: 51). These activities are one form of
He argued that it is likely that there will be a significant
the political aspect of accounting regulations. Politicisation of
degree of homogeneity of users beliefs
rule-making is not only inevitable but
and tastes and consequently, accounting
when a decision-making process depends
regulators must identify politically feasifor its success on public confidence, the
ble procedures which spring within an
critical issues are not technical, they are
The relevance of such analysis
acceptable framework that is able to
political
(Gerboth,
1973:
479).
springs from the fact that many
identify the required degree of homoMoreover, the need to obtain consensus
Middle-Eastern countries are trygeneity and the tolerated degree of hetbetween regulators is also one reason why
ing to develop their accounting
erogeneity of users preferences. He also
accounting standards are regarded as
systems to respond to the global
argued that if there is general agreement
political (Bromwich and Hopwood, 1983).
amongst stakeholders that the mechaaccountancy bodies.
nism for selecting accounting regulations
Therefore, the distribution of accounting
is suitable, this may be seen as a surroinformation has to take into consideration
gate for general agreement on the reguthe issues related to the fair allocation
lations themselves.
between economic units and the impact they may have on
the transfer of wealth, and consequently social factors. Tower
Cushings alternative lines of inquiry were investigated by
(1993) pointed out that by adopting different accounting proWalker (1984), Bromwich (1980), Dobbs and Keasey
cedures related to tax policies for example, governments may
(1990) and other researchers. Bromwich (1980) estabexert direct influence on the distribution of income and wealth
lished a framework which allows for the application of paramong economic entities (including individuals) and consetial standards that will maximise the utility of a decisionquently remove existent inequities.
maker using the accounting reports. He argued that stanThe considerations outlined above require the application of
dard-setters should have individuals expected utility in
social criteria rather than economic criteria. Consequently, the
mind while deciding about the desired information system.
choice of accounting regulation by regulatory bodies should
Walker (1984) investigated Cushings suggestion of relaxing
account for users preferences and the social and political
the assumption of complete heterogeneity of tastes among
requirements. The impact of such social influence was invesusers and concluded that a fruitful theory of social choice
tigated by Arrow (1963). Demski (1973, 1974) and Beaver
will require restrictions on both the heterogeneity of individand Demski (1974) have applied Arrows impossibility theouals preferences and on the structure of the public informarem to the issue of accounting regulation to show its political
tion problem they face (p. 285).
and social criteria and concluded that generally accepted
accounting regulations are impossible. Demski (1974: 232)
Cushings focus on the mechanism of social choice has
stated that since the evaluation of consequences ultimately
been explored by Dobbs and Keasey (1990). They noted
must entail trading off one persons gains for others this, in

Accounting

Cushing (1977) showed that Demski and Marshalls conclusions may not hold under some circumstances. He stated that different factors should be considered and suggested the following avenues:

30 OdG ` ` 2007 dG dG ` ` RG SG

Tower (1993) highlighted two important societal, intermediate goals for accounting as a social choice function (efficiency and equity) and argued that corporate reporting
should consider these criteria explicitly. He stated that regulation is an important tool to promote accountability and
proposed the provision of a greater amount of data in corporate reports and the inclusion of a wider representation by
stakeholders, including producers, in order to increase the
acceptability of accounting rules and consequently promote
compliance with accounting regulations.

turn, implies that one set of accounting research issues lies in

discovering the restricted environments in which acceptable
social evaluation criteria arise. Similarly, Marshall (1972)
argued that optimal accounting regulations are possible only
if individual preferences were known.

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THE CERTIFIED ACCOUNTANT 2nd Quarter 2007 Issue #30

particular, the income and wealth of different social interests, and to indicate the best form of regulation for achieving the welfare of the society.

30 OdG ` ` 2007 dG dG ` ` RG SG

Accounting

that once certain minimal institutional factors and their

effects on preferences are included in a model of public
information system choice, the choice need not be chaotic.
They argued that in order to resolve accounting policy
choice dilemma, there must be some agreement among the
accounts users regarding how they want to see the present
system changed.

THE CERTIFIED ACCOUNTANT 2nd Quarter 2007 Issue #30

57

To conclude, accounting regulation, like other forms of regulation, is enveloped within a particular social context and
professions legitimate themselves by attaching their knowledge to social values (Abbott, 1988). Maximising social
welfare by behaving in the public interest should be one of
the main governmental objectives from regulations (May
and Sundem, 1976). Social and political choices by regulators are inevitable. However, they require an explicit and
careful consideration of the preferences of all those who are
affected by policy alternatives.

information and makes adjustments to regulations easier.

Therefore, the justification is seen to be based on reducing
the costs of regulation.
Conversely, much of the literature sees regulation working in the interests of members of the profession.
Economists have long been sceptical of the competition
and welfare effects of the self-regulation of the professions. Friedman and Kuznets (1945) and Arnauld (1972)
have criticised many of its aspects. The main criticism by
those economists is their traditional cartel argument, in
particular, its controlling power over the entry to the market, its controlling power over prices, advertising and
competition.

The history of regulatory activity contains also many examples of lobbying by interested parties and such behaviour
has come to be recognised as important in accounting policy making. This lobbying behaviour highlighted by Watts
and Zimmerman (1986), Mian and
Smith (1990) and others has significant
effect on the efficiency of regulations and
the
standard
setting
process.
Accounting
regulations
are
Consultation between the regulators and
important to promote a high
interest groups may carry the danger
level of professional practice in
that undue emphasis may be put upon
the public interest and maintain
the views of certain groups to the detrithe professional status and
ment of others.
integrity.

3.3 Professional Considerations

Being a professional form of social regulation, accounting has also developed in
response to the rise of professionalism.
Professional integrity and expertise, business opportunities and lobbying behaviours are some of the factors that
emphasis the need for regulations.
Tower (1993), Richardson (1997),
Broadbent and Laughlin (1999) and several others have highlighted the importance of these elements. They argued
that accounting regulations are important
to promote a high level of professional practice in the public interest and maintain the professional status and integrity.
Beside this need for accountants to compete for professional integrity, Richardson (1997) argued that accounting
operates as a profession in two domains. One of these is the
regulatory domain of the standard setters and one is the
market place. The first domain is concerned with the development and protection of professional knowledge and
access to the professional community and the efforts to distance other groups by language and expertise; the other
concern is with the market opportunities. These two
domains are interrelated as the availability of market
opportunities rests on the existence of the professional
knowledge and the restriction to access it (Broadbent and
Laughlin, 1999: 6).

The regulation of the profession is usually carried out by a

mix of state, institutional and self-regulation. However, the
issue of self-regulation by the profession is delicate and
needs close consideration. Ogus (1995) argued that selfregulation may reduce the cost of the regulator acquiring

Taylor and Turley (1986: 29) stated that

private regulatory bodies may restrict
access to their service or may discriminate against certain of their members. They also stated
that their regulatory power may be used to exploit the public for private interest and hence the need for supervision
and control by governments.
In addition to the above points, there is also a need for creation of opportunities in the market. However, the creation
of these opportunities is influenced by competition.
Armstrong (1985) noted that the issue of professional rivalry is an important aspect of the dynamics of professional
development. This issue of professional rivalry, together
with the need for the creation of new market opportunities
are best described by Broadbent and Laughlin (1999). They
noted that in the context of the discussion of the Private
Finance Initiative in the UK, competition between accounting and other professionals, such as lawyers, actuaries,
bankers is very obvious, hence in order to maintain their
market opportunities, accountants must engage actively in
the promotion of the market for services However, as the
profession also has to operate on the level of regulation, it
cannot ignore the need to develop a robust set of regulations (p. 9).

30 OdG ` ` 2007 dG dG ` ` RG SG

Accounting
However, Bromwich (1985: 63) noted that despite control
factors, enterprises have considerable discretion as to the
accounting practices embodied in this accounting package.
Choices are often permitted in the method of dealing with

given accounting items. He argued that it is likely that

where such freedom existsthe information provided might
be expected to support the picture of the financial position
of the enterprise which those in power in the corporation
wish to present to the outside world. In recent years, evidence has increased of the active management of reported
financial performance by listed corporations (Briloff, 1972;
Griffiths, 1986; Smith, 1992). In his best-selling book,
Smith (1992) named and analysed 208 UK companies
which practised different degrees of creative accounting.
Tweedie and Whittington (1990) provided both an academic review of the major technical weaknesses in UK standards and set of illustrative cases, and Griffiths (1986,
1995) and others provided a professional and popular
review of these manipulations.

56
4. The Case Against Accounting Regulation
The legal and regulatory environment in which firms operate has evolved rapidly in recent years. However, some
have suggested that accounting regulations (law, principles
and standards) are not necessary, because the market can
decide what accounting principles to demand. Bromwich
(1985) tried to identify those conditions which render regulation in any form unnecessary in order to indicate those
general characteristics of accounting which seem to make
imperative regulation in some form. He stated that most of
those who urge that the provision of accounting information
should be left to the free market argue that the institutional
framework does not correspond to the ideal market settings. Moreover, they suggest that accounting regulation is

THE CERTIFIED ACCOUNTANT 2nd Quarter 2007 Issue #30

3.4. Other Considerations

Accounting standards aim to promote comparability, consistency and transparency in the interests of users of financial statements. Experience shows that, in the absence of
regulation, companies reports may not give the information
that users need to make informed assessments of companies. Therefore, great emphasis is placed on to the role of
regulations in raising the quality of accounts and achieving
the objectives for corporate reporting. These objectives were
highlighted by Baxter (1978: 25). He stated that standards raise the quality of accounts, make company reports
more intelligible and foster comparability; they dispel
doubts and we hope soon bring harmony of principle. In
a world made safe enough by standards, accounting will be
plagued by few scandals and our noisy defamers will have
to hunt elsewhere for quarry. This need for accounting regulations to make the business world a safer place was
emphasised by the scandals of the 19th and 20th century
and the non-compliance activities of the 1980s and 1990s.
Moreover, one central focus of accounting is the measurement of business performance. A good set of accounting
regulations can protect stakeholders by making the profession more accountable to external interests. Fair accounting
standards can ensure public confidence in the impartiality
and effectiveness of professional regulations and discipline.

Accounting
30 OdG ` ` 2007 dG dG ` ` RG SG

ineffective in achieving its aim of accurate, reliable, consistent and comparable financial reporting.

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55

Those who favour the provision of accounting information

by the market would expect firms managers to be willing
to issue sufficient information to allow interested outsiders to monitor their behaviour (Jensen and Meckling,
1976). They also point to evidence that supports their
theory. They cite, for example, the voluntary provision of
accounting information by enterprises prior to any legal or
societal requirements for such information (Benston and
George, 1976).
Those who are against accounting regulation suggest that
the standard setting process is biased in favour of the setters. The involvement of different bodies and institutions
in this process has significant influence. Such influences
are highlighted in the constitution and the finance of regulatory bodies. Shah (1996) noted the involvement of different groups in the creation of the regulation and raised
questions over the integrity and morality of the accounting
system. Hopwood and Page (1985) and Tinker et al.
(1982) stated that the imbalance of economic and political considerations of the setting process leads to the creation of inefficient regulations.
Other dangers are directly related to the nature and procedures of the regulation setting process. Baxter (1978: 34)
warned of the defects and dangers of standards: the truth
is relative standard procedures may become petrified procedures accounting figures are not docile, and do not lend

themselves to standardisation the wording of standards

will inevitably bring difficulties of interpretation standards-makers may have to bow political pressures even if
a standard lay down a principle well, it may leave scope for
personal estimates.
The literature of accounting regulation identified the economic, social and political factors associated with the
development of accounting rules and examined the events
that shaped the regulatory systems around the world. In
response to the growth of business enterprises and shareholders demanding more stringent accounting regulations,
and in response to financial abuse and shocks in the form
of scandals and important failures, business laws gradually incorporated more extensive accounting provisions.
These provisions were imposed on corporations as a promise to restore order and provide a new basis for the trust in
economic transactions. Therefore, the fortune of accounting has always been tied to the general fortunes of the
business climate.
The literature also established the aim and purpose of
accounting regulations and identified the needs for these
rules and the conditions which render them unnecessary.
The general view in the literature is that arguments in
favour of non-regulation are unconvincing, despite concerns about the quality of financial reporting practices and
compliance with applicable accounting standards. It was
shown that these rules have consequences for information
provision and resource allocation in the market and for
wealth and income distribution.

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