SS TEST FAR660/OCT 2018

SOLUTION TEST FAR660 OCTOBER 2018

Question 1

a) Contribution by Luca Pacioli

 He is generally associated with the introduction of double-entry bookkeeping.
and he published a book (Summa de Arithmetica Geometrica, Proportioni et
Proportionalita), which include two chapters describing double-entry bookkeeping.√

Cushing outlines a series of developments of the double-entry model. They include the
following:
 Around the sixteenth century a few changes were made in the bookkeeping
techniques, noticeably, the introduction of specific journals for the recording of
different types of transactions. √
 The 16th and 17th centuries saw the evolution of the practice of periodic financial
statement. √
 The application of the double-entry system was extended to other types of
organization. √
 The 17th century saw the use of separate inventory accounts for different types of
goods. √
 Beginning with the East India Company in the 17th century, and continuing with the
growth of corporation following the industrial revolution, accounting acquires a better
status, characterized by the need to inform absentee investors, the need for
auditing, the need for cost accounting, and a reliance on concepts of continuity,
periodicity and accrual. √
(Any 5√ x 1 = 5 marks)

b) Management Contribution phase

 Management had complete control over the selection of financial information
disclosed in annual reports √
 Characterised by ad hoc solutions to urgent problems and controversies√
 Lack of theoretical support √
 Focus on minimisation of income taxes √
 Smoothing of earnings √
 Complex problems avoided in favour of expedient solutions √
 Significant influences of the period
o Interest as a cost controversy: √
 The need to invest large amounts of capital for long periods
o Increased overhead √
 The inclusion of overhead in product cost became an issue
o Growing effect of taxation of business income √
 Arguments for improvement in standards of financial reporting
o From 1900, New York Stock Exchange required corporations to publish
annual financial statements √
o Calls for protection of investors
o Board of Examiners established in 1917 to create a uniform certified
practising accountant (CPA) examination√
(10√ x ½ = 5 marks)

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 SS TEST FAR660/OCT 2018

Institution Contribution phase

 Marked the creation and the increasing role of institutions on the development of
accounting principles. √
 Increasing role of institutions on development of accounting principles:
o Creation of the Securities and Exchange Commission to administer
federal investment laws √
o Emergence of accounting principles √
o Companies were permitted to choose their accounting methods but had
to disclose them √
 Committee on Accounting Procedure (CAP) began issuing accounting research
bulletins (ARBs) in 1938 √
(5√ x 1 = 5 marks)

(Total: 10 marks)

c) Important development of the Malaysian Companies Act.

 Companies Ordinances were established before Companies Act 1965√
 Malaysian Companies Act was established in 1965 that repealed the Ordinances
which formally established the requirements for reporting; and rules and regulations
on accounting. √
 It also contained the Ninth Schedule that specified the disclosure requirements in the
financial statements of Malaysian companies. √
 The Act was used as the absolute disclosure requirements rather than as minimum
requirement because an accepted accounting framework for financial reporting did not
yet exist in Malaysia. √
 This changed when Malaysian approved accounting standards were amended to
converge with IFRS issued by IASB. The focus now is on providing information that is
useful to users in making economic decisions. √
 Companies Act 1965 was replaced by the new Companies Act 2016 in its entirety. √
 Key feature of the new Act is the requirement for reporting companies to comply with
the approved accounting standards issued by MASB. Thus, removing conflicts in some
areas that existed before. √
 Further, the Ninth Schedule is removed which means Companies Act does not
prescribe accounting treatments and disclosure requirements for financial reporting. √
(Any 5√ x 1 = 5 marks)
(20 marks)

Question 2

a. Purpose of accounting theory.

1) Explain and predict accounting practice as it is. √

2) Project ability and predictability. √
3) Justify existence of accounting profession and accountancy. √
4) Can be used as pedagogical devices to impart knowledge. √
5) Evaluate current accounting practice and guide the development of new accounting
practice. √
(Or any logical answers)

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 SS TEST FAR660/OCT 2018

(5√ x 1 = 5 marks)

b. Explain five (5) arguments to support the assertion that historical accounting is largely a
syntactic theory.

 Traditional historical cost accounting has been theoretically interpreted as almost

completely a syntactic theory.
 This interpretation of accounting theory may be described as follows:
 the semantic inputs of the system are the transactions and exchanges recorded
in the vouchers, journals and ledgers of the business.
 All these steps were accomplished on the basis of the premises and assumptions
of historical cost accounting; inflation is not to be recorded and market values of
assets and liabilities are ignored.
 Use double-entry accounting and the principles of historical cost accounting to
calculate profit and loss and the financial position.
 The individual propositions are verified every time the statements are audited by
checking the calculations and manipulations.
 However, the accounts are rarely audited specifically in terms of whether and
how people will use them (a pragmatic test).

 The theory has semantic content only on the basis of its inputs.

 There is no independent empirical operation to verify the calculated outputs, for

example ‘income’ or ‘total assets’. These figures are not observed; they are
simple summations of account balances and the auditing process is, in essence,
simply a recalculation.

Sterling comments:
If one were to confirm a theory of astronomy, as illustrated by a particular
planetarium, one will check on the accuracy of the observational inputs, and
check for errors in computation. However, at some point, the outputs of the
system would be verified by looking at the sky to see if the stars were in fact in
the position indicated by the planetarium.

 Traditional historical cost accounting has also been criticised on the basis of its
syntactic, for example, with respect to the practice of summing several different
money amounts assigned to specific assets (i.e. summing of cash held today with
cash paid for land 20 years ago, which the company still holds today).

 Further criticism by Chambers:

 The internal inconsistency of historical cost accounting is similar to the
philosophy of doublethink. Doublethink means the power of holding two
contradicting beliefs in one’s mind simultaneously, and accepting both of them.

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 SS TEST FAR660/OCT 2018

 For example, valuations are incorporated in balance sheets… but the balance
sheet is not a valuation statement. Fixed assets should be carried at cost … in
historical accounts, unless such cost is no longer meaningful.

 There are many imprecision of definitions in accounting. In terms of Popperian

approach to science, many of the propositions of conventional accounting are not
falsifiable.
 Popperian approach of verifying theory:
All hypotheses proposed must be capable of falsification. If a hypothesis is not
proposed or worded so that it is falsifiable, then it is not informative and does not
add to scientific progress. Once proposed, a hypothesis needs to be tested
rigorously and ruthlessly by both analytical and empirical analysis.

(Any 5 point x 2√ x 1=10 marks)

(15 marks)

Question 3

a. Positive accounting theory can help provide an understanding of the role of accounting√
which, in turn, can form the basis for developing normative theories to improve the practice
of accounting√. Understanding the impact of accounting is a factor that accounting
standard setters consider√ in developing prescription for practice√. Thus, both positive
and normative can co-exist and can complement each other√.

(5√ x 1=5 marks)

b. Agency relationship explains financial statement as a tool to report about the company
from the agent to the principal√. It also explains the practice of creative accounting in the
financial statement by directors because it could influence the decision to remunerate
them for example to report artificially high profits for their companies to trigger bonus
payment√√.

The main reason why companies use creative accounting is because of the pressure
placed upon management√ to show favorable returns on their investor’s money√. This
idea of seeking to please shareholders is reinforced by Agency theory√. Agency theory
states that individuals seek to maximize their own utility, and act only in the individual’s
best interest√. Financial reports produced by companies are the “basis” of the contract
between each company and its investors√. So, acting in the company’s best interest,
management will use creative accounting to enhance their financial reporting, and
therefore protect the ‘basis’ of their contract√.

In addition, pressure from management can also cause the accountants and auditors to
produce favorable reports to shareholders√ by using creative accounting techniques to
improve results√.

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 SS TEST FAR660/OCT 2018

(10√ x 1 =10 marks)

(15 marks)
TOTAL: 50 MARKS

(15 marks)

(Total: 50 marks)