Accounting Theory and Policy Essay Example | Topics and Well Written Essays - 2250 words

Accounting Theory and Policy - Essay Example GAAP and IFRS.The main reason for starting the debate was the series of corporate scandals in the U.S. where managers acted opportunistically to circumvent accounting rules to the detriment of investors, a result that accounting standards were supposed to help in preventing. Standards were established to ensure that financial reporting reflected the economic substance, not just the form, of transactions. However, auditors allowed different forms of reporting manipulation provided these were consistent with the interpretation of precise rules-based standards, allowing compliance with the "form" of financial reporting even as it failed to reflect the true economic "substance" of such transactions.Another reason for the debate is the move towards the need for convergence because of the number of accounting standards currently in force, which creates problems related to timeliness, compliance, comparability, and consistency. Accountants find rules-based (also called cookbook or checklist ) standards too detailed and time-consuming, causing delays in reporting, and unable to meet the challenges of a complex and fast-changing financial world. Rather than help accountants exercise professional judgment and objectivity, having too many rules provide specific benchmarks that makes it easy for auditors to fulfil compliance in form but not in substance. Therefore, since principles are more general than detailed rules, FASB is of the opinion that developing principles-based standards would make convergence easier and, at the same time, allow auditors to minimise the tendency of managers to engage in manipulations of reported financial results. Rules-based accounting standards-setting in the U.S. resulted from years of consultations regarding increasingly complex financial transactions. Companies and auditors asked for "bright line" rules, so-called because they contained precise numerical cut-off points supposedly to guide transactions reporting. However, as the example of accounting for capital leases showed, companies found a way to use professional expertise, creative arrangements, and over-liberal judgment to circumvent the rules contained in a 450-page FASB document to clarify the topic. Why do companies restructure transactions even in the face of "bright line" rules The main reason is that managing earnings can be beneficial for managers. Managers have incentives to look after their own best interests, leading them to manipulate transactions if the benefits outweigh the costs such as taxes, penalties from SEC enforcement, and balance sheet reclassifications. Minimising costs would maximise profits and, in most cases, benefits to managers. Auditors also have incentives to earn as much revenues from their services, which may be affected by reporting manipulation, so they sometimes allow debt to be classified as equity (some auditing fees depend on company asset size). By maximising profits, earnings manipulation also allows managers to keep their jobs, avoid shareholder lawsuits, and raise the share price so they can exercise stock options and earn higher salaries. Evidence shows that managers are more likely to manipulate financial reporting if there are precise (rules-based) accounting standards than when standards are flexible, and that auditors are more likely to allow this as long as the rules allow it. When there are no "bright line" rules, but only concepts-based standards, managers are less likely to engage in costly