FAR 600

Note Q&A

CHAPTER 1-HISTORICAL DEVELOPMENT OF ACCOUNTING

Q1(b)
Describe the importance of accounting history to the development of accounting
practices.
Accounting history is a study of the heritage of accounting and its contribution to accounting
pedagogy, policy and practice.
With regards to accounting practice, accounting history could provide a better assessment of
the existing practices by a comparison with the methods used in the past. This calls for more
accounting history inquiry. It is a tool for a historiography of accounting to provide important
knowledge contributing to a better conduct of accounting research, practice and inquiry.

Q1(b)
Explain the importance of history to accounting pedagogy, policy and practice.
Accounting history is a study of the heritage of accounting and its contribution to accounting
pedagogy, policy and practice.
With regards to pedagogy, accounting history can be very helpful to a better understanding
and appreciation of the field of accounting and its evolution as a social science. Its meant to educate
the accounting professional members to appreciate their intellectual heritage. Accounting history
needs to be documented and incorporated by members who have the historical skills in order to
analyze and interpret historical developments in accounting thought and practice.
With regards to policy perspective, accounting history is instrumental to a better
understanding of the accounting problems and their institutional contexts as well as the formulation
of public policy.
With regards to accounting practice, accounting history could provide a better assessment of
the existing practices by a comparison with the methods used in the past. This calls for more
accounting history inquiry. It is a tool for a historiography of accounting to provide important
knowledge contributing to a better conduct of accounting research, practice and inquiry.

Q1(a)
Describe the notable characteristics of the management contribution phase.
Q1(a
Describe the Professional Contribution Phase (1959-1973) and its impact on the
development of
accounting principles and practices in the USA.
In this phase, professional bodies played a significant role in developing principles.
The professionals, AICPA took lead role in GAAP formulation through collaborative efforts
between the Accounting Principle Board (APB) and Accounting Research Divisions (ARD).
The APB issued various Opinions. However, it was criticized for ad hoc opinions and failure to
solve problems of accounting for business combinations and goodwill.
The dependence of associations and agencies also had the following outcomes
Authority of Statements were not clear-cut
They do not rely on established theoretical framework
Availability of alternative accounting treatment
Abuses of annual reporting were also noted in this phase.

COMMON TEST
Describe what it means by the politicization of the standard setting process.
The politicization of accounting standards is a situation created by the generally accepted view
that accounting numbers affect economic behaviour and consequently, that accounting rules should
be established in the political arena. According to Horngren, setting of standards is a social decision.
Because standards place restrictions on behaviour; therefore, they must be accepted by the
affected parties. Acceptance may be forced or voluntary, or some of both. In a democratic society,
getting acceptance is an exceedingly complicated process that required skilful marketing in a political
arena.

Illustrate the significant developments that influence the formulation of accounting

principles in the
USA during the following phases:
i. Management Contribution Phase (1900-1933)
In this phase, management had complete control over the selection of financial
information disclosed in annual reports.
The influence of management in the formulation of accounting principles arose from the
increasing number of shareholders and the dominant economic role played by industrial
corporation after 1900
The consequences of the dependence on management initiatives include:
Focus on pragmatic solutions, tax minimization, earning smoothing and variety of
accounting techniques
Given the pragmatic character of the solutions adopted, most accounting techniques
during this period lacked theoretical support
The management focus was more on the determination of taxable income and
minimization of income taxes
The techniques adopted were motivated by the desire to smooth earnings
Complex problems were avoided and expedient solutions were adopted
Different firms adopted different accounting techniques for the same problem
The phase set the stage for the beginning of a harmonisation between tax accounting
and financial accounting.
Another important event was the growing effect on accounting theory of taxation of
business income
ii. Institution Contribution Phase (1933-1959)
This phase was marked by the creation & the increasing role of institutions on the
development of accounting principles
It includes:
i. The establishment of Securities Exchange Commission (SEC) to administer federal
investment laws including the Securities Act that regulates trading securities.
SEC sent a definitive message that unless the profession established a standardsetting
body, SEC would use its mandate and develop accounting principles.
This set the role of SEC as a creative irritant in the development of accounting
principles in the USA.
ii. The AICPAs Special Committee proposed the first formal attempt to develop
generally accepted accounting techniques known as Mays broad principles which
became the focal point of the development of principles in the USA.
iii. The Committee of Accounting Procedure (CAP) to issue accounting
pronouncements called the Accounting Research Bulletins (ARBs).
However, CAP was criticized for various reasons:
Failure to work on unpopular issues
Failure to develop a comprehensive statement of basic accounting principles
Failure to give adequate hearing to accounting practitioners
failure to limit the alternatives available to management
iii. Professional Contribution Phase (1959-1973)
In this phase, professional bodies played a significant role in developing principles.
The professionals, AICPA took lead role in GAAP formulation through collaborative efforts
between the Accounting Principle Board (APB) and Accounting Research Divisions (ARD).
The APB issued various Opinions. However, it was criticized for ad hoc opinions and
failure to solve problems of accounting for business combinations and goodwill.
The dependence of associations and agencies also had the following outcomes
Authority of Statements were not clear-cut
They do not rely on established theoretical framework
Availability of alternative accounting treatment
Abuses of annual reporting were also noted in this phase.
iv. Politicization Phase (1973-present)
During this phase, Financial Accounting Standards Board (FASB) and various pressure
groups are moving toward a politicization of accounting.
The limitation of professional associations and management in formulating accounting
theory led to the adoption of a more deductive approach and politicization of standardsetting
process.
According to Horngren, setting of standards is a social decision.
Because standards place restrictions on behaviour; therefore, they must be accepted by
the affected parties.
Acceptance may be forced or voluntary, or some of both.
In a democratic society, getting acceptance is an exceedingly complicated process that
required skilful marketing in a political arena.

CHAPTER 2-ACCOUNTING IN ISLAM

In relation to the objective of providing information, the type of information and the users
of that
information, discuss the differences between Islamic and conventional accounting.
ISLAMIC ACCOUNTING CONVENTIONAL ACCOUNTING
Objective of
Providing Information
To enable users to ensure that
Islamic organizations (whether
business, government or NFP)
abide by the principles of the
Shariah or Islamic Law in its
dealing and enables the
assessment of whether the
objectives of the organizations
are being met.
Have to adhere to certain
Shariah principles and rules and
also try to achieve certain socioeconomic
objectives encouraged
by Islam.
To permit informed decisions
whose ultimate purpose is to
efficiently allocate scarce
resources available to their most
efficient (and profitable) uses by
providing information efficiency
in the market (FASB, 1978)
Users use the information to
make the appropriate buy, sell or
hold decisions on their
investments.

Type of Information Concentrates on identifying socioeconomic,

religious events and
transactions
Concentrates on identifying
economic events and transactions

Users of Information Whole gamut of stakeholders

recognized by the corporate report
Shareholders and creditors
(financiers - who provide the funds)

Q1

a) i) Elaborate on the fundamental differences between conventional and Islamic

accounting.
[same as Q1(a)-January 2013]
ii) What are the difficulties faced by the accounting profession in introducing the concept
of
Islamic accounting in the development of accounting standards?
The challenges faced by the accounting profession are as follows:
i. Businesses may question whether Islamic Accounting is relevant and necessary
ii. Extending the notion of accountability into conventional accounting may meet significant
resistance as the business case has not been successful
iii. Maintaining dual accounting conceptual framework may be a challenge for the national
standard setter
iv. Lack of intensive research into establishing a solid theoretical base for incorporating
Islamic values
v. The political will may be lacking
Q1
a) State the objectivity of accounting systems during the early development of Islamic
State.
The objectives of accounting systems were to ensure accountability, facilitate decision making
generally and permit the evaluation of completed projects. Some accounting systems
incorporated monetary and non-monetary transactions, while others were solely based on
monetary measurement. The reason for this was to ensure the proper collection,
disbursement, recording and control of certain state revenues and expenses.
b) i) Discuss the concept of Islamic accountability.
Faruqis (1982) concept of Khilafah (vicegerency) explains the vicegerent status of the
man in the world, in which that Allah has given amanah or trust of the earth to man while
other creatures have no ability to fulfil it.
Man is not only accountable for the spiritual aspects but also for the social, business and
contractual dealings as Allah also commands man to give back things that have been
trusted, to whom they are due.
Hameed (2000) suggest that this kind of accountability can be used as the main objectives
of Islamic Accountability. This suggestion is supported by Khir (1992) who asserts that this
concept will give great motivation for the practical development of Islamic Accountability.
Islamic accountability is defined by Hameed (2000) as being premised on both Islamic or
Muslim organization and owners with dual accountability.
Primary accountability: The concept of Khilafa whereby a man is a trustee of Allahs
resources
Secondary accountability: A contract between an owner or investor and a manager
Based on Islamic accountability, subsidiary objectives can be determined such as Shariah
compliance, assessment and distribution of Zakat, equitable distribution of wealth among
stakeholders, the creation of a cooperation environment and solidarity among the
Ummah.
ii) Discuss how zakat helps an organization to be more accountable.
Adnan and Gaffikin (1997) assert that the primary objective of Islamic accounting
information is the provision of information to satisfy an accountability obligation to the
real owner (Allah S.W.T)
They argue that by making Zakat the primary objective, one tends to avoid the unwanted
practice of cheating or window-dressing in any form, as he/she believes that Allah always
watches him/her. Consequently, accounting information will indirectly fulfill its users
needs as well as its societal responsibility.
Triyuwono (2000) believes that the use of Zakat oriented accounting would result in a
more Islamic organization as it implies certain features.
The transformation from profit maximization to Zakat optimization.
Any policy of the enterprise must comply with the Islamic Shariah as Zakat has been
taken as the ultimate goal.
It would inherently incorporate a balance between individual character and social
character whereas the Zakat concept encourages Muslims to make profits (under
Shariah guidance) some of which would then be distributed as Zakat representing
ones concern for social welfare.
The enterprise would be encouraged to participate in releasing humans from the
oppression of economic, social and intellectual factors and releasing the environment
from human exploitation.
It provides a bridge between the world and the Hereafter as Zakat raises human
consciousness that any worldly activities are related with their destiny in the
Hereafter.
Chapra (1992) said that an Islamic system in business should be able to achieve the
maqasid al-Shariah (objective of the Shariah) which includes everything that is needed to
realize falah (success in the world and the Hereafter) and hayat tayyibah (good life)
within the constraints of the Shariah.

Q1

a) i) Describe the meaning of Islamic accounting.

Islamic accounting is the accounting process which provides appropriate information to
stakeholders of an entity which will enable them to ensure that the entity is continuously
operating within the bounds of the Islamic Shariah and delivering on its socioeconomic
objectives. Islamic accounting is also a tool, which enables Muslims to evaluate their own
accountabilities to God.
ii) Explain why Islamic accounting is considered more holistic in nature?
Islamic accounting can be defined as the accounting process which provides appropriate
information (not necessarily limited to financial data) to stakeholders of an entity which will
enable them to ensure that the entity is continuously operating within the bounds of the
Islamic Shariah and delivering on its socioeconomic objectives.

b) Discuss how zakat system acted as the impetus for the development of Islamic
accounting in
the early Islamic state.
Zakat is an obligation of Muslims to give a specific amount of their wealth with certain
conditions and requirements to beneficiaries called Al-Mustahiqqin. The concept of Zakat
exemplifies Islams strong concern with social and economic justice. It serves as an equitable
redistribution of wealth and income, which is enforced through moral obligation and fiscal
measures. As many have argued, however, the redistributive economic impact of Zakat
depends on how it is administered, especially with regard to collection and distribution.
Management of Zakat is financially self-sustaining. Those who collect and distribute Zakat Al-
Mal are paid from Zakat proceeds. Zakat collectors are among the Zakat Al-Mal beneficiaries
in Islam.

Q1

a) Discuss the differences in the concept of accountability from both Islamic and
Conventional
accounting perspectives.
Islamic Accountability
Islamic accountability or accountability to God is discharged through accountability to
society.
It is the primary objective of Islamic Accounting.
Islamic accountability premised on both the accountor (Muslim organizations) and the
accountee (Owners) having dual accountabilities.
Islamic accountability is defined by Hameed (2000) as being premised on both Islamic or
Muslim organization and owners with dual accountability.
Primary accountability: The concept of Khilafa whereby a man is a trustee of Allahs
resources
Secondary accountability: A contract between an owner or investor and a manager
Based on Islamic accountability, subsidiary objectives can be determined such as Shariah
compliance, assessment and distribution of Zakat, equitable distribution of wealth among
stakeholders, the creation of a cooperation environment and solidarity among the
Ummah.
Conventional Accountability
Conventional accountability is as a form of principal agent relationship.
The agent (accountor) is accountable to the principle (accountee)
Accountor is supposed to take certain actions in managing resources given to him to meet
certain objectives and to account to his principal by giving information about his actions
to him

b) Explain the concept of CSR from Islamic perspective.

Islams concept of CSR encompasses a broader meaning, embracing the taqwa (Godconsciousness)
by which corporations (as groups of individuals) assume their roles and
responsibilities as servants and vicegerents of God in all situations.
CSR is a moral and religious initiative based on the belief that a corporation should be
good despite the financial consequences.
A corporation invoke the Shariah and employing in taqwa-based business paradigm in
pursuit of ultimate happiness in this life and in the Hereafter.
A corporation also acknowledged its social and moral responsibility for the well-being of
others (e.g., consumers, employees, shareholders, and local communities).
Moderation and concern for the needs of others, along with ones own.
Individuals and corporations are encouraged to sacrifice, give up, and spend their wealth
on the poor and the needy while expecting their reward only from God.
This sense of duty, responsibility, and spirit of sacrifice, which Islam nurtures, actually
helps remove self-centeredness and covetousness and promotes compassion, caring,
cooperation, and harmony among people.

Describe Adala (Justice) and Ihsan (Benevolence) as was discussed by the scholars.
Adala (Justice)
Allah commanded the maintenance of justice under all circumstances and in all aspects of life (Al-
Quran 6:152, 5:9)
The Prophet (pbuh) has also reiterated the maintenance of justice and has sternly opposed
against indulgence in injustice.
The Quran commands Muslims to be just and truthful while bearing witness and while deciding a
disputed matter, which is not only among them but also when dealing with their enemies.
Muslims are not allowed to exploit others and also may not let others exploit them. (Ahmad,
1995)
There are certain safeguards guidelines provided by the Quran. Ahmad then proposes some
principles for safeguarding the rights such as; (1) writing of a contract; (2) witnesses; and
(3) the principle individual responsibility.
Ihsan (Benevolence)
Ihsan means good behaviour or an act which benefits other persons without any obligation.
Siddiqi (1979) views Ihsan as being even more important in social life than justice.
If justice is the corner stone of society, Ihsan is its beauty and perfection.
If justice saves society from undesirable things and bitterness, Ihsan makes life sweet and
pleasant.
Ahmad (1995) outlines certain manners that would support the practice of Ihsan. There are:
1) Leniency
The foundation of Ihsan
Can be expressed in term of politeness, forgiveness, removing of other peoples hardship
and providing help.
2) Service Motives
Means Islamic business organizations should consider others needs and interest, provide
help and spend on others, recommend and support a good cause to others
Through involvement in business activity, a Muslim should intend to provide a needed
service to the community and humanity at large.
3) Consciousness of Allah and His prescribed priorities
Engagements in business should not become a hindrance to remembering Allah and
complying with His commands (Al-Quran 24:37)
The believers are asked to recognize and observe the priorities determined by the Quran,
such as;
i. to prefer the great and everlasting rewards of the Hereafter to the finite benefits of
the present world
ii. to prefer that which is morally pure to that which is impure
iii. to prefer what is lawful to that which is not

Q1

i) Discuss why the provision of a fair Zakat base is required and determined in Islamic
accounting.
Under the Islamic world, in order to account for the provision for Zakat, most important
consideration is the pleasure of God and accountability to Him. This accountability has
manifested in the form of how one can account for his/her Zakat obligations properly since
Muslims cannot segregate a worship activity from a non worship activity. Zakat is a religious
obligation and hence a faithful Muslim would not cheat on Zakat. The recipients are well
defined in Quran, and most motivates the Zakat payers as they realize that it will mostly used
for the poor and the destitute

ii) Explain the concept of asset as an element in Islamic financial statement.

Many versus in the Quran deal with various aspects of property and assets. An Islamic asset
includes all valuable property resulting from previous events belonging to the owner. Such
asset should be usurped and if obtained in a lawful (halal) was has economic benefits for its
owners. Lawful acquisition is a critical aspect of asset in this context; right to interest income
are never recognized.
CHAPTER 3-ACCOUNTING THEORY CONSTRUCTION

Define accounting theory and state the main purpose of accounting theory.
Accounting theory is defined as ...logical reasoning in the form of a set of broad principles that
(1) provide a general framework of reference by which accounting practice can be evaluated and
(2) guide the development of new practices and procedures.
The main purpose of accounting theory is to explain current accounting practice.

Discuss the differences between normative and positive accounting theory.

NORMATIVE POSITIVE
Prescriptive Descriptive, explanatory or predictive
Value laden Non-value laden
Does not involve empirical methodology Empirically based
Normative theory is a prescriptive theory that is stated in terms of what should occur in order
to achieve the theorys objective. Normative accounting theories prescribe the correct way to
account. Positive accounting theories mean an empirically tested theory that describes, explains or
predicts accounting practice. Thus, normative accounting theories (NAT) are prescriptive, whereas
positive accounting theories (PAT) are descriptive, explanatory or predictive.
NAT is more concerned with policy recommendations and with what should be done, rather
than with analyzing and explaining what currently accepted practice was. In other word, NAT prescribe
how people such as accountants should behave to achieve an outcome that is judged to be right,
moral, just or otherwise a good outcome. NAT dismiss conventional historical cost accounting as
being meaningless or not decision useful and prescribe the use of more useful systems of accounting
based on inflation adjustments. Normative theorists usually attempt to derive either the true income
or adopt the decision-usefulness approach whereby accounting reports are an input into users
decisions.
PAT concerned with explaining and predicting current accounting practices. PAT do not
prescribe how people (e.g. accountants) should behave to achieve an outcome that is judged to be
good. Rather they avoid making value-laden prescriptions. Instead, they describe how people do
behave (regardless of whether it is right); they explain why people behave in a certain manner; or
they predict what people have done or will do. This means, the focus is on understanding and
explaining the techniques and methods that accountants currently use and why have ended up with
the conventional historical cost accounting system.

Describe pragmatic and normative approaches in accounting theory construction.

Pragmatic Theories
Descriptive Pragmatic Approach
An inductive approach-it is based on continual observation of the behaviour of practising
accountants and then copy their accounting procedures and principles; hence a theory can be
developed from these observations.
Accountants were trained by being appreciated or articled to a practicing accounting for a
number of years.
Psychological Pragmatic Approach
Theorist observes the reaction of user to accountants outputs (such as financial reports).
The user reaction is taken as evidence that the accounting information (financial statement) is
useful and contains relevant information.
Normative Theories
The years 1956 to 1970 were considered as a normative period. The accounting researchers were
more concerned with policy recommendation and with what should be done, rather than with
analyzing and explaining current or accepted practice.
Under true income approach, normative theorists prescribe an ideal approach for management
system to derive true income for organization.
Under decision usefulness approach, normative theorists prescribe accounting theory for
providing information most useful for decision making (investment decision).
In most cases, these theories were based on classical concepts of profit and wealth or economic
concepts of rational decision-making and usually made adjustments to account for inflation or the
market value of assets.
Normative theorists do not test their model, thus they fail to prove their assumptions. Many
assumptions are made based on logic, not proved by empirical testing.
Normative theorists relied heavily on syntactic logic in deriving their theories and concentrated
on measurement and semantic consideration and the theories are based on value judgement.

What do you understand by positive accounting theory? Discuss.

PAT is an empirically tested theory that describes, explains or predicts accounting practice.
Positivism means testing or relating accounting hypotheses or theories back to experiences or
facts of the real world.
The objective is to explain and predict accounting practice. Explanation means providing reasons
for observed practice. Prediction of accounting practice means that the theory predicts
unobserved phenomena. Unobserved phenomena are not necessarily future phenomena; they
include phenomena that have occurred, but on which systematic evidence has not yet been
collected.
In other words, positive theory seeks to understand accounting phenomena by observing
empirical events and to use these results to make predictions about a wider set of observations
and/or to predict future events.

Explain any three (3) criticisms associated with descriptive pragmatic approach of
construction of
accounting theory.
i. The descriptive pragmatic approach does not include an analytical judgement of the quality of
an accountants action; there is no assessment of whether the accountant reports in the way
he/she should
ii. This approach does not provide accounting techniques to be challenged, hence it does not allow
for change
iii. The descriptive pragmatic approach focuses attention on accountants behaviour, not on
measuring the attributes of the firm, such as assets, liabilities and profit (not concern with
semantics of accounting phenomena)

Elaborate how normative and positive complement each other.

As positive accounting theory can help provide an understanding of the role of accounting to
assist in the development of normative theory; and normative theory can suggest alternative
accounting that can be tested empirically.
Normative theory provides the suggestion and theoretical arguments as to why something
should be recognized, disclosed or presented in a particular way in financial statements. These claims
can then be tested empirically (positive theory development)
a) Discuss the weaknesses of the descriptive pragmatic approach and psychological
pragmatic
approach to accounting theory construction.
DESCRIPTIVE PRAGMATIC APPROACH PSYCHOLOGICAL PRAGMATIC APPROACH
The descriptive pragmatic approach does not
include an analytical judgement of the quality
of an accountants action; there is no
assessment of whether the accountant
reports in the way he/she should
This approach does not provide accounting
techniques to be challenged, hence it does
not allow for change
iv. The descriptive pragmatic approach
focuses attention on accountants
behaviour, not on measuring the
attributes of the firm, such as assets,
liabilities and profit (not concern with
semantics of accounting phenomena)
Some users may act illogical manner where
some give preconditioned response and others
do no react at all.
Accountants can manipulate accounting
transactions and then produced the financial
report
If the users react, it shows the financial
statements are useful and contain relevant
information

b) i) Comment on the main issues generally discussed by normative theorists during this
period.

ii) Identify two (2) major criticisms of normative accounting theory.

To be normative, one must specify an objective function- for example, efficiency, decision
usefulness, estimation of future share prices, improved quality of financial reports.
However, many of the above objectives are conflicting, and it is difficult to decide which
one is a superior objective. It should be noted that the definition of an objective of
accounting continues to be a controversial issue because it is noted that objective is usually
defined in a broad, non-specific manner.
Normative accounting prescriptions are irrefutable. Popper also makes the point that no
amount of empirical testing can prove or disprove the validity of normative accounting
prescriptions. Therefore they are weak hypotheses.
Prescriptions from normative theories are not supported empirically to provide justification
that it is better than the status quo. For example, the redefinition of the objective of
financial accounting from the traditional stewardship role into a decision-making role
(usually to aid investors) was never justified empirical research.
a) Discuss the fundamental aspects of contracting theory and agency theory.
Contracting Theory
The firm serves as the legal nexus (connection) of contractual relationships among
suppliers and customers of factors of production
The firm exists because it costs less for individuals to transact (contract) through a central
organization than to do so individually.
Rather than all individual suppliers of the factors of production individually contracting
with consumers for their output, contract are struck by the the firm between classes of
suppliers and consumers of factors
Example, contracts:- for the supply of goods
- of employment for factory and other workers

Agency Theory
A contract where one party (the principal) engage another party (agent) to perform some
service on the principals behalf.
The principal delegated some decision-making authority to the agent
Both the principal and the agent are utility maximizes and there is no reason to believe
that the agent will always act in the principals best interest.
Agency problem: problem of inducing an agent to behave as if he/she were maximizing
the principals welfare.
Agency cost: dollar equivalent of the reduction in welfare experienced by the principal
owing to the divergence of the principals and the agents interests.
Monitoring costs: The cost of monitoring the agents behaviour
Bonding costs: The costs of establishing and complying mechanism to guarantee that
the agents will compensate the principal if they act in a manner contrary to the
principals interest
Residual costs: The wealth effect of the fact that, even with monitoring and bonding
expenditure, actions taken by an agent will sometimes differ from those that would
maximize the principals interests (wealth)

a) Explain how agency relationship gives rise to agency costs.

The agency problems arise when an agent behave in a manner that does not maximize
the principals interest, instead he/she will maximize his/her personal interest by transferring
wealth from the shareholders (principals) to himself/herself.
The agency problems, in turn, give arise to agency costs. At general level, agency costs
are the dollar equivalent of the reduction in welfare experienced by the principal owing to the
divergence of the principals and agents interest. Agency costs include monitoring costs,
bonding costs and residual loss.
Monitoring costs are the cost associated with monitoring agents behaviour. Bonding
cost is the cost of establishing and complying with mechanisms set by the managers to
guarantee that they behave in the interest of principals. Monitoring and bonding activities
cannot completely align principals and agents interest because it is not cost-effective to do
so. Therefore, the costs associated with the continuing difference are known as residual loss.
Comment on the advantages and disadvantages of the pragmatic approach in
accounting theory
development.

Advantages
The solutions of practising accountants are related to the requirements of the business world
They have developed and been handed down over a number of centuries
It is a pragmatic approach to solve the problems of accounting

Disadvantages
There is no logical assessment of the observed actions (not deductive)
These theories do no generate change within accounting-does not allow change (or change
occurs slowly)
Concentrated on pragmatics and ignores the measurement issues (semantics)
Derived accounting procedures and principles are not challenged (we perpetuate current
practice)
Theory is more about accountants than accounting.

Extra: STRENGTHS OF PAT

Theories that generate hypotheses capable of falsifying through empirical testing
Able to explain and predict accounting practice rather than supply prescription
Able to rationalize existing accounting principles
Able to model the connection between accounting firms and market
and to analyze problems within an economic framework.

a) Briefly explain how agency problem arises.

Agency relationship occur when one party (the principal) engage another party (agent) to
perform some service on the principals behalf. The agent will be employed since he may have
special skills, or the principal might not have the time to carry out the task himself. The agency
problem that arises is the problem of inducing an agent to behave as if he/she were
maximizing the principals welfare, in turn, gives rise to agency costs. The principal will
therefore try to construct the agency relationship so that actions that are in the agents self
interest are also in the best interest of the principal.

b) Discuss the role of financial statement in agency relationship

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 the directors because it could influence the decision to remunerate them, for
example to report artificially high profits for their companies to trigger bonus payment.

a) Explain a theory by reference to its:

i) Syntactic
One of the valid in terms of its logical consistency.
A syntactic methodology consists of a syllogism in the form of a set of premises
(analytical proposition) which requires a logical test to validate its truth.
Rules of logic include mathematical rules and grammatical rules.
Sometimes, logically valid conclusions may not relate to the real world.
ii) Semantic
Involves the use of words, symbols, terms or concepts as rules of correspondence
to relate to the real world.
It makes a theory realistic.
In accounting, the assignment of numbers (symbols) serve as rules of
correspondence.
In practice, rules of correspondence are often loose and vague.
iii) Pragmatic relationships
Focus on the effect of words or symbols on the behaviour of people.
For example, the reaction of users to accounting information or to a particular
accounting standard. Some may accept while others may lobby against it.
The pragmatic approach may be further categorized into the descriptive pragmatic
approach and the psychological pragmatic approach.
A theory has to be pragmatic if it is to be careful and capable of real-world
application.
It is pragmatic if it enables us to make informed political, social and economic
choices.

b) The Conventional Accounting practice of Historical Cost does not fulfil the elements of
a
good theory. Comment on this statement.
Traditionally, HCA is largely a syntactic theory, but only to the extent of its reliance on
double-entry.
Logical processing of inputs through verification of vouchers, invoices and journals
(auditing)
Ultimately, it is a pragmatic theory (Descriptive Pragmatic Approach) handed down by
generations of accountants...A pragmatic theory is one that is useful and has real-world
implications. HCA has not been rejected for alternate valuation bases.

c) Explain how the supporters of Historical Cost Accounting defense the criticisms by
normative theorists.
The supporters of Historical Cost Accounting defense the criticisms of normative theories from
the following arguments:
They argue that there is no requirement that accounting outputs should have any
semantic content or be subject to falsification rules.
A role of accounting is to allocate the HC of resource usage against revenue using the
matching concept to determine the surplus secured from economic activity.
The criticism of double-think can be argued because diversity within accounting
techniques exists only since it is demanded.
In turn, the reason it is demanded is that different accounting techniques are needed to
account for different business situations.
Moreover, different political and regulatory costs affect each firm. Since firms seek to
minimize all costs, they will choose different accounting techniques.
How does contracting theory describe the reason for the existence of the firm?
Under contracting theory, the firm serves as the legal nexus (connection) of contractual relationships
among suppliers and customers, for instance consumers will be able to buy his products for
consumption from the firm instead of producing himself as this is cheaper. In other words, the
existence of the firm helps reduce the cost of factors of production such as the existence of the firm is
that they are an efficient means of organizing activity because they reduce contracting costs.

Explain the purpose of accounting theory.

Explain and predict accounting practice as it is
Project ability and predictability
Justify existence of accounting profession and accountancy
Can be used as pedagogical devices to impart knowledge
Evaluate current accounting practice and guide the development of new accounting practice

CHAPTER 5- NORMATIVE THEORIES OF ACCOUNTING

THE CASE OF CONCEPTUAL FRAMEWORK PROJECTS

a) What is a conceptual framework?

The FASB defined its conceptual framework as a coherent system of interrelated
objectives and fundamentals that is expected to lead to consistent standards. The conceptual
framework prescribes the nature, function and limits of financial accounting and reporting.
According to the exposure draft, the conceptual framework is a coherent system of
concepts that flow from an objective. The objective of financial reporting is the foundation of
the framework.

b) Explain four (4) benefits of having a conceptual framework for accounting?

The benefits of having a conceptual framework for accounting are as follows;
i. Accounting standards should be more consistent and logical as they are developed from
an orderly set of concepts. That is, the accounting standards will be developed on the
basis of agreed principles.
ii. The development of accounting standards should be more economical because the
concepts developed will guide the standard-setters in their decision making.
iii. When accounting concepts cover a particular issue, there might be a reduce need for
developing additional accounting standards.
iv. CFs have had the effect of emphasizing the decision usefulness role of financial
reports, rather than just restricting concern to issues associated with stewardship.
v. Become fundamental principles which then do not have to be repeated in accounting
standards.
vi. Enable comparability between companies in same industry and with past performances.

c) Describe the meaning of relevance and reliability, as the two main qualitative
characteristics
of financial information in the IASB Framework.

b) Describe the recognition criteria for assets and liabilities set out by the IASB
Framework.
The recognition criteria for assets and liabilities set out by the IASB Framework are as
followings:
Assets
1. There must be an expected future benefit.
2. The reporting entity must control the resource giving rise to these future economic
benefits.
3. The transactions or other event giving rise to the reporting entitys control over the future
economic benefits must have occurred.
Liabilities
1. An expected future disposition or transfer of economic benefits to other entities.
2. A present obligation
3. A past transaction or other event must have created the obligation.

c) Discuss any three (3) limitations of conceptual framework in providing guidance to

accounting standard setters.
The limitations of conceptual framework in providing guidance to accounting standard setters
are:
i. Being principally economic in focus, general purpose financial reports typically ignore
transactions or events that have not involved market transactions or an exchange or
property rights.
ii. CF simply represent a codification of existing practice, putting in place series of
documents that describe existing practice, rather than prescribing an ideal or logically
derived approach to accounting.
iii. CF can be too general in nature and the principles, therefore, may produce inconsistent
standards.
iv. The static nature of the framework may not be able to keep up with the changing and
dynamic environment that accounting operates in.
v. CF is theoretical and prescriptive in nature, and thus it may not help in coming up with
standards that could resolve problems in accounting practices.

Describe how a conceptual framework can contribute towards financial reporting and
development
of standards.
A CF can contribute towards financial reporting and developments of standards by:
Guiding accounting bodies in establishing accounting standards
Providing frame of reference in revolving accounting questions if there is no specific promulgated
standards
Increasing compatibility by reducing the number of alternative accounting methods
Determining the bounds of judgement in preparing financial statements.

a) It has been argued that the development of a CF would lead to improved financial
reporting,
and this improved reporting would provide benefits to financial statement readers as it
would enable them to make more informed resource allocation decisions.
Discuss the views that support the argument.
The benefits associated with having a Conceptual Framework are:
i. Accounting standards should be more consistent and logical as they are developed from
an orderly set of concepts. Thus with CF, the accounting standards will be developed on
the basis of agreed principles.
ii. The development of accounting standards should be more economical because the
concepts developed will guide the standard-setters in their decision making.
iii. When accounting concepts cover a particular issue, there might be a reduce need for
developing additional accounting standards.
iv. CFs have had the effect of emphasizing the decision usefulness role of financial
reports, rather than just restricting concern to issues associated with stewardship.
v. Become fundamental principles which then do not have to be repeated in accounting
standards.
vi. Enable comparability between companies in same industry and with past performances.

b) Discuss the opinions put worth which argue that the conceptual frameworks are used
as a
means of legitimising standard-setting bodies.
Hines (1991, p. 328) states that Conceptual Frameworks (CF) presume, legitimise and
reproduce the assumption of an objective world and such they play a part in constituting
the social world... CF provide social legitimacy to the accounting profession.
Since the objectivity assumption is the central premise of our society... a fundamental
form of social power accrues to those who are able to trade on the objectivity
assumption.
Legitimacy is achieved by tapping into central proposition because accounts generated
around this preposition are perceived as normal.
It is perhaps not surprising or anomalous then that CF projects continue to be undertaken
which rely on information qualities such as representational faithfulness, neutrality,
reliability, etc..., which presume a concrete, objective world, even though past CF have
not succeeded in generating Accounting Standards which achieve these qualities.
The very talk, predicted on the assumption of an objective world to which accountants
have privileged access via their measurement expertise, serves to construct a perceived
legitimacy for the professions power and autonomy.
if we accept Hines argument, we would perhaps reject the notion that the profession was
attempting to uncover any truths or ideas, and, rather, we would consider that the
development of CF was a political action to ensure the survival of the profession.

a) i. Explain briefly the following four primary qualitative characteristics namely

understandability, comparability, relevance and reliability.
Understandibilty
The information is considered to be understandable if it is likely to be understood by users
with some business and accounting knowledge.
However, this does not mean that complex information that is relevant to economic
decision making should be omitted from the financial statements just because it might not
be understood by some users.
Comparability
To facilitate the comparison of the financial statements of different entities (and for a single
entity over a period of time), method of measurement and disclosure must be consistent but
should be changed if no longer relevant to an entitys circumstances.
Relevance
Information is regarded as relevant if it ...influences the economic decisions or users by
helping them evaluate past, present or future events or confirming, or correcting, their past
evaluations.
There are two main aspects to relevance for information to be relevant it should have
both predictive value and feedback (or confirmatory) value, the latter referring to the
informations utility in confirming or correcting earlier expectations.
Reliability
Something is deemed to be reliable if it is free from material bias and error and can be
depended upon by users to represent faithfully the underlying items it claims to represent.
Reliability is defined as the quality of information that assures that information is
reasonably free from error and bias and faithfully represents what it purports to represent.
Reliability is a function of representational faithfulness, verifiability and neutrality.
ii. In balancing relevance and reliability, reliability may have to be sacrificed over
relevance.
Discuss.

a) Discuss the significance of the conceptual framework in developing useful general

purpose
financial reports.
The conceptual framework of accounting is a structured theory of accounting that
guides the development of accounting standards and rules to be used in accounting practice.
The divergence of theoretical propositions from different perspectives and the difficulties
faced by profession to adopt the solution to accounting problems warrants the need for an
integrated and interpretive framework.
At the highest theoretical level, the CF states the objectives and scope of financial
reporting which include the decision usefulness, stewardship and social objectives. At the
fundamental level, it identifies and defines the qualitative characteristics of financial
information (such as understandability, relevance, reliability, timeliness and comparability) and
the basic elements of accounting reports (such as assets, liabilities, equity, revenue, expenses
and profit).
At the lower operational level, it deals with the principles and rules of recognition and
measurement of the basic elements of financial statements or reports. At the reporting level,
it specifies the types of information to be displayed in financial reports or statements.
Purposes and benefits of CF:
To provide a guidance to standard setters in reviewing of existing of standards and
development of future standards.
To promote more harmonised reporting and reduce inconsistency of accounting
practices.
To limit the potential for political interference in standard setting.
As a basis for resolving accounting problems and disputes.
To provide a basis for reconciliation any differences between existing legislation,
guidelines issued by regulatory authorities and existing and proposed accounting
standards.

b) Discuss why a trade-off between the two characteristics (relevance and reliability) is
necessary in certain circumstances.
It appears that the IASB Framework gives greater prominence to reliability and relevance
then to understandability and comparability.
In balancing relevance and reliability Information might be relevant but so unreliable in
nature or representation that its recognition may be potentially misleading.
The potential constraints on producing relevant and reliable information: timeliness and
balancing costs and benefits.
There will be a trade-off between being able to produce information quickly (and thereby
enhancing the relevance of the information) and measuring this information accurately
(and thereby reliably), as the production of accurate information often requires
corroboration that occurs sometime later.
In these circumstances, it is a matter of judgement as how to balance relevance and
reliability (that is, how long to wait against the extent of reliability required).
That is, the longer we take to ensure information is reliable (perhaps through various
forms of auditing), the less relevant the information becomes.

CHAPTER 4-APPLYING THEORY TO ACCOUNTING REGULATION

Discuss four (4) reasons that support the need to regulate financial accounting practices.

Discuss the differences between the free-market and regulatory approaches to the
development of
theories of regulation for accounting and auditing.
Free-Market Approach
Has basic assumption that accounting information is an economic good similar to other goods or
services.
It is subject to the forces of demand and supply i.e. demanded by interested users and supplied
by companies in the form of financial statements
Through the interaction between these two market forces, equilibrium is reached which results in
the production of information at an optimal price.
Whenever a piece of information is demanded, the market will generate the information if the
price offered is right.
Proponents of this view argue that mandatory standards are undesirable because they tend to
overproduce standards in view of the fact that the cost of production of information is not borne
by users.
Regulatory Approach
Critics of the free-market argue that the theory is unworkable because the market mechanisms
will not be able to achieve a socially optimal equilibrium price for accounting information for the
following reasons:
Accounting information being public good create free-rider problem. Only regulatory
intervention can persuade firms to produce the information necessary to meet real demand
and to ensure en efficient capital market.
A firm has a monopoly on the supply of information about itself and therefore, the tendency
will be for them to under-produce and sell at high price.
Gain high degree of legitimacy and forms part of tradition and legal framework. However, this
may be hampered by high compliance costs, bureaucratic, political influence and a need for
enforcement for compliance.
Able to create a level of disclosure necessary and adequate for decision making in the hope to
provide protection of investors and public interest.

a) Discuss why the standard-setting body should remain independent.

Remove lobbying pressure from the government and minimize politicisation of standardsetting.
Remove lobbying from interest groups or being captured by any interest groups
Standards setting will not be monopolised by accounting bodies
Enable opportunity for wider users participation in the process
Better compliance from users since they feel that they are better represented and
participate in the standard setting process.
b) i. Discuss the importance of regulation in accounting.
Accounting information is a public or free good so it should not be treated the same as
other goods.
In the presence of free-riders, true demand is understated
- pricing-system does not function properly
Unregulated situation may lead to underproduction of information
Regulation necessary to reduce impacts of market failure where the interests of certain
groups need to be protected from the opportunistic behaviour of others.
ii. Discuss the differences between the two theories of regulation, namely; the public
interest
theory and the private interest theory.
Public Interest Theory
Regulation is to protect consumer interests by securing improved performance when
compared with an unregulated situation.
Regulation put in place to benefit society as a whole rather than vested interests
Regulation body considered to represent interests of the society in which it operates,
rather than private interests of the regulators.
Assumes that government is a neutral arbitrator and assumed not to have any set of own
interest
The objective of serving public interest may not be fully achieved as this theory ignores
the fact that equity is a matter of viewpoint
Regulation is an outcome of a complex lobbying process where some parties interests
will be ignored.
Private Interest Theory
Assumes that there is a market for regulation with similar supply and demand forces
operating as in the capital market.
There are many bidders in political market but only one group will be successful, that is
the highest bidder.
Group are often in conflict with each other and will lobby government to put in place
legislation which will benefit them at the expense of others.
Regulators (and all other individuals) deemed to be motivated by self interest
The regulator is not a neutral arbiter but is seen as an interest group itself
Regulator motivated to ensure re-election or maintenance of its position of power
Regulation serves the private interests of politically effective groups.

Elaborate how the establishment of MASB is able to reduce political influence in

standard setting
process as well as ensure the production of objective financial reports in Malaysia.
With the introduction of Financial Reporting Act 1997, two independent bodies namely
Financial Reporting Foundation (FRF) and Malaysian Accounting Standard Board (MASB) were formed
to take over the roles of standards setting process and issue of accounting standards from MIA and
MACPA.
The FRF as a trustee body is responsible for the oversight of the MASBs performance,
financial and funding arrangements, and as an initial source of views for the MASB on the proposed
standards and pronouncements. It means that MASB is functioning under the control and supervision
of FRF. Thus, MASB must seek view and obtain approval from FRF on any proposed standards,
pronouncements or framework to be issued.
The members of the board of MASB appointed by Minister of Finance include a chairman, the
accounting general, six MIA members and three advisors representing the Security Commission, the
Company Commission of Malaysia and the Central Bank. No party can control and dominate MASB.
The MASB adopts due process in standard setting process. In the due process involves many
stages of processes and views from many parties including industries, professional bodies, regulators
are taken into consideration.
The benefits of having an independent body are:
i. Remove lobbying pressure from the government and minimize politicization of standard
setting process.
ii. Removing the lobbying from interest group or from being captured from by interested group.
iii. Standard setting will not be solely under the control of accounting bodies.
iv. Give opportunities for wider user participation in the standards setting process.
Thus, the rationale for the establishment of an independent body that is responsible for
standard setting and issue of accounting standards is to reduce political influence and to give greater
opportunities to interested parties to participate in the standard setting process. This in turn will result
in quality standards that are accepted by the users.

Extra:
RESPONSIBILITIES OF FRF UNDER
FINANCIAL REPORTING ACT 1997
To review the performance of MASB
To be responsible for financing arrangements
and operations of MASB
To approve MASB budget
To maintain proper accounts and prepare
annual statements of accounts of FRF
To perform such other functions as prescribe
by MOF
FUNCTIONS AND POWERS OF MASB UNDER
FINANCIAL REPORTING ACT 1997
Issue new accounting standards as
approved accounting standards
Issue statements of principles for
financial reporting
Sponsor/undertake development of
possible accounting standards
Conduct public consultation as necessary
Determine scope and application of
accounting standards.

a) Why is it that general acceptance of accounting standards important to the accounting

profession? Discuss.
General acceptance of accounting standards important to the accounting profession because:
to ensure control of accounting outcomes and the regulatory process and to maintain
effective barriers to entry to the accounting profession
to legitimize the accounting process, particularly in the face of increased criticisms of
standards of accounting information reported
to increase status by virtue of association with legislative support
to increase demand for full GAAP statements and for interpretation of accounting
standards and financial statements
to reduce risk associated with abidance with a set of legislated rules

b) Briefly outline some arguments in favour of regulating the practices of financial

accounting.
Some of the arguments in favour of regulating the practices of financial accounting are as
follows:
Markets for information are not efficient and without regulation a sub-optimal amount of
information will be produced due to
monopoly of information by the supplier of information
the occurrence of fraud
the under production of accounting information as a public good
Investors need protection from fraudulent organizations that may produce misleading
information which due to information asymmetries, cannot be known to be fraudulent
when used
Regulation leads to uniform methods being adopted by different entities, thus enhancing
comparability
The need to achieve desired social goals which include fairness of reporting, information
symmetry and the protection of investors.

c) Why would free market advocates argue that the regulation of financial reporting will
lead
to an oversupply of accounting rules and standards?
Free-market advocates argue that if the users of financial accounting information are not
required to pay for the information then they will tend to overstate their demands and
needs for information in an effort to encourage regulators to mandate additional
disclosures.
Free-market advocates believe this creates unnecessary costs for organizations as they
will end up producing information that people would not demand if they knew they
would have to actually pay for it.
Free-market advocates argue that accounting information should be treated like other
goods, and forces of supply and demand should be left to operate freely to determine the
optimum amount of information to supply.

a) Discuss two potential failures of standard-setting under private interest theory that
might
give rise to the public interest theory.
The theory suggests that public interest approach is required to answer the demand of the
public for correction of market failures. The potential failures that give rise to public interest
theory are:
1) Lack of competition (company monopoly the industry)
2) Barriers to entry (newly incorporated company has difficulty to enter the market)
3) Imperfect information gaps, where the buyers cannot get access or unable to obtain any
information regarding the sellers or certain market signals.
These factors would all lead to the under-supply and over-pricing of accounting information.
Information asymmetry and market failure are factors that limit the production of the right
amount of information which has resulted in pressure on regulatory authorities to intervene.
The government is assumed to be a neutral party who intervenes to protect the public interest
and has greater enforcement powers.
For example, government intervention into the accounting standard process in Australia
started with the establishment of the Australian Standard Review Board (ASRB) in 1984. This
establishment is because of failures in the market for accounting information, evidenced by
the significant number of corporate collapses, even after auditors had certified the accounts as
true and fair view. These collapses would be deemed to indicate that there were serious
violations of competitive conditions.
It would be seen that the violations stemmed from information asymmetries between the
suppliers (corporate management and accounting professionals) and the external users of the
financial statements (investors), who have no idea what kind of accounting information do
they need to know and unable to determine the value of the accounting information they had
received.

b) Provide arguments to support the benefits of maintaining the standard setting

responsibility
in the hands of the professional body such as the MIA.
i. Accountants feel that accounting is primarily technical in nature. Thus, this will result
in the best solution to critical issues.
ii. They are independence, highly trained and objective in their approach to decide what
generally accounting principles ought to be.
iii. The complex situations that arise in the business world require that accountants
develop the appropriate accounting principles.
iv. The use of consensus to develop accounting principles would decrease the
professional status of the accountant.
v. Other arrangement would lead to lobbying by various parties to influence the
establishment of accounting principles.

c) What are the advantages if the responsibility of standard setting is given to a public
body
such as the MASB instead?
Accounting depends in large part on public confidence. Therefore, the critical issues are
not solely technical but should take into consideration social and political influence.
Greater autonomy with better availability of resources.
Increased independence
Broader representation and responsive to the needs and viewpoints of the entire
economic community, not just the public accounting profession.
There are numerous conflicts between the various interest groups. In the light of this,
compromise is necessary.
Over the years, accountants have been unable to establish uniformity and acceptability
that in itself indicates rule-setting is primarily consensual in nature.
CHAPTER 6-ACCOUNTING MEASUREMENT SYSTEMS

a) i) In the context of historical cost, state the objective of accounting, and the concepts
of
capital and profit.
Objective of Accounting
The stewardship objective of HCA emphasises a conservative contractual relationship
between a firm and those who provide resources to it by making management
accountable for the input of assets to operations and the subsequent outputs on the net
value of equity from operations. Thus, the income statement is the key communication
mechanism.
According to conventional theorist, owners and creditors are primarily concerned about
what management has done with the funds entrusted to them, thus determining the net
worth of the owners is not important (thus, not a relevant measure)
Capital and Profit
In HCA, to determine the profit, the accounting entity must first retain the same amount
of capital (assets minus liabilities) that it had at the beginning of the period- where all
assets and liabilities are valued at their historical purchase cost. Thus, income is the
increment in HC capital at the end of the accounting period.
Income statement is the most important financial statement, since it reveals the results of
the operations of the business. The balance sheet is not of great significance; it serves
merely as a connecting link joining successive [income statement] into a composite
picture of the income stream.

ii) Explain the concept of value in use and value in exchange within the argument of the
measurement systems.
Value in Use (VIU)
A VIU approach uses an external investor or a production-oriented entity as the
relevant benchmark. Such an investor (firm) rarely focuses on current liquidation values but is
interested in the prospects for future cash flows, which are more accurately predicted by
operating earnings than current cash flow. So what is required is a measure of income that
matches the CC of assets inputs against outputs. This approach concentrates on obtaining the
most efficient results from asset in use and does not consider adaptability as an option.
Value in Exchange (VIE)
EPA as a VIE approach takes the viewpoint of an internal manager or creditor who has
to make decisions related to the liquidity of the firm and current spending power; that is, the
short-term performance of the firm is more important. This approach is particularly important
for firms with liquidity problems (high-debt firms), or firms engaged in tradeable goods and
which are able to quickly adapt their operations to market conditions (such as mutual funds
that invest in tradaeble bonds or shares)

b) In current cost accounting, it is argued that with regard to profit, management often
faces
two decisions. They are holding decisions (whether to hold or sell the assets) and
operating
decisions (how to use and finance the entitys operations).
Explain the view which proposes that holding gains should be a component of profit.
A firm benefits from the increase in the price of its assets because, otherwise, a greater
cash outflow would be necessary if it were to purchase them now. The cost saving is a
component of income, it represents an opportunity gain
Revsine offers another explanation of a cost saving:
A cost saving measures a firms cash position advantage relative to other firms in the
industry that were not fortunate to hold the given asset while its price rose. When these
other firms do buy the asset, they will have to do so at higher prices.
As a consequence, their cash outflow will exceed the cash outflow of the firm which
experienced the cost saving.
The appreciation of value is an actual economic phenomenon that could be realised if the
firm were to sell the asset
Revsine suggests that the inclusion of holding gains as profit may also be justifies on the
ground that the changes in the CC of the given asset reflect changes in the future cash
flows expected to be generated from the use of the asset.
Holding gains qualify as profit because the price increases on which they are based are a
reflection of greater future earning power.
Including holding gains as a component of profit reflects a financial capital view.
Any amount at the end of the period that exceeds the amount invested at the beginning
of the period, excluding additional investments by and distributions to owners, is profit.
Therefore, holding gains are part of profit.

a) Provide four (4) criticisms against the use of historical accounting as a basis for
income and
capital measurement systems.
i. No consideration of price level changes
Financial statements prepared under HCA are merely statement of historical facts.
Changes in the value of money as a result of changes in general level of price are not
taken into account. Hence, they fail to give true and fair picture of the state of affairs of
the organization.
ii. Unrealistic fixed assets values
In HCA, fixed assets are recorded and presented at the price at which they are acquired.
Changes in the market value of such assets are ignored.
iii. Insufficient provision for depreciation
In HCA, depreciation is charged on the basis of HC of fixed assets, not at the price at
which the same assets are acquired. The provision made by way of depreciation charge
on the original cost will not be sufficient for the replacement of assets.
iv. Unrealistic profit
Income statement prepared under HCA does not reveal true profit. Revenues are
recorded on current value basis whereas expenses are recorded at HC. Profits are overstated
during the period of inflation.
v. Fails to present a fair value of financial position
Non-monetary items like inventory, building, land etc. are shown at HC, not at current
value. During inflation, non-monetary items are understated. Thus, balance sheet fails
to present a fair value financial position.
b) Discuss why the advocates of historical cost accounting reject current cost
accounting. Give
two (2) reasons to support your answer.
The advocates of HCA reject CCA because:
CCA violates the conservatism principle that a gain should be recognized at the time a
non-monetary asset is disposed of.
CCA lacks objectivity because in most instances the CC to be used is not based on actual
transactions in which the firm is a participant.
CCA violates the traditional realization principle. If the firm intends to use the asset, as
opposed to selling it, changes in its market price are irrelevant.
A fixed asset is not more valuable to a firm simply because its CC has risen. Its value lies in
its service potential, not in its market (exchangeable) value.
The basis of determining the increase in cost is very subjective. If there is no reliable
second-hand market, then the basis for determining the CC of a fixed asset used by the
firm must be the new asset expected to replace the old.

c) Assuming that you are in favour of exit price accounting, Provide two (2) reasons to
support
the view.

]
a) How will CCA based on physical capital maintenance help managers to make better
resource
allocation decisions?
1. CCA is concern about expectation of future events. For example, if the price of raw
materials is higher than previous price and expected to increase, the company needs to
alter its future raw material prices and review budget and financial resources for the
future.
2. Shareholders, stockholders, creditors and other stakeholders are also interested on the CC
of the corporations and the evaluation by outsiders based on CCA provides the means for
successful functioning of the economy. Therefore resources will be allocated more
efficiently.
3. Since CC reflects changes in the future cash flow expected to be generated from the use of
the asset, therefore, an increase in the value of land will justify it to be accordingly put for
better or more productive use.
4. Right dividend policy based on CCA will retain funds for profitable reinvestment. Wrong
dividend policy means it is paid out of capital maintenance adjustment and capital would
not have been maintained.

b) i) Discuss the reasons for the different opinions among the three people mentioned
above in
relation to issues involving measurement and valuation of fixed or non-current assets.
The above discussion highlight the fact that can have two important componentsvalue
in use, emphasis on a long term approach and value in exchange, which concentrate on
a short-term approach to valuation.
It also highlights the inherent problem with measurement concept of an asset.
Malaysian Proposed Framework allows some flexibility and states that: A number of different
measurement bases are employed to different degrees and in varying combinations in
financial statements. They include the following:
i. Historical Cost (HC)
ii. Current Cost
iii. Realisable/ Exit Value
iv. Present Value
The accountant is referring to the HC where assets are recorded at the amount of cash
equivalents paid or the fair value of the consideration given to acquire them at the time of
their acquisition less depreciation or net book value.
The managing director is talking about exit price where assets are carried at the
amount or cash equivalents that could currently be obtained by selling the asset in an orderly
disposal.
Both accountant and the managing director ignored the concept of the value in use.
To the Production Manager, an asset that is held rather that sold must be worth more to its
owner than its exit price or HC. What important are the value of the assets to the business
(value in use) and not the value in exchange.

ii) Discuss how the differences in the valuation of assets namely, Historical Cost, Exit
Price and
Current Cost, affect the calculation of depreciation and its representation in the financial
reports.
Using HC, depreciation expense will be charged to income statement on a yearly basis
and the net book value will be reflected in the balance sheet. After all of the original cost is
allocated, the book value will apparently become nil.
Under exit price, they will be no allocation cost and the increase or decrease in value
will be reflected in the balance sheet.
Under CCA, the revaluation will be done and reflected in the capital reserve account
and the depreciation allocation will be reflected in the income statement accordingly after
taking into account the revaluation.

b) Explain how each of the different measurement systems stated above (historical cost,
exit
price and current cost accounting) affects the accounting for depreciable fixed assets in
the
income statement and the balance sheet.

c) Both historical and current cost advocates accuse exit price proponents of ignoring
the
concept of value in use.
Discuss the concept of value in use.
Both HCA and CCA advocates accuse EPA proponents of ignoring the concept of value in
use.
Solomon argues that the value to the owner/firm is the relevant perspective.
An asset that is held rather than sold out must be worth more to its owner than its EP,
otherwise it would be sold.
The failure to recognize that an asset that is not for sale does not directly cause its owner
to suffer if its EP drops.
Some assets are highly specific to a particular business and may be an excellent investment
for the firm.
Because no alternative use exists for the asset outside the business, their resale value may
be zero.
But the assets would not have been bought if the firm thought the purchase would incur a
loss.
a) i) Explain the weaknesses of historical cost accounting in providing information for
economic
decisions.
Profit and assets under HC have no prospective information but rather they are entirely
retrospective information.
It adopts financial capital concept. However, capital is regarded as the nominal dollar
investment in the firm rather than purchasing power of investment.
It overstates profit in time of rising prices because it offsets HC against current (inflated)
revenue. As such, if dividend exceeds real profit, it could lead to the unwitting reduction
of capital.
HC may be more reliable than current price but it is less relevant for decision making
purposes.

ii) Discuss the effect on profit if a historical financial statement is replaced by current
cost
financial statement during the period of rising prices.
The actual performance of the business should be based on what actually happen in the
current period.
The profit for instance, must be calculated based on the CC information.
Income statements show the actual profit during the current period unlike the HC income
statement, which overstates profit in time of rising prices because it offsets HC against
current (inflated) revenue.
The balance sheet reflects the current market value of financial position.
The fixed assets reflect the market value of assets unlike HC which show the residual value
of assets.

b) Discuss to what extent the modified historical cost accounting weakens the concept of
providing reliable information but is able to give useful and relevant information instead.
HC is now usually modified in its application by revaluation of fixed assets such as land
and building. The compromised of modified HC has produced balance sheet with different
valuation of assets book value, amortised value and revaluation value.
Adoption different measurement bases for some assets on a discretional basis would
play havoc with the concept of producing a balance sheet as a faithful and reliable document.
The resulting hybrid offers an assortment of values, which must be surely undermining the
concept being upheld.
On the other hand, the compromised position (modified historical cost) able to
provide useful and relevant information and gives some comfort to those who prefer
intangibles, particularly brands, to be revalued rather than subject to a process of
amortization. The users of information still need to use their expertise or experts to properly
revalue the performance and financial position based on the available data and market
information.
a) What are the criticisms of current cost accounting from advocates of historical cost?
How do
proponents of current cost defend these criticisms?
i. Recognition Principle
Advocates of HCA argue that CCA violates the conservatism principle that a gain
should be recognized at the time a non-monetary asset is disposed of.
Proponents of CC point out that the unrealized holding gains represent actual
economic phenomena occurring in the current period and therefore should be
recognized.
HC theorists argue that because the firm intends to use non-current assets, rather
than sell them, changes in the market price of those assets are irrelevant for profits.
Supporters of CCA argue that the determination of periodic profit should be based on
what actually happens in the current period (i.e. change in the market price of the
assets) and not on what might occur (i.e. the intentions of the company)
ii. Objectivity of Current Cost
The advocates of HCA argue that CCA lacks objectivity because in most instances the
CC to be used is not based on actual transactions in which the firm is a participant.
CCA advocates however argue that objectivity is relative. Even under conventional
accounting today, some figures are more objectivity determined than others. The
important criterion is whether or not CCA meet a certain minimum level of objectivity.
For items whose market prices are relatively easy to obtain, the objectivity of their CC
would be acceptable to accountants.

b) What are the benefits and shortcomings of separating out the holding gains (or
losses) in
profit determination?
The benefits of separating out the holding gains (or losses) in profit determination:
Holding a certain composition of assets and liabilities will enhance the firms market
position. Managers and other want to know if these holding activities are successful.
Under HCA, gains are recorded only when the assets are disposed of. Thus, determining
whether managements holding activities are successful or not is virtually impossible
unless assets are bought and sold in the same period. So, when comparing firms we may
be misled as to which firm is more efficient. Therefore, the separation of holding gains
and operating profit gives credit to the appropriate managers.
The shortcomings of separating out the holding gains (or losses) in profit determination:
Confuse the valuation of management decision.
Hinders the allocation of resources in the economy

a) Discuss the criticisms of historical cost accounting when it is applied in times of rising
costs.
In a time of rising prices, HCA can cause the following outcomes:
If prices of different assets acquired in different periods are simply added together, then
the total figure can be quite meaningless, lie adding together different currencies. The
final figure will generally understate the current market value of the assets.
Tied to the above point, if assets are understated, then this will in turn mean that the net
book value of the entity (assets less liabilities) is understated. This could perhaps, lead to
the owners selling an entity for less than it is actually worth (although clearly the owners
should consider other information about the value of the organization before determining
how much to sell it for).
When HCA is used, depreciation and cost of goods sold are based on HC which means
that profits are effectively overstated in times of rising prices (because expenses through
depreciation are understated). Because dividends in turn can be paid up out of profits,
the actual operating capacity of the firm might be eroded because too much has been
distributed to the owner and not enough has been retained certain assets whose
replacement costs have increased.
HCA distorts the current years operating results because it includes in current year
income holding gains that might have accrued over a number of periods.

a) Discuss the reasons why historical accounting is arguably not objective.

HCA involves estimates, for example, cost allocation in depreciation.
HCA involves several valuation methods, such as in inventory (LCM and NRV) and
investment (LCM)
During inflation, cost is understated, income is overstated
Valuation of cost of asset may include incidental costs which is subject to discretion
Unrealized profit is ignored while unrealized loss is recognized.

b) Chamber (1966) sees the business firm as an adaptive entity and has presented a
comprehensive proposal for the use of exit price.
i) Explain the concept of adaptive behaviour of the firm as implied by (1966)
The concept of adaptive behaviour as defined by Chamber implies a continual attempt by a
firm to adjust to the competitive business environment for the sake of survival. To continue in
business, a firm must be able to engage in market transactions, and this is revealed by its
financial position. This related to the firms capability as an adaptive entity engaged in buying
and selling goods and services. The survival of the firm depends on the amount of cash it can
command. Adaptive behaviour, therefore calls for knowledge of the cash and current cash
equivalents of the firms net assets at any particular time. That time must be the present.

ii) Assume that you are in favour of exit price accounting, give reasons for your support.
Additivity
All the values in the financial statements are additive, where they refer to one
characteristic which is cash and cash equivalent.
Allocation
Thomas argues that in EPA, the financial statements are allocation-free. Thus, there is no
problem concerning the allocation of costs.
Reality
EPA involves references to real-world examples because, it is argued, every figure refers to
a present, actual market price. Any increases and decreases in values as determined in the
market, as well as items purchased, sold or paid.
Objectivity
EPA are objective because they are market determined. If there is no market price, then
the item is stated at zero.
A measure of risk
EPA can be an indication of the financial risk of purchasing an asset. For example, if a firm
purchases an asset and its exit value differs significantly from its entry price, then the asset
is a risky proposition. This financial information indicates that the purchase of such an asset
should be a long-term proposition whereby economic value is recovered by value in use.
CHAPTER 7-CREATIVE ACCOUNTING & EARNINGS MANAGEMENTS

i) Describe what you understand by creative accounting.

Creative accounting (CA) is a practice whereby a company takes advantage of loopholes to
show that they are more profitable or financially stable than they actually are. In many cases
of creative accounting, the company is not yet breaking the law, but is most likely engaging in
unethical behaviour. Creative accounting can lead to suspicion, audits by the government and,
in the case of fraud, the dissolution of a company. Some creative accounting is simply done in
error when an accounting system is not set up for checks and balances.

ii) Explain why managers would manipulate their companies accounts. Give three (3)
reasons
to support your answer.

Discuss two (2) reasons why managers engaged in creative accounting.

a. The pressure placed upon management to show favourable returns on their investors
money.
They need to do this in a way to pleased shareholders in which reinforced by agency theory.
Financial reports produced by companies are the basis of the contract between each company
and its investors.
Thus, management will use CA to enhance their reporting and protect the basis of their
contract.
Pressure from management may cause accountants and auditors to agree in producing
favourable reports to shareholders using CA techniques to improve results.
b. Vagueness and flexibility of accounting standards and legislation
The purpose of accounting standards is to regulate how financial reports should be prepared and
presented
It also must allow individual reporting entities discretion in deciding what accounting method
best suits its organizational needs.
Accounting rules allow a reporting entity to choose between different accounting options.
A company therefore has the option of deciding on an accounting method that gives their
preferred image.
c. To stop shareholders from withdrawing capital
CA provide the opportunity for accountants to boost the financial performance and make the
true state of economic look much more better
Thus, CA will eventually help to stop shareholders from withdrawing their capital in the business.

a) i. Briefly describe two (2) classifications of creative accounting practices.

a. Recognizing Premature or Fictitious Revenue
Premature revenue recognition refers to recognizing revenue for a legitimate sale in a
period prior to that called for by GAAP. In contrast, fictitious revenue recognition
entails the recording of revenue for a nonexistent sale.
Revenue for ordered goods that have not left the shipping dock might be recognized
as though the goods had already been shipped. Such an act would entail premature
revenue recognition.
For product that might be shipped and revenue recognized in advance of an expected
order it would entail fictitious revenue recognition.
b. Aggressive Capitalization and Extended Amortization Policies
For aggressive capitalization and extended amortization policies, companies will
minimize expenses by aggressively capitalizing expenditures that should have been
expensed or by amortizing amounts over extended periods.
When capitalized, expenditure creates an asset that is amortized over some
predetermined useful life. When contrasted with the more conservative expensing
option, near-term earnings are increased, implying higher earning power.
c. Misreported Assets and Liabilities
As for misreported assets and liabilities, companies include assets that are not subject
to annual amortization, such as accounts receivable, inventory, and investments.
Expenses and losses can be minimized through an overvaluation of such assets.
For example, by overestimating the collectability of accounts receivable, the provision
for doubtful accounts, an operating expense, is reduced.
d. Getting Creative with the Income Statement
Getting creative with the income statement includes steps taken to communicate a
different level of earning power using the format of the income statement instead of
through the manner in which transactions are recorded.
Companies may report a nonrecurring gain as other revenue, a recurring revenue
caption, or a recurring expense might be labelled as nonrecurring.
e. Problems with Cash-flow Reporting
Given the potential recurring quality of operating cash flow, the higher the apparent
level of that cash flow statement subtotal, the greater will be a companys apparent
earning power.
In order to boost operating cash flow, a company might classify an operating
expenditure as an investing or financing firm. Similarly, an investing or financing inflow
might be classified as an operating item. Such steps will not alter the total change in
cash.

ii. Explain two (2) factors that motivate managers to engage in creative accounting.

b) In your opinion, should managers practice earnings management? Why or why not?
The Good Side of Earnings Management
When a contract imposes strict or incomplete terms on a manger; it can provide an
option of flexibility, where it excludes a managers opportunistic (self-interested)
motivations.
EM can be a device to unblock communication to outsiders or market. By using the
financial statements to communicate the financial health of the firm, EM can be used to
inform outsiders or market of managements inside information as per their exercised
expertise. The market cannot unravel this EM since it is based on inside information
about sustainable earning power. However, the market can use the EM to infer what this
inside information is.
For a contracting perspective EM can be good is related to the efficient contracting versus
opportunistic forms of positive accounting theory. It is desirable to give managers some
ability to manage earnings in the face of incomplete and rigid contracts.
The Bad Side of Earnings Management
EM reduces the reliability of financial statement. The managers change reported earnings
for reasons that are not clear.
EM that makes the company look better than it really is may result in disappointing for
the single investor and potentially leads to a welfare loss in society when the resource
allocation is distorted.
Firms that engaged in excessive EM will have to carry the burden of a tarnished
reputation. This may affect its ability to attract future investors. The image of accounting
profession will also be tarnished, which in turn may affect the credibility of the
profession.
The opportunistic EM from opportunistic manager behaviour when they use EM for
instance, to maximize their bonuses. Another example is when managers want to raise
new share capital, they will use EM to maximize the proceeds from the new issue. This
will benefit the current shareholders at the expense of the new shareholders.

a) Discuss the motivations behind earnings management

The motivations behind EM are as follows:
To meet investors earnings expectations
Firms that report earnings greater than expected typically enjoy a significant share price
increase. Conversely, those that fail to meet expectations suffer significant price
decrease. Thus, investors should be aware of this incentive.
Debt contract motivations
Debt contracts typically depend on accounting variables arising from the moral hazard
problem between manager and lender. EM may be used as a device to reduce the
probability of covenant violation (i.e. against lenders best interest) in debt contracts.
Initial public offerings (no established market price)
Managers of firm going public may manage earnings reported in their prospectuses in the
hope of receiving a higher price for their shares. Many IPO firms manage their earnings
upward. Lower earnings will contribute to poor share performance.

a) Discuss two implications and consequences of creative accounting.

Creative accounting (CA) may force investors to go elsewhere to invest their money, in an
attempt to find a country that can actually stem to tide of fraud cases, the borderline CA
practices.
Engaging CA practices hurts not just the immediate shareholders and stakeholders, but the
country as a whole. In the end, the economy suffers as investors look elsewhere.
Legislation may limit a firms ability to engage in scheme such as stock options or using
subsidiaries and associates to hide losses or liabilities but they never catch up.
Reliability is one of the core requirements of accounting standards. If accounts cannot be
relied upon due to the application of CA, then they are unethical, so they no longer serve
their purpose.
CA harms everyone, from the shareholders, owners, stakeholders, to the accounting
profession itself. There may be a short-term benefit to record a little revenue from the next
period, but still unsettle for next period and the risk involved unresolved.
b) How could firms manage earnings in accounting for research and development (R&D),
and in
off-balance sheet financing?
Research and Development (R&D)
In R&D, research costs should be recognized as an expense when incurred and should
never de deferred.
Development costs incurred in applying research finding or other knowledge are applied
more specifically to new or improved products and processes.
They may be deferred and included in the balance sheet. However, there remains the
problem of the subjectivity involved in capitalization.
No amount of guidelines will eliminate the individual estimations involved in compiling the
figures and because such reporting can easily be misused, the published figures, while
significant, can never be more than a guide.
The standard requires development costs that meet several specified criteria to be
capitalized and emphasizes that such developmental expenditure should relate to new or
substantially improved products. Thus, routine improvements to existing product would
not be developmental activity and could not be capitalized.
In conclusion, the accounting treatment of R&D costs is important in determining income,
and such costs should be accounted for in a way, which will provide useful information.
Off-Balance Sheet Financing (OBSF)
OBSF is other form of creative accounting is that rather than distorting or manipulating
financial reports, it does not reveal certain financial information.
It is effective because OBSF is not likely to be detected by independent users of company
accounts.
The arrangements are designed to comply with law in a form rather than a substance sense
such as stock purchase options, factoring of debtors, operating leases etc.
The basic idea is the true financial position of the company in relation to its debt is
distorted
In using OBSF, companies are able to show better debt ratios, borrow more money and still
maintain the appropriate debt ratio required by lenders and show a favourable income
level.

a) Define earnings management.

Earnings management (EM) is the choice by a manager of accounting policies (such revenue
recognition and depreciation policies) or in discretionary accruals (such as inventory values
and timing and amounts of non-recurring and extraordinary items) so as to achieve some
specific objective.
OR
EM is the process by which management can potentially manipulate the financial statements
to represent what they wish to have happened during the period rather that what actually
happened. EM occurs in corporations where managers attempt to present a more favourable
financial picture of the company performance through discretionary accruals.
b) What would be the managers argument to support the contention that smoothing
earnings
is useful for shareholders? Explain.
The managers argument is that if smoothing earnings is used responsibly, it can
reveal the managers estimate of persistent earning power. Since the manager is typically the
person best placed to know the firms future prospects, this estimate credibly reveals inside
information. Other ways of revealing persistent, typically result in major stock price declines.
Another argument is that smoothing avoids large increases in earnings followed by
large decreases, as, for example, ABCD in its first quarter 2004 decreases in earnings,
particularly of below investors expectations and if perceived as persistent, typically result in
major stock price declines.
c) Discuss how the shareholders would argue against the managers answer as in (b)
above.
The shareholders may argue that EM, such as smoothing, hinder investors ability to know
what is really happening within the firm. For example, losses and gains such as those resulting
from fluctuations in commodity prices have really happened. They should not be artificially
smoothed by means of earning management, including excessive hedging. Excessive income
smoothing may also indicate opportunistic managers behaviour.

a) i) How is off-balancing-sheet-financing (OBSF) being used as a technique of creative

accounting?
OBSF is other form of CA is that rather than distorting or manipulating financial reports,
and does not reveal certain financial information.
It is effective because OBSF is not likely to be detected by independent users of company
accounts.
The arrangements are designed to comply with law in a form rather than a substance sense
such as stock purchase options, factoring of debtors, operating leases etc.
The basic idea is the true financial position of the company in relation to its debt is
distorted.
ii) Why do managers employ creative accounting techniques?

b) Discuss the following earnings management patterns that managers may engage in:
i) Taking a bath
It can take place during periods of organizational stress or reorganization, including the hiring
of a new CEO. If a firm must report a loss, management might want to report a large one and
it has little to lose at this point. This will enhance the probability of future costs.
ii) Income minimization
Such a pattern may be chosen by a politically visible firm during periods of high profitability.
Policies that suggest income minimization include rapid write offs of capital assets and
intangibles, expensing of advertising and R&D expenditures, successful-efforts accounting for
oil and gas exploration costs, and so on.
iii) Income maximization
Managers may engage in a pattern of maximization of reported net income for bonus
purposes, providing this does not put them above the cap. Firms that are close to debt
covenant violations may also to maximize income.
iv) Income smoothing
Managers have an incentive to smooth income sufficiently that it remains between the bogey
and cap. Otherwise, earnings may be temporarily or permanently lost for bonus purposes.
Furthermore, if managers are risk-averse, they will prefer a less variable bonus stream, and
hence may want to smooth net income.

CHAPTER 8- EMERGING ISSUES IN ACCOUNTING AND AUDITING

a) Discuss four (4) factors that could possibly contribute to the recent growth of
sustainability
reporting.

b) Explain four (4) benefits of filing financial reports using XBRL.

A universally accepted information sharing tool
XBRL is available universally in many countries and facilitates sharing business
information in many languages, on virtually any computer platform and in multiple
accounting standards. Companies can increase automated information sharing with
minimal implementation costs. Information can be converted into a variety of formats
including HTML, spreadsheets and databases.
Real-time reporting
Accountants will be able to audit their clients on a continual basis and less field research
time. Financial analysts are able to compare companies and evaluate them with greater
ease. Timelier presentation of facts will present a more relevant picture of the financial
status of an organization.
Beneficial for a variety of stakeholders
It can be utilized by investors to facilitate analysis of financial results, by companies to
eliminate manual input and review of information passed through the financial reporting
process, and by governmental entities to efficiently gather information from business.
Open Source
Organizations have paid to develop taxonomies that can be used without any cost to
those that use them. By utilizing the freely available XBRL resources, companies can
benefit from XBRL while keeping implementation costs to a minimum

i) Discuss two (2) benefits associated with sustainability reporting.

The benefits associated with sustainability reporting are as follows:
It instils discipline and helps a company think about and defined its long term vision and
raises awareness of sustainable practices in the wide organization. The vast majority of
the participants felt that the process of reporting helps improve long term thinking by the
company.
A benefit to organizations in their communication with stakeholders. Robert Kraybill
stated that reporting and the data gathering and strategy behind the reporting can
increase their ability to communicate with investors regarding their social impact and
KPIs.
Help companies set target and KPIs. Even in the case where companies fail to meet those
targets, Rebecca Lewis felt that the process of setting them can help companies reduce
risk and identify opportunities and build resilience into the core business model.

ii) Explain why Global Reporting Initiative Reporting Framework is needed for
sustainability
reporting assurance. Give three (3) reasons to support your answer.
Sustainability reports based on the GRI Reporting Framework representation disclose
outcomes and results that occurred within the reporting period in the context of the
organizations commitment, strategy, and management approach.
The GRI Reporting Framework contains general and sector-specific content that has been
agreed by a wide range of stakeholders around the world to be generally applicable for
reporting an organizations sustainability performance.
The GRI Reporting Guidelines offer Reporting Principles, Standards Disclosures and an
implementation Manual for the preparation of sustainability reports by organizations,
regardless of their size, sector or location.

a) What is the meaning of sustainability accounting? Discuss.

Sustainability accounting (SA) is a subset of social accounting. The term sustainability
can be regarded as meeting the needs of the present without compromising the ability of
future generations to meet their own needs.
Thus, sustainability is concerned with both environmental protection (eco-efficiency)
as well as justice between peoples and generations (eco-justice). SA focuses on reporting the
economic aspects of the firms operation, including information relating to their relations with
their employees, communities and the environment.
For Instance, a firms report might contain information about its policies, actions and
commitment in providing quality product to their consumers, using fair trade suppliers and
local suppliers, supporting charitable events and organizations in local communities, and
reducing their impact on the environment through waste and carbon emissions.
One of the most widely used set of guidelines for sustainability reporting is the one
published by Global Reporting Initiative (GRI). The GRI guidelines form the basis of
sustainability disclosure framework and contain principles and guidelines plus standard
disclosures for all types of organizations.
Extra: Why do you think it is necessary for companies to seek sustainability reporting
assurance?
Auditing is argued to provide the benefits by increasing the credibility of management-prepared
financial statement and
improving the quality of an entitys accounting system based on feedback from auditing process.
Therefore, companies with the most to gain from increasing the credibility of their reports are
more likely to seek assurance.
According to KPMG, companies claim they seek assurance on their corporate responsibility report
to increase the credibility of their report and processes and
also because they wish to improve the quality of reported information.
Furthermore independence assurance provides confidence to stakeholders on the credibility,
relevance and reliability of the report.
b) Discuss the factors that contribute to the increase in the number of companies
seeking
assurance for their sustainability reports.
The factors that contribute to the increase in the number of companies seeking assurance for
their sustainability reports are:
An important ingredient in the usefulness of company financial reports is independent
assurance of the report. Independent assurance provides confidence to stakeholders
about the credibility, relevance and reliability of the reports. Similarly, companies seek
assurance on their corporate responsibility reports to increase the credibility of their
reports and possesses and because they wish to improve the quality of reported
information.
An increase in the demand for verified environmental information among the users and
public. Consumers are concern about the green washing claims. Green washing is the
practice of disseminating disinformation so as to present an environmentally responsible
public image.
Demand for verified environmental information for regulatory purposes has driven the
provision of assured information to a wider group of stakeholders. For example, the
Scandinavian countries were among the first to mandate environmental reporting and
ensure companies made the information available to their externals stakeholders
In the United States, the change in attitude towards sustainability reporting and
assurance could be due to the end of the Bush Administration, and the activities of lobby
group. In addition, the incentive could also be attributed to the growth of the Carbon
Disclosure Project (CDP). The CDP contains data from corporations on their climate
change risks, strategies and greenhouse gas emissions.
i. Discuss four (4) obstacles faced by accountants in embracing sustainability reporting.
Four obstacles by accountants in embracing sustainability reporting are:
Reporting of qualitative factors is difficult
No mandatory standards and clear guidelines
No mandatory audit on environmental reporting
Increased costs to firms
ii. Do you agree that sustainability reporting enhances public trust? Give reasons to
support
your answer.
Companys performance is not only measured from financial aspects but is evaluated from its
sustainability aspect of environmental and societal. The long term sustainability of corporation
depends on public trust. Corporations must attract and retain investors, employees, creditors
to continuously support the corporations product and services. Enhanced reputation enables
the corporations sustainability. Lack of responsibility by corporations towards sustainability
reporting may lead to risk of losing investors and public trust.

a) Describe what you understand by social and environment disclosures as compared to

financial disclosures in financial statements.
Broadly speaking, and compared to conventional accounting, social and
environmental disclosures encompasses the following characteristics (Gray,1990):
disclosures for different things, other than or in addition to economic events;
disclosure in different media, in other than or in addition to financial terms;
disclosure to different individuals or groups, beyond the regulatory, investor and
shareholders to a wide range of stakeholders; and
disclosure for different purposes, other than for decision based on financial results.
A Corporate Environmental Report (CER) is a tool to communicate a companys
environmental performance. It is used to demonstrate company-wide integrated
environmental management systems, corporate responsibility and the implementation of
voluntary initiatives and codes of conduct.
It is important to underline that the CER is a means to environmental improvement
and greater initiatives, not an end in itself.
The scope of social and environmental disclosures includes:
- Labour and Working Conditions - Minority and Equity Issues
- Pollution Prevention - Energy Use
- Health, Safety and Security - Cultural heritage
On the contrary the main purpose of financial accounting is to communicate an
organizations financial position to investors, banks, regulators, and other outside parties that
might be interested. There are many rules associated with financial accounting, as the reports
must be prepared in accordance with MASB accounting standards and are statutory in nature
and be certified by external, independent auditors.
b) Discuss the potential hurdles for reporting social and environmental issues solely in
financial
terms.
The potential hurdles for reporting social and environmental issues solely in financial terms
are as follows:
i. Returns are more difficult to quality
Investors will lean toward those outcomes that are easier to measure in financial terms,
leaving many non-profits out of the radar screen.
ii. Costs calculated are intangible
When reporting SER financially, many of the costs calculated are intangible.
Measurement of social and environmental performance is difficult and new
measurement techniques need to be developed.
iii. No framework to measure SER
There are no universally agreed frameworks that the accounting profession can use to
measure SER. There are also concerns about what form information should take- in
particular how appropriate is it reduce all SER impacts to monetary units.
iv. Challenge to report and verify non-financial information
It a challenge for accountants to report and verify non-information the same way that
financial information must meet. The question is how to enable the financial principles
of financial reporting to be applied to SER: relevance, understandability, reliability and
comparability.

a) Explain in what way do the fulfilment of the social contracts leads to organizational
legitimacy?
Social Contract Theory attempt to show that individual and social group rights and liberties
are founded on mutually advantageous agreements which are made between members of
society (Rawls, 1999).
Within the context of organizational interaction with society, Legitimacy Theory has
emerged, asserting that organizations continually seek to ensure that they operate within
the bounds and norms of their respective societies, that is, they attempt to ensure that their
activities are perceived by outside parties as being legitimate (Deegan, 2000, p.253)
Organizations exist in a particular society when they are considered to be legitimate. Indeed
society confers upon the organization the state of legitimacy, defined as a condition or
status which exists when an entitys value system is congruent with the value system off the
larger social system of which the entity is a part (Lindblom, 1994)
Legitimacy theory itself relies upon the concept of a social contract which is used to define
an arrangement between an organization and members of society.
Under legitimacy theory, it is considered that an organizations survival will be threatened if
society perceives that the organization has breached its social contract. Organizational
legitimacy is, therefore, considered to be a resource on which an organization depends for its
existence.
According to Shocker and Sethi (1973, 1974), a social contract is conceived to exist between
the organization and the public at large, not just its owners.
Legitimacy theory suggests that, where there is a severe breach of a social contract by an
organization-where there is a serious failure to comply with societal expectations, the
community may revoke its contract to continue operations.
In such circumstances, the costs of the organization continuing to operate can be perceived
to be greater than its benefits to society as an ongoing entity.
If this is the case, the social contract with that organization may be terminated.
On the other hand, organizations that are perceived to be honouring social contracts are
regarded as providing benefits to society in excess of costs and remain constantly poised to
continue to enhance their performance.
Extra: PURPOSE OF CSR
To increase/gain customer loyalty
To increase companys image as credible and reliable business partner for suppliers and customers
To improve employee productivity
For better community relationship
To help organization hire and retain people they want
Extra: PRINCIPLES OF CSR
1. Sustainability- Concern with the effect which action taken in the present has upon the options
available in the future. It implies that society must not use no more of a resources that can be
regenerated
2. Accountability- Concern with an organization recognizing that its actions affect the external
environment, and therefore assuming responsibility for the effects of its actions
3. Transparency- The enterprise shall clearly, accurately, and comprehensively declare its policy,
decisions, and activities, including known and potential effects on environment and society.
Moreover, such information shall be available to affected persons, or those who are likely to be
affected materially by the enterprise.

b) How does corporate social and environmental reporting contribute to the increase in
shareholders wealth?
CSR reporting is an approach to give businesses the opportunity to express their
commitment to their society. Setting goals and managing a companys performance under a
holistic economic, environmental and social perspective is a key to long term local and
international business success.
CSR could also improve the quality of information available to fund managers and
investors. Shareholders and potential shareholders can exercise effective control only if they
have clear and meaningful information about the main drivers of a companys past and future
performance.
CSR reporting will enable them to make a proper assessment not only of past
performance but also of the directors view on the companys future prospects and its
approach to managing all those factors-environmental performance, employee issues,
relations with suppliers, customers and local communities-which are crucial to the companys
future success and reputation.
It will take a complete change of focus for investors and managers to supplement
traditional financial information with more CSR data. An increase in disclosure can surely help
to bring these non-tangible benefits, which can have positive financial implications, to the
notice if investors.
Extra: SARBANES-OXLEY ACT (2002)
Were introduced to prevent auditor independence problems by restricting auditors provision of
non-audit service to their clients.
Even if there is no actual independence impairment to prevent,
these regulations could help auditors and their clients avoid problems caused by perceived
independence impairments.
The introduction of SOX following the collapse of the Enron Corporation and the audit firm Arthur
Andersen can be viewed through the lens of the public interest.
In US prior to SOX, audit firms reviewed each other under a system of peer reviews administered
by the AICPA.
This process involved gathering information on audit firms quality control procedures by reviewing
staff and inspecting documentation.
It was criticised this review process was not sufficiently rigorous and reviewers would be unlikely to
detect important deficiencies.
It was suggested that staff could be trained to answer a reviewers question and documents could
be produced which showed a more thorough audit than actually took place.
Since 2004, the Public Company Accounting and Oversight Board (PCAOB), which was established
under the SOX legislation, have conducted independent inspections of audit firms.
Another key provision in SOX is a restriction on the provision of certain consulting (non-audit)
services by audit firms to their clients.
The financial statements auditor is banned from providing consulting services to their clients,
except for some specific exceptions with the prior approval of the clients Audit Committee.