The Nature of Accounting Regulation

Ian Dennis

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781134451524
• Edition: 1
• Topic: Business
• Subtopic: Financial Accounting
• Index: Business

Accounting standards are an essential element in the regulation of current financial reporting. Standard setters promulgate such standards, and companies and professional accountants follow them in preparing financial reports. Although much has been written about the history of standard setting, the conceptual underpinnings of accounting standards, the process of setting them, and whether such standards should be 'rules-based' or 'principles-based, ' there has been little written about the kind of thing they are. This book examines the nature of accounting standards and the very idea of a rule, of implementation guidance, and of the objectives that are included in them. It enables the reader to grasp the reasons for promulgating standards, the role of the conceptual framework in setting standards in an institutional context, and the kind of rules that are useful in regulating financial reporting. The insights provided by this examination are used to throw light on the distinction between 'principles-based' and 'rules-based' standards and on the nature of 'good' accounting standards.'

1
Introduction

This book is about the nature of accounting regulation. ‘Regulation’ has been defined as ‘the imposition of constraints upon the preparation, content and form of external reports by bodies other than the preparers of the reports, or the organizations and the individual for which the reports are prepared’ (Taylor and Turley, 1986, p. 61). Given this definition, regulation can be undertaken by various bodies. Legislatures can impose constraints on external reporting through the law. In the UK this is evident in the Companies Acts. Legal regulation of financial reporting is not directly examined in this book. Instead the book focuses on the kind of regulation that is imposed by standard setting bodies and, in the case of the UK and the EU, may be adopted by legislatures. As has been observed, ‘the recent history of accounting… has been marked by the rapid and continuing promulgation of accounting standards’ (West, 2003, p. 1). In the UK the standards promulgated by the International Accounting Standards Board (IASB) as a result of EU decisions and in the U.S. by the Financial Accounting Standards Board (FASB) are central to the regulation of financial reporting for companies listed on stock exchanges. Although the examination of accounting regulation may be relevant to financial reporting in countries other than the UK or EU countries, issues that are particular to them are not analysed. Entities whose financial reports are not regulated by these standard setting bodies are not specifically considered.

What the Book is not about

It might appear rather negative to begin a book by stating what it is not about. The problem with accounting regulation is that it is a large topic, and there are a number of important areas of academic research which adopt different methods of enquiry that could be covered by an examination of the nature of accounting regulation. All the approaches to research in this area and the questions asked in these enquiries cannot be considered in a book of this size. It is better to come clean and indicate what will not be considered rather than to disappoint expectations. This will hopefully forestall the kind of objections to the research that amounts to criticism that is, in essence, ‘I would like you to have considered…’ or ‘Why haven’t you done it like this…?’ At least stating what is not covered at the outset will allow readers to decide whether or not to continue reading after the first few pages.

Other things that will not be considered in the book include the question of why we need to regulate financial reporting in the first place. There is a large literature that considers the arguments for and against regulating financial reporting (see the review by Bushman and Landsman, 2010). This literature is not examined in the book. There is regulation of financial reporting, and it happens through the promulgation of accounting standards. The book is not concerned with the question of whether or not there should be such regulation. The book does not get involved in the question of whether or not standard setting is political. It is accepted that financial reporting has ‘economic consequences’ (Zeff, 1978) and that political considerations may be involved in standard setting (Solomons, 1978; Zeff, 2002; Moran, 2010). Standard setting is an intentional action, and there can be a number of different motivations that give rise to different descriptions of what they are doing. This book takes seriously the suggestion that standard setters set standards by considering ‘principles’ in a conceptual framework. It therefore takes seriously the idea that an important reason for the actions of standard setting involves such a framework. This is not to discount the fact that there may be other motivations as well. It would only follow that considering the motives provided by a conceptual framework would be pointless if they played no part, or very little part, in explaining or justifying or giving reasons for the action of standard setting. The book does not review the history of standard setting in any detail. This is well covered by accounting historians (Zeff, 1972; Zeff, 1999). It acknowledges that standards set by the IASB and the FASB are important determinants of financial reporting and does not explore how this state of affairs came about.

What the Book is about

Having stated what the book is not about, the contribution of the book and the areas that are examined will now be described. Given that financial reporting is regulated, the nature of this activity and the constraints that are imposed by accounting standards are examined. Chapter 2 starts with the obvious point that accounting and financial reporting involve intentional actions. The nature of intentional actions is explained, and the role of practical reasoning in arriving at a desire to perform such actions is examined. The insight that accounting and financial reporting are rule-governed is explored. The practical reasoning to a desire to do something that is in accord with a rule involves taking the rule as part of the reason for performing such actions. Chapter 3 goes on to examine the nature of rules and of practices of following rules. Different practices are identified. It is suggested that financial reporting is an institutional or legal practice where the reasons individuals undertake the actions that constitute financial reporting include the desire to act in accordance with rules established by institutions or the legislature. Where this is the case, examining the reasons for particular actions involves considering not just why individuals follow such rules but also why institutions like standard setters promulgate the rules preparers and accountants want to follow. This leads to a consideration of accounting theories in chapter 4. Two broad approaches to accounting theorizing are examined. One looks at accounting theories as providing general rules from which the more specific rules included in accounting standards are derived. Another approach considers that accounting theories provide reasons for adopting specific rules by identifying what is wanted in promulgating such rules. These reasons constitute premises in practical reasoning to the promulgation of rules by standard setters. Conceptual frameworks in accounting and financial reporting are explained by reference to these two kinds of theorizing. ‘Principles’ in a conceptual framework can be understood either as general rules that underpin more specific rules or as reasons for adopting specific rules. This provides insight into what is meant by normative theorising in accounting. It also provides one understanding of what it means for the rules in accounting standards to be ‘principles-based’. The nature of the reasoning from ‘principles’ to specific rules is also examined. It is suggested that the model of such reasoning is not deductive but of some other kind. This throws light on the kinds of statements that are included in a conceptual framework and on the role of judgement that must be exercised by the standard setter in reasoning to accounting standards. The kinds of rules that are derived from a conceptual framework are examined in chapter 5. Two different conceptions of rules are identified that deal in different ways with the problem that particular rules may not fulfil the desires that constitute the reasons for their promulgation. A further problem with rules is explored in chapter 6. The language used to express the rules in accounting standards may be vague or indeterminate. The use of explanatory guidance in such standards to overcome these problems is explored. The implications of the analysis in these chapters for the nature of accounting standards are drawn in chapter 7. The anatomy of standards is described. Standards can include objectives, rules and explanatory guidance that deal with the problems of standards setting identified in the previous chapters. The book finishes with drawing out the implications for standard setters of the analysis of the nature of accounting regulation through accounting standards.

The Method in the Book

The book makes a contribution to understanding the nature of accounting standards and the use of conceptual frameworks in setting accounting standards. The repeated references to questions about ‘the nature’ of intentional actions, practical reasoning, rules and practices of following rules, theorizing about accounting, ‘principles’, ‘conceptual frameworks’, ‘principles-based’ standards and implementation guidance are meant to indicate that the approach to considering the nature of accounting regulation in this book uses the method of conceptual enquiry. Power writes that ‘little attention has been given to the role and status of what might be called “conceptual considerations” in financial reporting’ (Power, 1993, p. 44). In particular, he argues that there has been a failure to make adequate enquiries into the nature of the concept of a ‘conceptual framework’ for accounting. Wittgenstein’s philosophical method might be called conceptual enquiry, and this kind of enquiry is made in this book in relation to the concepts used to explain aspects of accounting regulation. It includes the idea that such regulation proceeds from consideration of the ‘principles’ in the conceptual framework. Wittgenstein once observed that ‘concepts lead us to make investigations; are the expression of our interest, and direct our interest’ (Wittgenstein, 1953, §570). The idea that standard setting involves reasoning from ‘principles’ in a conceptual framework to the intentional action of promulgating rules in accounting standards that include objectives and implementation guidance makes use of a number of concepts, such as ‘principles’, conceptual frameworks, intentional actions and rules. All these throw light on another concept—that is, the concept of accounting regulation. If standard setters are interested in and directed in their regulation of accounting by such concepts then it is important that they are clearly understood. As will be argued in the book, this is seldom the case. Conceptual considerations are often ignored in the rush to achieve results in setting standards in a competitive environment. The suggestion that it may be wise to get clear about concepts before rushing headlong into actions supposedly guided by them may be dismissed as too ‘philosophical’ an approach. Indeed it is! However, this is seen as a merit rather than a criticism of this book. As Lyas has written, ‘no discipline worth bothering about can seek to evade such conceptual enquiries. For first, these enquiries constitute the hygiene of the reasoning of a discipline. Without them we are prey to the loose, the ambiguous, and the down-right slovenly’ (Lyas, 1993, p. 156). Accounting regulation stands in need of a little ‘hygiene’.

Before that can be done there is the need for a little ‘hygiene’ in respect to the notion of ‘conceptual enquiries’. In modern philosophy the idea of a concept is equated with the meanings of words (Craig, 2005, p. 135). An enquiry into concepts is thus an enquiry into the meaning of words or expressions. Three kinds of conceptual enquiry can be identified: descriptive, evaluative and prescriptive conceptual enquiry (Dennis, 2008, pp. 261–263). Wittgenstein suggests that ‘the meaning of a word is what is explained by the explanation of the meaning’ (Wittgenstein, 1953, §560). The explanation of the meaning of a word is something that gives a rule for the use of the word (Baker and Hacker, 1980, p. 35). One objective of conceptual enquiry is thus to identify the rules for the use of words or expressions that are followed by those who use these expressions. Descriptive conceptual enquiries examine the use of expressions and the explanations that are actually given of their meaning. Wittgenstein claims that ‘philosophical problems arise when language goes on holiday’ (Wittgenstein, 1953, §38). This occurs when there is a misunderstanding of the meaning of words or expressions employed in discourse in a discipline. The extent to which the concepts employed in the discipline of accounting regulation are misunderstood is examined in descriptive conceptual enquiries.

Wittgenstein adopted what has been called a ‘naturalistic’ view of language. This is the idea that language ‘develops over millennia to fit our needs. As something arises that we need to mark off, so we develop, by a linguistic reflex, as it were… to mark distinctions that it seemed important to us to make’. It follows that ‘to understand the meaning of any term is to understand those human interests, needs and practices in the context of which it arose and into which it fits’ (Lyas, 1993, p. 163). One implication of this approach is that concepts are created and do not just happen. To understand why a concept has been created for use in a discipline, why a certain meaning or rule for the use of the expression has been established and followed, it is important to grasp the ‘human interests, needs and practices’—interests, in short—which constitute the objectives or desires that prompted its creation. This is the role of an evaluative conceptual enquiry. The idea that concepts are created is a key assumption made in the literature on the social construction of reality. This has been expressed in the accounting literature as the idea that the concepts we use are shaped by us and not found in nature (Young, 2006, p. 581). An evaluative conceptual enquiry seeks to understand these interests and the beliefs that underpin the creation of the concepts used in a discipline. These constitute the reasons for constructing the concept. Where the descriptive conceptual enquiry identifies different explanations of the meaning of expressions or where the explanations are understood differently this may be because the underlying interests that prompt the development of the concept are different.

A further kind of conceptual enquiry is a prescriptive conceptual enquiry. The objective of such an enquiry is to consider whether, if the explanations of the meaning of an expression suggest the expression is vague and if there appear to be different interests underlying the use of a concept, the concept is actually useful. It considers whether it might be better to adopt one or other of the meanings identified or to abandon the use of the expression entirely where it generates confusion that cannot be cleared up. Where there is evidence that confusion has arisen as a result of misunderstanding our language, where there is evidence that language has ‘gone on holiday’, then the aim of philosophy is to investigate such lapses with a view to unravelling the knots in our thinking (Baker and Hacker, 1980, p. 288). One way to do this is to see how the concepts relate to underlying desires and beliefs and ensure that differences in understandings about how the concepts can fulfil them are cleared up. This is a justification for prescriptive conceptual enquiries. The book employs these three methods in examining the nature of accounting regulation.

2
The Nature of Modern Accounting Practice

In considering the nature of modern accounting practice it seems sensible to start with the question ‘What is accounting?’ A blindingly obvious answer is that accounting and financial reporting are things accountants do. This answer provides a key to understanding what goes on when accountants undertake accounting—namely, they perform actions. It also makes us think about both what they are doing in doing accounting and also to consider why they are doing what they are doing. Many textbooks on accounting begin by considering the question ‘What is accounting?’ An answer may be given by quoting the American Institute of Accountant’s (now AICPA, American Institute of Certified Public Accountants) definition of accounting as ‘the art of recording, classifying, and summarizing, in a significant manner and in terms of money, transactions and events which are in part at least, of a financial character, and interpreting the results thereof’ (AICPA, 1941, quoted in Berry, 1993, p. 2). The AICPA Accounting Principles Board (APB) define accounting as ‘a service activity’. The American Accounting Association describe accounting as ‘the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by the users of the information’ (quoted in Kam, 1990, pp. 33–34). What is explicit in the APB definition and implicit in the other descriptions of what accounting is about is that accounting is an activity or action. Recording, classifying, summarizing, measuring and communicating are all examples of things accountants do. What is also obvious is that the actions involved are intentional. They are not accidental, for those undertaking them intend to perform them.

Intentional Actions

The analysis of intentional actions in the philosophical literature is complex, and this is not the place for a full analysis of such actions. In some sense, intentional actions are actions that we want to do (Goldman, 1970, p. 50). It has also been suggested that wanting to do something causes us to do it (Goldman, 1970, p. 93). If one performs an action because one wanted to perform it the ‘because’ may indicate a causal explanation. The desire to act is part of the causal explanation of the action. If we do something intentionally then we want to do it, and having such a desire caused the action to occur. There is another strand of thought in the philosophical literature that says that intentional actions ‘are the actions to which a certain sense of the question “Why?” is given application; the sense is of course that in which the answer, if positive, gives a reason for acting’ (Anscombe, 1957, p. 9). To take a common, or garden, example of an intentional action, consider the action of going to the shop. If the question ‘Why did you go to the shop?’ is asked then you may mention as a reason a desire to allay hunger and a belief that going to the shop would allow you to buy food which would allay your hunger. Even where one did something solely because one wanted to without any other reason the question is, at least, ‘given application’ in the sense that the question is not rejected. One does not reply, ‘I didn’t want to go to the shop’ (but went by mistake, say) (Anscombe, 1957, p. 30). For many of the intentional actions that we undertake we can give reasons for wanting to perform them. This does not imply that in all cases reasons will be given for actions. Some intentional actions may be performed just because one wanted to perform them.

Although acting because one wants to act in a particular way may be part of a causal explanation of an event, saying that one acted because one has reasons for acting is not a causal explanation. There is a huge philosophical literature on whether reasons are causes of action (see a summary in Goldman, 1973, pp. 76–80). This issue cannot be gone into here. Suffice it to say that there is nothing contradictory in accepting that wanting to do something causes one to do it whilst rejecting the view that having a reason for wanting to do something is a causal explanation of doing it. Having reasons for an action may not be the ...

Table of contents

• Cover
• Title
• Copyright
• Contents
• 1 Introduction
• 2 The Nature of Modern Accounting Practice
• 3 The Role of Theory and of Conceptual Frameworks in Standard Setting
• 4 Kinds of Rules in Accounting Standards
• 5 The Nature and Role of Explanatory Guidance in Accounting Standards
• 6 The Nature and Role of Objectives in Accounting Standards
• 7 The Anatomy of Accounting Standards
• 8 Implications for Standard Setters
• References
• Index