Accounting Theory and Governance Management

Questions: 1. What is triple bottom line reporting, and what has it to do with sustainable development? Do you think that triple bottom line reporting can actually lead to separate bottom lines for the social, environmental and economic performance of an entity? Discuss fully2. Explain in detail the key elements and criticisms of Positive Accounting Theory. Do you agree with the criticisms? Why or why not?3. Compare historical cost accounting with exit price accounting. In your answer discuss which method is better for accounting and why?4. Explain the connection between agency theory and corporate governance. Analyze the costs and benefits of building corporate governance mechanisms? Answers: 1. Triple bottom line accounting is a modified version of the bottom line approach of accounting. The framework has three parts. They are social, environmental and financial. The three divisions are also known as the three Ps: people, planet and profit. They are considered as the three pillars of sustainability. Interest in the triple bottom line accounting has been growing both for the profit, non profit and government sectors. The performance of the organization can be measured using the TBL framework (The Economist, 2009). The traditional business accounting system uses the bottom line approach where the profit and loss is recorded at the bottom of the income statement. However the triple bottom line approach adds two more concerns additional to the profit and loss. They are the social concerns and the ecological concerns. The TBL standard is wide spread in the South African media. An example of an organization applying triple bottom line approach would be a social enterprise that runs as a nonprofit organization but income is earned by the organization by offering opportunities to the handicapped people who has been labeled as unemployable (Savitz, 2013). The triple bottom line of the 21st century has been discussed by John Elkington in his book Cannibals in the year 1997. In this book he described financial, social and environmental approach as three separate bottom lines of the companies. The triple bottom line approach measures the economic value of the company. It measures the extent to which an organization is socially responsible and takes into account the environmental responsibility of the company. According to Elkington, there should be three bottom lines on a basis of which the performance of the company should be analyzed. Thus it can be said that reporting using triple bottom line can lead to separate bottom lines which will analyze the environmental, social and economic performance of the company (Avalonbreads.net, 2015). Companies belonging to the 21st century are focusing on sustainable approach. There is increase in commitment of the organization towards corporate social responsibilities. Companies consider three aspec t of the business practice that will be beneficial for the people, planet and maximize the profit of the organization. A TBL company will think of the well being of the labor, corporate and the stake holders. Thus in this form of accounting the interest of the stake holders is taken into consideration. Thus triple bottom line accounting can lead to separate bottom lines for the social, economic and environmental performance of the entity (Scerri and James, 2010). 2. Key elements of Positive Accounting Theory Positive accounting theory can be defined as a branch of accounting research that explain and predict the actual accounting practices. The accounting theory makes predictions of the events of the real world and translates them into accounting practices. According to this theory they want to maximize the survival prospects and thus they organize themselves in an efficient manner. The firms also seek for minimization of the cost of contract so that they can maximize their benefits. The positive accounting theory (PAT) predicts the choices that the management would undertake so that it can make choice of the accounting policies (Riahi-Belkaoui, 2004). The theory has been introduced so that it can merge the efficient security market with their economic consequences. Criticisms against Positive Accounting Theory There are several criticisms against positive accounting theory. It does not provide any measure for improving the accounting practice. The theory is based on the assumption that all the action of the firm is driven towards maximizing their wealth. But many researchers find the assumptions to be negative and simplistic in nature which is a simple perspective of the human kind. There has been no development of the accounting theories since its inception. There is no accuracy in the predictions made by the accounting theory. It does not provide any kind of prescription or positive growth towards the accounting practices. The issues that have been addressed by the accounting theory like the debt hypothesis, political cost hypothesis and the bonus hypothesis has not shown much development since its inception (Porwal, 2015). The criticism against positive accounting theory is justified. The accounting theory has not shown any kind of progress since its inception. The hypothesis focused by the accounting theory has not shown any kind of development. The theory is based on the basic approach of wealth maximization. This is a basic approach towards accounting (Whittington, 2007). It is very simplistic approach of accounting. There is no accuracy of the predications of the accounting theory. This approach will not be feasible enough for solving the complex accounting problems. Thus any kind of progressive growth in the accounting practice cannot be seen with this approach. On the other hand the normative approach towards accounting is flexible and applicable in todays business environment (Idowu and Louche, 2011). 3. Historical cost of accounting can be defined as accounting practice in which the price of the asset in the balance sheet is based on its nominal or the original cost. The original cost is the cost when the asset was acquired by the company. The historical cost method is used in United States for the valuation of the assets under the generally accepted accounting principles (McCarthy et al., 2012). According to this accounting principle, the assets are held in the balance sheet at their historical cost even if there has been considerable change in the value of the asset over the period of time. But according to this accounting principle all the asset items are not calculated at the historical cost. For example, the securities that are sold in the market are not valued at their historical cost. The price of the securities is set at market value (Greuning and Koen, 2001). On the other hand exit price accounting can be defined as the form of current accounting practice in which occurs when the entity has decided to exit the industry. The assets have been sold out by the company and the net selling price of the assets is noted in the balance sheet on an orderly basis based on the sales. The price of the asset is based on fair value i.e. the price that would be received by selling the asset in a transaction between the buyer and the seller that takes place in an orderly manner between the participants of the market at the measured date. According to generally accepted principles of accounting exit price is defines as the fair value which is received by the firm on selling the asset in an orderly manner. The selling cost or the other cost of transaction is not considered in fair value but it includes the net realizable value (Stickney et al., 2010). The exit price concept is a better approach of accounting than the historical cost accounting. The exit price concept of accounting is based on fair value. It is the current exchange value which can either be the current entry price or it can be the replacement cost or the exit price. On the other hand the historical cost method values the asset at a historical cost. The current price of the asset is not considered. This is an unrealistic approach towards accounting. The exit price approach is based on fair value and it is realistic and fair approach of accounting (Cooper, Lee and Funnell, 2012). 4. Connection between agency theory and corporate governance Agency theory is concerned with resolving the problems that exist between the relationship of the principal and the agents in the business. The agencies of the business are the share holders and the principals of the business are the company executives. The agency theory addresses two basic problems that arise as a result of conflict between the agent and the principal due to variation in opinion and when both the parties have different opinion towards risks. Corporate Governance lays down the mechanism in which the corporations and the business organization are controlled (Chan-Lau, 2001). The duties and responsibilities are distributed among the participants of the organization. The principles of corporate governance are laid to reduce the conflict between the stake holders and the owners of the business. Thus agency theory and corporate governance are related to one another. The agency relationship will strengthen if the corporate governance principles abide by the requirements of the share holders. This will maximize the value of the organization (Rezaee, 2009). Costs of corporate governance mechanism Corporate Governance rules gives rise to various conflicting views between the share holders of the firm and the owner of the firm. This spoils the agency relationship between the owner of the business and the shareholders of the organization. The rules are biased in nature. The corporate governance rules are laid down aligning to the interest of the managers (John and Makhija, 2011). Benefits of corporate governance mechanism The benefits of corporate governance include strengthening the right of the share holders in the organization so that both the parties can enjoy the benefits of corporate governance. The right of the investors is protected and it provides legal protection from the expropriation by the managers (Fernando, 2009). References Avalonbreads.net, (2015).Triple Bottom Line: Earth, Community, Employees | Avalon International Breads. 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