The content of this essay will be structured in a similar fashion to the course handout given to us by Derry Cotter. It aims to look at the regulatory environment in which organisations have to operate, and so it will focus on the three main issues highlighted by Derry:

• Is Regulation necessary?
• Public and Private Regulation.
• The Economic Consequences of accounting standards.

• Is Regulation Necessary?

The question on whether a regulatory system is needed is a highly debated issue with numerous outcomes of both a positive and negative nature. Despite these affects Beaver (1989, p.178) says, "The point is that perfection is unattainable. Any system, even a regulated one, will incur some frequency of abuse…The central issue is whether or not there is some flaw in the private sector (e.g. some market failure) that leads to the conclusion that governmental regulation is a more desirable solution." A number of broad points can be made in relation to the advantages of Regulation:

• Protects investors and Creditors ~ creates investor confidence and helps prevent fraud
• Facilitates an effective capital market~ related to the ideal of the efficient market hypothesis and optimal use of economic resources
• Provides a basis for an equitable tax system ~ as the Revenue Commissioners use the Financial Statement to levy taxable income
• Provides a basis for a well informed system of Government grants and subsidies

Beaver (1989) gives three reasons why regulation is needed:

• Externalities Þ These are actions of one party that have effects on other parties who are not charged via the price mechanism e.g. writing off to AIB for their financial reports. They have to send it out to you so they are incurring the cost and you are the free rider. Another example is that disclosure by a firm about its success (or lack) with respect to some product development may provide information to competitors. In an unregulated environment the company would have no incentive to do this.
• Unequal possession of Information Þ This is due to that in unregulated markets information accumulates in certain areas and creates imbalances. A 2-tier information base would form and this would be to the expense of smaller investors. However, regulation does not ensure full information either but implements systems to ensure a more equitable distribution of information. Beaver says that a common argument against this is that analysts gain information and this can be passed on to investors for a fee, but this causes problems in relation to wealth distribution. Information Asymmetries are avoided to some extent by implementing regulations for firms to comply with.
• Management has an incentive to suppress information Þ This is applies for both good and bad information so as to disclose as little information about competitive advantage as possible. Could result in a situation where adverse selection occurs and where you have a market for lemons i.e. where the buyer cannot distinguish between good and bad products and hence prices drive the good products out with all bad products remaining.

However, there are a number of problems held by organisations in relation to regulation. Firstly, as already mentioned it is impossible to attain perfection. Secondly, if there were no regulation then firms would not have the expense of auditors; review panels, publishing reports etc. and these are costly items. The main objectives of a regulatory system are:

• Stewardship > Managers have to report for all their actions
• Usefulness for decision making > can be used by Investors, Creditors, Government, Employees, Analyst, Supplier, Customer and General Interest groups.

• Public and Private Regulation

So, firstly, if we need regulation who do we want to implement the rules the Government or a private body? There are a number of advantages that can be gained by having a private body perform this function. Firstly, there are better skilled people to look after these aspects. Secondly, political interests wouldn’t affect the private sector i.e. after every four years there wouldn’t be a new group of individuals looking after the regulatory environment. Thirdly, the private sector may be faster in implementing standards than the public, due to the length of time it takes for the government to pass white papers and green papers etc, so there is greater flexibility available with the Private sector. However, there also needs to be a social conscience in the standards in relation to the redistribution of wealth, which a government body would have. In an optimal environment, it would be beneficial to have a supervisory role for the government combined with the flexibility and expertise offered by the private sector.

A Private Limited Company has between 1 and 50 shareholders, has a restriction on the transfer of shares and cannot offer shares to the public. If a company fails to meet any of the three requirements given there it becomes a Public Limited Company. Pre 1986 Private companies did not have to disclose anything, but now they have to conform to some level of disclosure.

Public Sector Regulation This is legislation that is laid by the government. Basic financial reporting requirements are enacted in legislation. This includes standard formats for the layouts and also outlines basic measurement rules for assets and liabilities. In Ireland the rules for preparation of accounts were originally outlined by the 1963 Companies act, largely superseded by the 1986 companies act. Rules for Group accounts are in the 1992 act. Compliance with legislation is a mandatory requirement, and penalties for non-compliance are set out in the company’s acts. Cotter (H/O 26/2/01) says, "A company’s financial statements should give a true and fair view. Although…it is normally taken to include compliance with legislative requirements and accounting standards, rules, procedures and conventions".

Private Sector Regulation This is executed by a number of bodies that issue authoritative guidance relating to the preparation of financial statements.

• The Accounting Standards Board/ASB Þ Issues accounting Standards (FRS’s). It also inherited SSAP’s from its predecessor the Accounting Standards Committee. ASB also issue s discussion papers and issues non-mandatory ‘Statements of Best Practice’ on topics such as the Operating and Financial Review /OFR. Companies must in practice comply with the ASB rules.
• Urgent Issues Task Force/ UTIFÞ This board addresses matters of great importance and responds with albeit temporary recommended accounting treatment before the permanent solution is validated. In practice companies must comply.
• Financial Reporting Review Panel Þ Exists in the UK only, and it reviews companies’ compliance with the Rules of the ASB and UTIF. It has the power to trigger litigation against non-complying companies so it is better to cooperate then face the bad publicity.

(Full breakdown of all the FRS’s and SSAP’s in the H/O 19/2/01 so I’m not typing them out for ye † )

Cotter (1993, p.17) mentions the benefits of FRS3 in his article Using FRS3: Reporting Financial Performance. One main point that he makes is that "the ASB has addressed the widespread abuses of extraordinary items under the now superseded SSAP6, by defining ordinary activities in a very broad manner. Extraordinary items are material, abnormal items, which fall outside of an entity’s activities". He also mentions the fact that where there is a ,material difference between an entity’s profit/loss as prepared on a historical cost basis and prepared on a modified historical cost basis, FRS3 requires a note of the historical cost, profit or loss for the period to be presented.

• The economic consequences of accounting standards

This topic reflects the additional issues that are affected by accounting standards and is mainly related to the economics consequences of these standards. An article by Stephen Zeff in 1978 addressed this topic. The sense of growing appreciation in the US during this period led to a more detailed analysis of these impacts. It is feasible to assume that the standards, partially due to the fact that some boards who set these standards are basing their assumptions on economic results (Zeff, 1978, p.19). Zeff’s article was a representation on a cultural trend to evaluating companies more critically as "to suggest that accounting policy makers should seriously consider the impact of proposed accounting standards on the micro and macro economic welfare of affected parties would have been labeled before as a heresy" (Zeff, 1978, p.20).

Zeff mentions that one of the frequently used examples of how accounting standards affect more then just accounting practices is through the implementation of LIFO inventory accounting on financial reporting, as it affects how a firm runs its business. Similarly, the same could be said for the impact that JIT has on accounting systems so these factors cannot be said to be wholly independent of each other. Such organization wide implications can be seen to go considerably beyond the realms of purely accounting issues. Other considerations include the possible implications for tax reform, the possible impact on wage bargaining and the need to counteract criticisms of profiteering by big business along with possible implications for stock prices (Zeff, 1978).

Zeff then goes on to list what he sees as some of the major factors that have contributed to the emergence of economic consequences as a substantive issue. Firstly, he mentions the fact that increased public awareness has led to a greater need for such information. Secondly, the sheer intractability of accounting issues being addressed means that they cannot be completely extricated from wider business related areas. Thirdly, the enormity of impact such as trying to cope with foreign exchange fluctuations, domestic inflation and relative price changes are all related to these standards. Fourthly, the growth in the information economics, social choice, behavioral, income smoothing and decision usefulness literatures in accounting.

Finally, Zeff mentions the economic consequences of lease capitalization. In the 1970’s, if you were leasing certain equipment then you had to show these only in your P&L account and not in your balance sheet, in what was known as off balance sheet financing. This was beneficial for companies, as you would then underestimate their amount of liabilities, as you were not including the leased items. This then impacted areas other than accounting standards as it:

• Increased elements of risk for shareholders in relation to true financial condition of a company.
• Increased risk to suppliers in relation to credit ratings, risk premiums.
• Employees could become uneasy if a firm continually leases assets instead of purchasing.

The ASB noticed these abuse of the rules and implemented SSAP 21 which required that leases be included in the Balance Sheet of the company, and once this was introduced large amounts of debt showed up in company’s balance sheets.