Ch 5 Accounting Veiwpoints

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Ch 6: ACCOUNTING VIEWPOINTS - What this chapter covers

ACCOUNTING VIEWPOINTSA function of a range of factors

• History• Culture• Societal values• Nature of economic activity• Objectives of those who

– Prepare – Interpret – Apply1

In order to understand, practice and study accounting - it‟s important to consider oradopt a particular perspective or viewpoint of account ing practice

o Accounting exits b/c of the commercial and transaction-based activities of

economies and individual entitieso A society/economy (and therefore its participants/citizens/individuals etc) will

typically adopt specific, unique accounting viewpointo The adoption of an underlying viewpoint of accounting is affected by a number

of factors: history, culture, societal values, and the nature of economic activityand the objectives of those who prepare, interpret and apply accountinginformation.

o Quantifiable logico Governmento Groupo Individual

o Latham: Political perspectives in Australiao Lefto Right

o The chosen viewpoint may not necessarily be derived from quantifiable logic

o The viewpoint may affected by/derived from belief systems: commonly affectedby religious or political beliefs – both of which are products of human interaction – humans are not completely rational - no belief system is representative ofabsolute truths

o Latham gives the example of political ideologies in Australia. : the right- supportmarket forces as the most appropriate means of achieving society‟s objectives.Alternatively the left: government intervention is appropriate and necessary.Neither of these schools of thought are correct or an absolute truth. THISAPPLIES TO VIEWPOINTS ABOUT ACCOUNTING AS WELL.



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Objective of accounting (SAC 2) – Measurement – Reporting – Economic activity

• Significant changes

– Reporting entities – Public and private

THE ESTALISHED AND UNDERLYING OBJECTIVE OF ACCOUNTING IS THEMEASUREMENT AND REPORTING OF ECONOMIC ACTIVITY & more recentlythe effect of entities activities on the community and physical environment – thesegoals influence an accounting viewpoint adoptedMany potential users of accounting info – different needs – Q: WHOSE NEEDSSHOULD BE TAKEN INTO ACCOUNTING BY AN ACCOUNTING THEORY? Thequestion has attracted significant debate esp. in the 1950s an 1970sThough the question had been codified by SAC2: Objective of General PurposeFinancial

Under SAC 2: the objective of general purpose financial reports is to provide infouseful for making and evaluating decisions about the allocation of scarce resources(para 43)Under SAC 2 there are 3 main categories of financial statements users

1. Resource providers (shareholders and debt holders)2. Recipients of Goods and services (customers)3. Parties performing a review or oversight function – independent auditors,

management, govt etc.

THE BOUNDARTY ASSUMPTIONS

• Activities and means of supporting an entity‟s activities need to be defined • Set of assumptions or principles about boundaries of an entity

– Process of creating a reality (Hines)• Each viewpoint defines the boundaries to support perspective adopted

o Boundary = the activities to be measured and reportedo All discussed accounting theories define the boundaries of an entity to support

the adopted perspectiveo Hines: the concept of accounting perspectives are basically a process of creating

a reality that suits the view of those putting forth the perspective. The proponentsof a given “perspective theory” create a picture of the organisation – define itstraits & features etc – it‟s on this basis that people act and think – by respondingto that picture they make it real.

o The boundaries are human defined – subjective



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Australian Theorist – Edward Ball: Boundary of Assumption

Ball proposed a universal definition of the reporting entity concept, which =consistent with SAC 2 (but SAC 2 is more broad & is more appropriate)A Reporting entity‟s boundaries are defined by reference to ownership and controlReporting entity = any unit or activity that controls the utilisation of scarceresources in order to generate economic benefits & sufficiently significant towarrant the prep of general purpose fin reportsSufficiently significant = relevant for decision making and accountability purposesLIMITATIONSIgnores that many users of financial statements have no controlAlso only acknowledges entities for which it‟s appropriate to issue general purposefin reports – not really universalThe boundary assumptions SAC 1 Definition of a Reporting Entity :

• Broader definition of a reporting entity• Links the reporting entity to the reporting needs of users and the objectives of

general purpose financial reportsBut:

•

Definitions may be altered by organisations in response to organisational orexternal pressures• Increasing external demands on organisations to expand reporting to include

non-financial impacts

SAC 1 – defines the reporting entity and outline criteria for its boundariesProvides a more broader definition of a reporting entity than Bell

Reporting entity = All entities in respect to which it‟s reasonable to expect theexistence of users dependent on general purpose financial reports for which infowill be useful to them for making and evaluating decisions about the allocation ofscarce resources

THE PROVISION OF INFORMATION IS THE SOLE BOUNDARY CRITERION PERSAC-1 (unlike Ball does not look at control)



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NOTE: Company Law of the jurisdiction in which an entity operates will oftenredefine the boundaries in response to organisation or external pressures eg. Corptakeovers restrictions

PROPRIETARY THEORY

• Littleton: proprietorship – Substance of double-entry system – Purpose of the firm

• Goldberg: – Instances where double-entry system used but proprietorship is

not underlying objective

Proprietorship theory = the entity is the agent/instrument through which theindividual or shareholder operate. Therefore the owner is the centre ofattention. All accounting concepts, procedures and rules are formulated withthe owners in mind

o Littleon: without proprietorship/owners there would be no point in havingbothering with the dr/cr system. No reason why dr should = cr. Ifimplemented would simply be a set of rules.

o The central feature of the proprietary theory is its emphasis on the capitalaccount and capital preservation ,and the balance sheet which had thedominant position.

o In this theory the capital account was no longer considered to be a residualaccount but became firmly identified with the owner - just as the entire firmwas considered his possession, not something apart from him.

o Attention shifted from mere transactions (concentrating on the exchange ofvalues) to making profit for the owner - a crucial step in the direction towardstwentieth-century accounting theory

Proprietary Theory – Balance Sheet A/c’s

The viewpoint of the proprietor as the centre of interest is reflected in the ways inwhich the accounting records are kept the financial statements prepared.

Everything is interpreted from the perspective of the proprietor.The objective of accounting policies/procedures & rules is to determine the net worthof the proprietorTherefore the accounting equation is:

Assets – Liabilities = Proprietors Equity

• Balance sheet accountsAssets – Liabilities = Proprietorship

• Profit – Owner‟s net worth primary concern (balance sheet) – Income earned and expenses incurred due to actions of the owner

The balance sheet is seen as the sheet of proprietorship, the bal sheet is a reflection

of their net worth & is prepared to measure the changes in proprietary or wealth



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o Assets = belong to the proprietoro Liabilities = the obligations of the proprietor

Profit = increase in the net worth of the proprietorProfit is earned & expenses are incurred b/c of the decision and actions of the

owned. Income and expenses are subsidiary accounts of P which are used todetermine the profit of the owner.Vatter: “The theory of double entry is based on the idea that expense and revenueaccounts have the same algebraic characteristics as net worth ie accounts tendingto increase net worth are increased by credits and accounts intending to decreasenet worth are handled in reverse order. “ Profit is the increase in the wealth of the owner from the business operations duringa given period.

o Income = an increase in the proprietorshipo Expense = a decrease in the proprietorship

Financial Capital Concept:

o there is no distinction between the assets of the proprietor and the assets ofthe entity

o All profit is distributable to the ownero If the entity requires additional resources - they are available from the

owner‟s own resourceso Capital represents the cash invested by the owners plus profits reinvested by

retention in the business.

Effect on practice

To a large extent present accounting practice is based on proprietary theory.Examples below:

o Dividends = a distribution of the owners profits & therefore not an expenseo Interest & income Tax = an expense b/c they reduce the owners wealtho Salaries paid to the owners are not an expense – are s distribution of profito Group financial statement: the parent is seen as owning the sub & any

minority interest are seen as an expense

Limitations –

Developed when businesses small – Increasing separation of ownership and control – Corporate entity – Accountability

Theory was developed at a time where most business entities were sole traders &partnership & closely held companies – ie at a time when the ownership & controlwere not separatedCorporation‟s legislation also stipulates that even closely held/ single owner companies have a separate legal identity to that of their owner/s



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Under the proprietary theory, „the . . . proprietor . . . [is] seen as owning the firm‟sassets and owing its liabilities‟ (Zeff, 1961, p. 105). That leads to the unsound view,for example, that General Motors does not own its factories.

Besides, „ownership . . . is a nebulous concept and is extremely difficult to

define‟(Goldberg, 1965, p. 162). In any event, who owns the assets and whoOwes the liabilities should not even necessarily be determinative for financialreporting: „legal title is not the determinant of asset existence‟ (Vatter, 1947, p. 17).

the firm . . . not its shareholders . . . makes a product or delivers a service . . . isregulated, taxed, and controlled by a wide array of government agencies and courtsof law . . . it is potentially misleading to combine the interests of the firm and itsshareholders in accounting reports. (Revsine, 1982, p. 77)

Entity theory

• Formulated to address separate legal status of company• Accounts and transactions are classified and analysed from the viewpoint of

the entity as an operating unit• Accounting principles and procedures not formulated in terms of a single

interest e.g. proprietorship

o The leading proponent of the entity theory believed that „the doctrines of proprietorship

o have led to serious error‟ (Paton, 1922, p. 53).SEPARATION: Sees thecorporations as having a separate legal identity/personality to its owner

o VIEW POINT: sees accounting procedures as conducted from the viewpointof the entity. Accounts and transactions are analysed from the view of theentity as an operating unit

o The enetiyt viewpoint is well presented in h`1e corporate view pointo The role of Book keepers and accountants is to record the history of the

business

Two Views of an Entity:Objective of accounting from entity position?

1. Business firm operates for the benefit of equityholders2. Entity in business for itself

• From either view the stewardship role is of primary significance

Traditional view: the firm operates for the benefit of equity holders i.e. those thatprovide the firm with funds. The firm must report on the status and consequence ofthat investment. Sees equity holders as associates of the businessNewer Interpretation: sees the entity in business for itself & interested in its ownsurvival. B/c it‟s concerned about its own survival, the business entity reports toequity holders in order to meet the legal requirements and to maintain a goodrelationship with them in case more funds are needed in the future. Sees equityholders as outsiders to the business s



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2 Version of the entity theory: BOTH HAVE THE SAME CONCLUSION =STEWARDSHIP OR ACCOUNTABILITY IS OF PRIMARY IMPORTANCE. Themodern approach:New forms of disclosure are being required by corporations‟ law that integrate

financial, environmental, & social reporting factors – KNOWN AS THE TRIPLE

BOTTOM LINE APPROACHPurpose of such = to report on the entity‟s activities on a range of stakeholders,beyond the shareholders and the information generators (i.e. managers, accountantsetc)This new type of accountability has seen new type of accounting practices generatedCorporate Social Responsibility is important – public suspicious /critical of the singleshareholder perspective – a co exists to create wealth for its owners – best way toensure this is to heed t broader community needsExpectations form the broader community are Shifting main stream corporateaccountabilityExample James Hardie:

• Balance sheetAssets = Equities

• Profit – Emphasis on the determination of profit – Income statement more relevant than balance sheet

• Effect on practice – Proprietary view has a greater impact on present procedures

Balance sheet: net worth of the proprietor is not a meaningful concept, b/c the entityops the centre of attention. Owners and creditors are simply the providers of funds.The business unit owns the resources of the enterprise & is liable to the claims ofboth owners and creditors. Therefore:

Assets = EquitiesAssets = Liabilities + stock holders equities

Assets = rights accruing to the entity.Both shareholders and creditors are equity holders. Though they each have differentrights to income, risk, control and liquidationThe balance sheet shows the assets of the entity which represent a “direct”statement of the value of the entityProfit: Because the business unit is held responsible for meeting the claims of

equity holders, the entity theory is said to be income centred and consequently income statement orientated Income = an increase in the stock holders equity after the claims of other equityholders (for example creditors). The increase in the stock holders equity is onlyconsidered income to the stock holder if a dividend is declared . Undistributed profitsremain the property of the entity .Accountability to the equity holders is measured by recording the operating andfinancial performance of the firmCreditors have a specifically determinable claim and shareholders have a residualclaim on the assets of the company in the case of dissolution - H/e from the standpoint of the entity both are just providers of funds

Entity theory leads to the unjustifiable view that taxes and interest are not expenses:



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„From an entity point of view, taxes and interest represent distributions of its incomefrom operations like dividends, rather than expenses required to earn entity income‟(Skinner, 1987, p. 45).

Physical capital concept

• Under the entity view – Physical capacity of the entity to deliver goods and services is

determined after taking into account changes in prices of assetsand liabilities

• Financial capital concept – Changes in the monetary values of assets and liabilities are

included in profitIf an entity view is taken – which of the following are appropriate fordetermining profit

1. Financial capital or physical capital?

Financial Capital refers to the funds provided by lenders (and investors) tobusinesses to purchase real capital equipment for producing goods/services.Physical Capital comprises physical goods that assist in the production of othergoods and servicesThe traditional view of the entity theory emphasises accountability to equity holdersfor the funds provided by them. This relates to the investment of the equity holders &therefore a financial capital approach is implied.The newer interpretation of the entity theory would take a physical capital approachas the entity is concerned about itself. Thus the entity would naturally be concernedabout its operating capability. The equation assets = equities sits well with the

physical capital view b/c owners equity is not recognised directly. The focus is onassets, and the physical capital view is focused on assets & on the entity‟productivity operating capacity

2. Historical or current cost

Under the traditional entity theory any of the alternatives would fit in. H/e it has beenargued that since entity holders are mainly concerned about the amount of theirinvestment, historical cost is the logical choice. This is so b/c the use of the funds isprovided by the equity holders is invested in assets , the amount of the investmentprice is the purchase price – the historical cost . But weher equity holders are only

interested in the original amount of their investment is debateable. Many believethey are interested in changes in value.Under the new entity theory, the question at the end of the period is: How muchdoes the entity need in order to maintain its operating capability? The amountneeded at the end of the period is the amount to purchases the asset, which iscurrent, cost

3. Nominal dollars or constant dollars

The term Constant dollars refer to a metric for valuing the price of something overtime, without that metric changing due to inflation or deflation. The term specificallyrefers to dollars whose present value is linked to a given year. Constant dollars areused to compare the "real value" of an income or price to put the "nominal value” (ie



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value unadjusted for inflation) in perspective. For example, who was making moremoney, your father who made $5,000 at his first job in 1957, or you when you startedat $18,000 in 1986? The answer depends on how much can be purchased by eachsalary.

Under both versions of entity theory neither is favoured. Constant dollar accountingto correct a mathematical problem of dollars different purchasing power beingadded together, mathematically the numbers must be the same Domain. Quality ofunit of measure is needed. If such a correlation is needed , then a general priceindex is pertinent to the entity‟s circumstances should be selected.



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FUND THEORY

Vatter • Focuses on Impersonal „fund‟ rather than a personality• Assets = Restrictions on assets (equity, liabilities)• Frame of reference for government and not-for-profit organizations• Cash flows

Purpose of fund theory = developed a framework underlying the logic of modernaccountingConsiders proprietary and entity theory inadequate b/c they personalize the businessunitCentral idea/concept is the fund which is an area of operation, a centre of interest ora centre of attentionThe Accounting Equation: Assets = restrictions on assetsRestrictions on Assets :



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Commander theory

Goldberg • Focus on control of resources• Accounting functions carried

out on behalf of commanders• Financial position and performance statements• Effect on practice



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INVESTOR THOERY

Staubus • Investor viewpoint• Assets = specific equities + residual equity• Emphasises needs of external users• Cash flow information

Enterprise theory

Staubus • Investor viewpoint• Assets = specific equities + residual equity• Emphasises needs of external users•

Cash flow information

Ch 5 Accounting Veiwpoints

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