Essay on What Would Financial Statements Look Li

Submitted By Caffrey-Li
Words: 2452
Pages: 10

What would financial statements look like if there were no accounting standards?

In the late 15th century, Italian mathematician Luca Pacioli, known as the father of accounting, documented the procedure for double-­‐entry bookkeeping, which records each transaction in the two accounts affected by the exchange (Beattie, 2009). Since this innovation made the bookkeeping process more efficient, it spread globally and became the foundation for modern accounting. Accounting is the practice that is concerned with methods for collecting, measuring and recording an enterprise’s transactions, of which the objective is to summarise and communicate the results of the transactions to users for comprehensive economic decision making (Thomas and Ward, 2012). The way that this information is communicated is through financial statements such as the balance sheet, income statement and cash flow statement. These financial statements are governed by accounting standards, which provide a guideline about how a firm should prepare, present and share its financial data. This essay will analyse, how necessary accounting standards are, if financial statements are to show a fair and consistent representation of an entity’s performance, financial position and changes in financial position.

Drawing on Jensen and Meckling (1976), an agency relationship arises as a contract under which one or more principals (e.g. equity shareholders) engage another person as their agent (e.g. manager) to perform a service on their behalves, which involves delegating some decision-­‐making authority to the agent. It is assumed that agents are self-­‐interested and will potentially behave opportunistically. Without a contractual mechanism to restrict the agent’s adverse action, the principals will pay the agent a lower salary. Therefore, the agents are assumed to have incentives to enter contracts that appear to limit behaviours detrimental to the principals.

As suggested by Bence (2014), contracts that bond a business are constructed and monitored by accounting. The value of the firm and the manager’s compensation could change if the accounting rules change. According to Positive Accounting Theory (PAT), which attempts to understand and predict managers’ selection of accounting methods, managers might manipulate the profits of the company to some extent in order to create the appearance of a strong financial condition and stability. PAT hypothesises three incentives for managers to manipulate profit. First, the Bonus Plan Hypothesis dictates that managers with bonus plans might use accounting methods that increase current period