Rationale for Financial Accounting Regulation



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Rationale for Financial Accounting Regulation


McLeay & Riccaboni (2000) defines financial accounting as the process of collecting and processing financial information to assist various parties or stakeholders, who are external to an organization, in making economic decisions. Thus, financial accounting should always serve its major purpose of providing the organizations’ accurate and full financial information to these external parties. However, it is commonly understood that people have different information needs, a condition that makes it impossible for the accountants to generate financial reports that would meet every individuals’ needs (Cataldo, 2003).

From the above argument of conflicting demands, the need for regulation of financial accounting arose. The dangerous working environment witnessed in Britain immediately after the Industrial revolution is one of the unforgettable vices that comes with the rule of pure capitalism. The 19th century was the worst economic period for Britain due to a lack of regulation in her economic market.

As a lesson from Britain's economic experience and the crash of their economy, the United States government became the first government to introduce the accounting regulation. The year 1934 marked the active implementation of these regulations through the United States Securities Exchange Act, which required disclosure of specific financial information by organizations that were seeking to trade securities (Previts, 2008).

Need to Eliminate Information Asymmetry

Since accountants are part of their employers’ assets, the argument that they always work in the interest of their employers, rather than in the public interests, makes it necessary to have regulations that would ensure some greater degree of accuracy in the financial reports. Cataldo (2003) noted that a lack of proper regulations is likely to lead to violation of individuals’ rights to such information. Consequently, only those individuals with power can access such information while the individuals with limited power are left out to make their economic decisions in dark. The establishment and implementation of the financial accounting regulation help to correct these inefficient and inequitable markets and access to such information.

According to Walton & Aerts (2006) regulation is the sure tool that would prohibit companies and other financial accounting organizations from hiding financial information from external parties. The initial provision of limited separation between the management and ownership of business organizations served the most crucial role of eliminating business owners from the accounting activities in their business firms.

Additionally, the presence of any kind of information is the power that can propel the success of a country or an organization. On the contrary to this sacred belief, biased or false financial information that has been given to the investors is the reason for poor investment decisions made by such investors. It should be understood that failure in one investment is not just a problem to the individual investor, but it also affects the national and global economy (McLeay & Riccaboni, 2000). 

Need for Standardization in Accounting Practice

Regulation creates room for uniformity in the accounting methods to facilitate comparability between different financial organizations (Unnibhavi, 2005). The regulator's duty of determining the acceptable and the unacceptable activities helps in ensuring quality in service delivery by all the players in financial accounting. The common understanding of every practice is that such practices must have a defined rule that determines the dos and don’ts. Without such regulations then there will be no wrong way of presenting financial reports.   

The case that led to the formation of the Australian Accounting Research Foundation (AARF) in the 1960s is real evidence for the need for uniformity in accounting practices worldwide (Previts, 2008). In the period when there were no agreed accounting standards and defined conceptual framework, many companies in Australia failed economically. The series of researches and the long process of coming up with the financial accounting standards should be viewed about the harmony these standards have brought in the accounting field. 

Lastly, investors and other users of an organization’s financial report should be given the possibility of comparing the organization’s financial reports and progress over time (Bryer, 2012). For this to be possible, the regulations of the accounting practices must be put in place. These regulations not only provide for uniformity among different organizations but also ensure consistency in the financial reporting of an individual organization.  

Investors Should be Protected from Deceptive Financial Organization

Some of the organizations seek to exploit investors by giving them misleading information about the financial status and progress of the organization. The organizations’ need for windfall profits has been the major cause of this vice (McLeay & Riccaboni, 2000). The continuity of investment and development of any country requires fair and transparent dealings with every stakeholder in an organization. The effects of a discovered deceit are very disastrous compared to those of slowed down the economic growth of a country. 

Regulation should not be seen just as an individual’s thing but also from the institutional theorists’ point of view, regulation is broader than an individual’s preferences in an organization (Bryer, 2012). Regulation at an organizational level should be viewed to work for the benefit of the entire organization rather than to the management or the business owners’ interests. All the stakeholders at this level should be able to access accurate financial information in order not to be exploited by unscrupulous management (Previts, 2008).

The same rule should also be applied both nationally and internationally. Every shareholder and investor should be guarded against the ill-mannered organization. The current move towards privatization of companies and businesses has seen many citizens buy shares in several companies whose financial reports are hardly understood by the majority of the shareholders (Unnibhavi, 2005 p. 235). It is in the national interest that the citizens’ resources are transparently accounted for, through financial report regulations.        


Even though there have been several arguments against the implementation of financial accounting regulations, the benefits that accrue from these regulations outnumber the disadvantages that are being cited by the critiques. The understanding and appreciation of order should focus the attention of every accountant into embracing these regulations from a rational perspective. Since many theories are explaining the concept of financial accounting regulations, accountants should learn to understand these regulations from all perspectives.

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