Looking back at Part 1 of the essay, my understanding of the profit figure and the complexity that lies behind it were overly simplistic. I initially only understood that the true profit figure was a simple calculation of revenue, costs, expenses, interest, and taxes according to the IFRS standards.
Throughout the module, I have realized that my limited understanding stems from mis-analysing the question. To properly answer the question, there are two fundamental aspects needed to be addressed, these are: ‘What is truth in the context of accounting?’, and ‘Can accounting profit achieve this state of truth?’. Accounting as a study involves accountants and as such carries the complexity that comes with human behaviour in achieving truth. Working towards the truth in accounting, we must shift from subjectivity to objectivity. The circumstances in achieving objectivity is defined as “… the ability perceive thoughts and physical substance in a manner lacking in perceptual defects” (Wagner, 1965:602).
He argues that as there are no universal natural way in detecting perceptual defects in thoughts, it is then the responsibility of mankind to socially agree upon a universal way to detect perceptual defects in thoughts specifically in accounting. As such accounting standards was created to detect these perceptual defects in accounting. Wagner concluded that professional judgement in a competent, ethical manner and in accordance with generally accepted accounting standards, can shift subjectivity into objectivity and truth.
The following paragraphs look into the two components, accounting standards and professional judgement, crucial in achieving objectivity according to Wagner (1965). The above ideas are so far in line with the ideas presented in part 1 of the essay, to prescribe accountants (Normative Theory) to achieve truth; Critical theory of accounting, however, presents a starkly different way of thought into the study. Critical theory looks into the different powers at play. Deegan and Unerman (2011) states that as accounting standards and frameworks are developed through public consultation, parties with greater power may then have a greater impact onto the development of these standards, as such, this process is considered political. Further, we can look into the sources of funding of the IFRS to find that 25% are contributions from accounting firms (ifrs.
org, 2018). This questions the independence of standard setters in the standard setting process. Developing from the first part, critical theory has exposed myself into the the many complexities at play with standard setting, rather than a straightforward solution.
The political nature within the standard setting process thus threatens the objectivity provided by accounting standards. In the absence of accounting standards, we are left with professional judgement to produce an objective portrayal of a firm’s financial picture. In this case, provided that the decision makers have adequate professional judgement and ethical framework, firms have more flexibility to adapt and portray a more truthful representation. However, this a double edged sword as it can allow opportunistic behaviour, explored in the next paragraph through positive accounting theory.Positive accounting theory (PAT) introduces a third form of insight where rather than prescribe, they describe and predict actions of accountants in reality. PAT proposes 3 main hypothesis on the basis that accountants will always act in their own interest to maximize their utility function, which is wealth.
The first hypothesis which states that, ceteris paribus, when a manager has a bonus plan attached to accounting figures, they are more likely to choose accounting policies which shift income forward. PAT assumes a dark portrayal of human behaviour where we are only motivated on maximizing our utility of wealth, which is overly simplistic and inaccurate (Scott, 2012). Yet, it can’t be denied that numerous PAT research points toward the existence of opportunistic behaviour in these firms.
Building on the first part of the essay, I knew that ‘creative accounting’ was a variable to consider, but thought it was mitigated through standards and frameworks. This is not to say that standards are entirely void of use, they are useful in the cases of improving comparability. However, I believe that the heart of the issue of opportunistic behaviour observed in PAT lies in the culture of firms. Setting up more standards and regulations to limit opportunistic behaviour is just plastering more bandaid. To give an analogy, setting standards are akin to that of setting up barriers and pathways to guide you to your destination (objectivity).
However, if we are instilled the correct mindset and sense of direction (ethical framework), we are then able to find our way to the destination without guidance. Regulators in the industry should start to look into shifting focus into regulating culture to shape the right ethical framework within firms. “Right behaviour stems from decision makers having the right ethical framework” (Sants, 2010:4). However, this is not a straightforward solution of prescribing what culture should be, as seen in the case of accounting standards; every firm is different and has its own unique culture.
Thus, Sants (2010) proposes to rather focus on prescribing what unacceptable culture looks like, thus giving guidance for firms to build their own culture.To conclude, at present it is impossible to say that accounting profit is simply a measure of the true profit of an organization. There are numerous variables at play from the political aspect of accounting standards to the opportunistic behaviour observed in PAT. “Truth itself is obviously a difficult concept to define… in some jurisdictions it was decided that true and fair was achieved if financial statements simply complied with relevant accounting regulations…” (Deegan and Unerman, 2011:90). However, we should not be content with this reality that Deegan and Unerman provided, but rather seek objectivity through regulating culture not standards in the long term, while in the short term, accounting standards are still needed as ethics of decision makers are not at an ideal level yet.