The economic consequences of accounting standards have been on debate for a long time. It is generally agreed that all the accounting policies have got an economic consequence. It is further argued that the accounting decisions and policies tend to favor some group over others. It has been reported that the investors have always opted for decision which give them authority and an ability to regulate what the executives undertake while the corporate executives have always wanted a closed door operations. It has been argued that most of the accounting procedures and decision have been designed to favor the reporting firms with the hope of benefiting the investors. However, further arguments deny this claim arguing that there can be no win-win situation. It should be noted that the al the accounting decisions have got economical consequences. The financial statements are intended to give information to the investors which they will in turn use to make investment decisions.
This paper will examine the consequences of accounting decision son the business world. The paper examines the how the accounting choices will affect the welfare of parties interested in a firm. The paper shows how the accounting reports can affect the decision making process by business, creditors and governments. The paper will make a detailed analysis of some real life examples to bring out the consequences in a clear and concise way. The paper makes use of literature review as method of collecting data and care is taken to use only credible sources which can be relied on.
According to Schroeder, Richard, Sevin, Schauer, David (2006), economic consequences can be defined as the, “the impact of accounting reports on various segments of our economic society” (par. 1). There have been various studies on this area meant to find and determine the extent of economic consequences brought about by the accounting decision. These consequences are said to cut far and wide and touch on various stake holders. Schroeder, Richard, Sevin, Schauer, David (2006) argue that the economic consequences brought a bout by the accounting options may be intended or unintended. In clarifying this they cite the example of SFAS No. 106, 1985. This statement made the requirement that all the business firms were from the pay as you system to a different system whereby the employees were to benefit from health care and other ways. They disclose that the intended economic consequence of such a standard was, “the disclosures of annual estimated costs for future employee health care obligations as current expense” (Schroeder, Richard, Sevin, Schauer, David, par. 1). However they also argue that there were some unintended economic consequences, “the release of SFAS 106 also had unintended economic consequences in that many companies simply ceased providing such benefits to their employees, at a large social cost” (Schroeder, Richard, Sevin, Schauer, David, par. 1).
Schroeder, Richard, Sevin, Schauer, David (2006) explain about the progress which has been in the accounting decision and the influence it has had on the economy:
In May 2003, the Financial Accounting Standards Board issued SFAS No. 150, “Accounting For Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (SFAS 150, 2003). This pronouncement requires companies to record and report mandatorily redeemable preferred stock (MRPS) as a liability on their balance sheet and the dividends on these securities as interest expense. Most companies previously disclosed MRPS between the liability and stockholders’ equity sections (i.e., the mezzanine section) of the balance sheet. (Schroeder, Richard, Sevin, Schauer, David, par. 1)
It is reported that the above was meet with a lot of resistance with much concern being voiced about the economic consequences of the businesses which impacted by its provisions: “companies that compliance with SFAS 150 could cause some companies to be in default of their debt covenants or to experience large increases in interest costs” (Schroeder, Richard, Sevin, Schauer, David, par. 1). They give an example of t he AOL Time Warner reporting the following shortly after the release of the SFAS 150: “The adoption of the provisions of FAS 150 will require the company to reclassify $1.5 billion of mandatorily convertible preferred stock … from shareholders’ equity to liabilities” (Schroeder, Richard, Sevin, Schauer, David, par. 1).
A company’s long term debt relative to its equity is significant because of its relation to the risk associated with investing in the company’s stock. An increase in the debt to equity ratio of a company will lead to the rise in the perception of the riskiness in the investing in the company’s stock. This is direct effect on both the company and the investor. The shares of the company in the stock market are likely to fall as investors will shy from trading in the stock for that company. This calls for the formulation of the criteria for classification of the liabilities and equity for the purpose of the decision makers to reliably evaluate the a company’s ability to in meeting the current needs and determining the riskiness inherent in future cash flow projection (Al-Moghaiwli, 1999).
From the accounting view both the liabilities and equity are claimants of the enterprise assets whereby the liabilities represent the creditor claims whereas the equity represents the ownership interest. It is argued that the way liabilities and equity are defined has led to the raise of many questions with respect to financial statements’ classification as either equity or debt. It is argued that SFAS 150 was formulated to help in the classification of the certain financial instruments as liabilities in order to represent some obligations. According to SFAS 150 obligations are conditional or unconditional responsibilities for the transfer of assets. However, in the case that the there is an issuance of stock then the company is not obligated to redeem the shares. But in the case the company is obligated to redeeming the shares then it will not be obligated to transferring of assets or issuance of additional equity (Al-Moghaiwli, 1999).
It is reported that the there are certain issuance of stock such as the MRPS which impose obligations that require the entity issuing to transfer the assets or the equity shares. This implies that the according to SFAS 150 then the redemption of the redeemable stock is a requirement only on the liquidation of the reporting entity and that the stock in such a case ought to be treated as a liability. Redemption provisions are only incurred between the owners of businesses which are closely held. These agreements more often than not give guidance on the orderly disposal of the owners’ investment in the business firm on the event that there is a separation between the business and the owner. Due to the fact there is not equity securities do not have a market, the departing owners can only depend on the remaining owners for the provision of their liquidity. It is argued that redemption is a better option as compared to the depending on the remaining owners for the purposes of funding of the buy out due to the fact that the remaining owners may necessarily not be in a financial position to implement that obligation (Kieran, Janice and Peter, 2006; Schroeder et al,. 2006).
It has been argued that the provisions of the SFAS 150 with respect to MRPS are potentially devastating to the non-public companies. It is claimed that the result of such effect on the standard has been the elimination of the net worth of the company which specifically has issued MRPS:
A comment letter to the FASB from the Financial Executives Institute maintained that the application of SFAS 150 to non-public companies would present an overly pessimistic picture of the entity’s financial position that might result in its disqualification from bidding on private contracts or the prevention of obtaining bank financing. (Schroeder, Richard, Sevin, Schauer, David, par. 1).
It is reported that the chief effect of SFAS 150’s provision is the classification of some amount which early was taken to be equity to the liability of the balance sheet section. It is claimed that this classification is likely to lead to the reduction of the reported income. It should also be noted that increased reports on the liabilities is likely to have an influence a firm’s ability to issue an additional debt and may lead to debt covenant violation. At times the corporate executive have are more likely to modify the accounting figures if they perceive the figures portrays a negative image of the company. This modifications is likely, has as been seen above, likely to lead to wrong perception of the company and as a result deductions of wrong taxes and making of wrong decisions by the investors and other stakeholders with respect to the company in question. This also has serious consequences on the government revenue as losses are likely to be incurred on the part of the government. According to Albrecht (2010), the government ought to take some measures to stop some of the fraudulent accounting decisions which are made by the corporate bodies.
Albrecht (2010) argues that the government ought to take the responsibility to adjudicate on the competing economic interests. He gives the example of how the U.S. controls the accounting standards where the federal government acts as the determinant of the accounting standards: “Not only does the federal government have the authority to determine accounting standards (the Securities and Exchange Act of 1934 affirms it), but it has the responsibility to do so” (Albrecht par. 1). He advocates for such of a system because of the fact that the accounting standards form an integral part of the economic system and as such the need to maintain a stable economy arises:
We have not always realized the political nature of standard setting in the U.S. However, since the formation of the FASB every potential accounting standard has had to go through a political process: discussion memorandum, then exposure draft. And the SEC always has the ability to override (which it has upon occasion). (Albrecht par. 1)
Albrecht (2010) also brings up the issue of the politics in the accounting standards. He views that the political participation in the accounting system is not a bad idea due to the fact that politics will keep the accounting standards in check and a void exploitation by the corporation world. He believes that the politics will keep the accounting standards at a level of national interest. At this point he argues against the Obama administration initiative of delegating the accounting system to non-Americans. He argues that the government ought to adjudicate the accounting standards as that is one of its duties. He claims that delegating such a duty to a foreign body will not be of an interest to any of the U.S. citizens since the foreign body in control of the accounting lacks any interest in the America n affairs of adjudicating between competing American interests (Albrecht, 2010).
As reviewed above the accounting decision form a significant part of the economic system and as such needs to be controlled. There is need to empower such bodies as FASB to ensure the general interest of the public is taken care of and general to ensure the economy is stabilized. There is need to ensure that the usefulness of financial reporting is enhanced such that its reliability and relevance is brought out for use by the various stakeholders of the statement issuer. There is also a need to keep all the standards current in order to ensure that there is a reflection of the changes in the economic environment and methods of doing business. There is also a need to ensure that there is convergence internationally of the accounting standards. This will help for the cases of the multinational companies and will generally improve on the understanding of the information contains in the financial reports and how there affect the everyday running of the business.
It should be aimed at making decisions which are as objective as possible: the information should be neutral and make reporting which are as faithful as possible without necessarily coloring the message to communicate a different message apart from the one it ought to communicate. Such bodies should strive to bring the needed changes in a manner that will keep the disruption of the economic activities at its lowest: this will call for the establishment of the setting of reasonable and appropriate dates and transitions provisions which will ensure that the changes are smooth and are not economically disruptive. Such changes will equally call for perusal of the past decisions which have been made and examine their effects in order to come up with changes which will keep all the effects to the lowest level possible.
Accounting decision have been reviewed to have serious effects on the stakeholders of corporate firms who include the government, creditors and other businesses. The accounting decisions at times can be modified to fit the interest of some few groups at the disadvantage of others. The modification of the financial decisions and altering can have serious consequences on the stakeholder s of a business. The government is likely to lose taxes from wrong image created. The investors are also likely to be misled by the wrong figures and accounting decision given. This leads to making of wrong investments. Other businesses which in a way depend on the corporate body in question are also most likely to be led to make the wrong decision because they will use fraud information to make business information. The overall impact is that the economic stability of a nation is compromised and made vulnerable to economic turmoil.