Q1) European Union and the Capture Theory

It is certainly a fact that the world revolves around the concept of Self-interest. Financial reporting and its regulation are no different as they too are affected by the self-interest of the Professional Bodies involved (Deegan, C. 2009). But, when the goings gets tough, these individuals group into team to help achieve their objectives. These individuals do have a burning interest to control and oversee the regulations which is not possible because of the non-compliance and the lack of legitimacy (Gaffikin, M 2008). . Instead, alternatively, these groups capture the government regulations which are primarily intended to protect the public interest. Such control of the regulatory bodies by those entities which usually belong to some specific industry is best explained by Capture Theory (AmosWEB. 2011). This is possible due to the large extent of interaction possible during the regulating process. The demand for lobbying will continue to exist as long as the net benefit stays positive and lobbying costs are prohibited. Such empathised regulations which are made according to the needs of the professional bodies are moreover legitimised by the government (Gaffikin, M 2008).. So, during the standard setting, it is inevitable that the regulators have to work in an overly political environment. Such is the politics of the foundation of the regulations. With a follow up of the idea; Markets require full and transparent information, because of which the companies must disclose the information the way it should be, IASB (International Accounting Standard Board), attempted to force the firms to account for the derivative losses or gains on their books. In 2003, the volume of financial derivatives increased multi-fold and as recorded by a report by the Bank for International Settlements: the fair value of over-thecounter derivatives was $7.9 trillion (Whittington, G. 2005). As historic cost of accounting was applied for financial transactions; the values of the derivatives had very low or even zero historical cost; yet their current values were highly sensitive to the underlying variable such as interest rates or exchange rates (Wild, J.J 2007).. Thus, it was very crucial that the entities measure the derivatives at current value under the IASB Fair Value standard (Whittington, G. 2005). Shaken from the Enron affair and the disruption of capital markets, IASB hoped to control the further unpleasant surprises, uncertainty and lack of confidence in business for the sake of the upcoming economic prosperity (Whittington, G. 2005). But, the draft that IASB proposed soon attracted various wedges filled with power struggles from different stakeholders. Powerful stakeholders like European banks and French Government lobbied and raised a voice against the drafts proposal ideas saying; it would ultimately result in an

artificial volatility and it will have harmful consequences on the financial stability (Bengtsson, E. 2011). French President Chirac along with other banks of European Union took the political lobbying one step further by venting their concern that the IASB standards was not being abundantly profound about the interest of the European entity and that, in particular, will make the European economy go haywire because of the rise of the volatility following the submission of the drafts of the new standards. Moreover, the European Central bank rejected the proposal of the draft on the grounds that it gave banks too much flexibility to engage and increase their capital ratios. (Kerwer, D. 2007). Because of these reasons IASB failed to pass the endorsement of EU. As such, IASB had to skim down the standards at the end of the financial year. Even then, IASB concerns about the possible incompatibility between the American and European Unions standards; it being the long term goal of the IASB (Deegan, C. 2009). Following the decision IASB Chairman Sir David Tweedie warned; If political pressures in a national or regional context are able to overrule standards that have been developed in a deliberate and open manner, then it may lead to a system of beggar thy neighbour which will not provide the consistency and quality of accounting standards that the worlds markets demand (Bengtsson, E. 2011 pp.5). The above sentence is the most blatant description of the capture theory. The fact that the IASB introduced the draft in order to develop and increase the level of comparability, in order to meet the global Capital Market needs, has no impartiality whatsoever. Such manipulation of the regulations and the susceptibility of political pressure from the favoured clients give rise to a biased regulation. Nowadays, Accounting standards are tempered by the political action to a large extent because of which, we can illustrate that such standards have become the product of political action as much as they are of logical and empirical findings (Gerboth, DL. 1973). In a sense, we can say that the accounting had become an explicit political issue. In our case, regardless the essence of the rules introduced by the IASB, EU gets to choose what standards it wishes to adopt. Either, the essence is of a development of an independent standard designed to serve the community and protect the public interest or, the essence be a designated design to quench the supposed interests of the European Economy and other groups that were lobbying against the regulations (Chung, D, Y. 1999). Even though few powerful companies are affected, I think that the fair and transparent financial reporting must be promoted regardless of any behaviour from the lobbyist. A financial report must have real economic consequences as derived from an economic reality

of the society. Regulators must disclose the standards based on the representation of the economic reality and consequences o0f the society; not for a single individual.

Q2) Positive Theory Perspectives

Accounting theories basically constitutes a logical reasoning which in turn provides or becomes a set of principles, policies, methods, rules, procedures & conventions (Jones, S., & Riahi-Belkaoui, A 2010).. While normative theory go to a length to prescribe how a particular practice should be undertaken regardless of any loose ends from an existing practice; Positive theory seeks to explain and predict some specific phenomenas. It mostly focuses on the assistance of the accounting in the functioning of the relationship between various stakeholders, who are involved in providing resources to the company, and the organization (Henderson, S., Peirson, G., & Harris, K 2004).. Such relationship can exist between the owners and the managers, managers and the creditors and so on. Based on the economics-based assumption; that all individuals action is driven by selfinterest, Watts and Zimmerman argued that the individuals will always act in an opportunistic manner to the extent that the actions will increase their wealth(Gaffikin, M 2008).. Holding onto this idea, positive theory expects the organizations to seek and put in place mechanisms that align the interests of the managers of the firm with the interest of the owners of the firm. Our case, illustrated in Accounting Headline 7.7, can be looked upon two different perspectives: Efficiency and Opportunistic perspectives. Efficiency perspective explains how various mechanisms are put into place to lessen the agency cost of the firm, which are, the costs that are associated with assigning the decision making authority to the agent (Wild, J.J 2007). Opportunistic perspective explains how, after the contractual arrangements of the firm, it can seek to explain and predict certain opportunistic behaviours that may subsequently occur (Henderson, S., Peirson, G., & Harris, K 2004). It considers the past contractual arrangements that were negotiated as they were considered to be the most efficient in aligning the interest of the various individuals within the firm. Since, it is impossible to write contracts that are capable of guiding all accounting methods in all circumstances, there will always a possibility for the agents to be opportunistic (Wild, J.J 2007). Hence, Positive theory proposes that there will always be scope for agents to opportunistically add or delete particular accounting methods in preference to others.

The opportunism perspective aligns almost fully with the early description of the positive theory by Watts and Zimmerman (1978). The basic concept that this perspective holds is that it is not cost-effective or possible to write contracts that would prevent all the post opportunism (Healy 1985). For example, Managers can use post-opportunism accounting guidelines in a free-for-all situation to maximize the current value of profits-linked organizations compensation and increase leverage or interest cover. All this is performed, while technically following the laws and regulations. According to this perspective, stakeholders create incentives to parley a set of contracts explaining their affiliation with the firm that minimizes the total sum of agency costs which in turn maximizes the value of the firm (Smith & Warner 1979). Even the smallest of policy decision, recording for goodwill in our case, may upset and have an impact upon the financial statement variables (Watts 1977). When a company divulges into different research and development in hopes for the future prosperity, they cannot judge exactly when intangible asset is developed in the house and when it will affect the economics in the future. With this type of investment, it is sometimes difficult to separate the goodwill from other ordinary costs (Wen, I. 2011). When the new accounting standard is introduced and the companies are forced to account the intangible asset, the profit/loss figure is highly distorted. Now, what was otherwise accounted as expenses are now accounted as assets and vice versa. This increases/decreases the value of assets or expenses, which in turn increases/decreases the value of the firm. However, in our case, to expense everything that constitutes forthcoming economic ties would be rather conservative which may eventually leave the users of the financial statements with indecisions (Wen, I. 2011). Because of which the value of the company drops. The imposition of a particular accounting method to an organisation does not necessarily distort the efficiency of the organisations. But it is not always the same. Different standard board have their own rules and ways of accounting. For example, a regulation would not let us capitalize the primary expenses on the purchase of a plant but another one does. Now, we may have a difference in a net value of the plant over the period. But the work and the workload remain the same for that plant. Its efficiency does not have anything to do with how we book its logs or profits. Efficiency of the organisation would depend much upon the physical abilities of the companies rather than how we record it in the books. However, due to new accounting standards, if the fluctuations are high and too often, then credit rating companies might think bad of them and may withdraw any financial help they promised.

Investors lack of confidence on the company also dries out because of that same condition; these will obtrude the efficiency of the company to some extent.

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