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HI6025 Accounting Theory And Current Issues For Management Accounting

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  • Course Code: HI6025
  • University: Holmes Institute
  • Country: Australia

Question:

Each group can choose a peer-reviewed journal article that discusses the implications of accounting theories (agency theory, institutional theory, stakeholder theory, legitimacy theory, debt-covenant theories) to organisations; OR a peer-reviewed journal article that discusses the implications of positive accounting theories hypotheses (bonus plan hypothesis, debt- covenant hypothesis, political cost hypothesis ) to organisations.

 

Answer:

Introduction:

With the constantly changing economic conditions in the recent era, it has become essential of using flexible approaches and tools. The article that has been selected to fit the purpose of this assignment is “Management accounting and agency theory”. The current paper intends to describe the way management accounting evolved and the area of scope for additional extension of management accounting with the help of agency theory. For designing the future direction of management accounting, it is crucial to obtain an overview of the development of that field. Thus, this assignment provides a brief discussion of the evolution of management accounting, agency theory and its related issues. Finally, this assignment sheds light on discussing the implications of agency theory in the field of management accounting. 

 

Development of management accounting:

In the words of Agoglia, Hatfield and Lambert (2015), management accounting is developed on business practice and it needs to serve for promotion of business activities. This field has evolved with the establishment of the big organisations between 1850 and 1925 that necessitated the need for information crucial for control and planning. During this time, it is necessary for the organisations to streamline production that has resulted in the establishment of management accounting. The manufacturing firms now use to appoint staffs on long-term contracts, which was not prevalent before the industrial revolution. In addition, the headquarters are now separated from the factories, which raised the information system and the requirement to analyse the managers and staffs of the organisations.

There is considerable impact of mass distribution and production on the management accounting concept, which needs to deliver information regarding the turnover in individual areas along with generating formal reports on performance. These are little different from the reports that the current management accounting provides. The requirement for management information results in development of control systems and budget planning, which would help in ensuring that the various activities of the different divisions are in tandem with the business objectives.

As laid out in the article of Bou?ková (2015), management accounting has concentrated traditionally on financial outcomes and it has remained oblivious of the other indicators like market position, customer loyalty, customer relationships, loyalty and staff motivation. With the formation of non-financial indicators and association with external business environment, new demands are levied on the management system and information support in the perspective of management accounting. Such extension of management accounting gives new information, which might enable in solving critical issues. Thus, there is a proactive approach in responding to the situation by transferring management accounting from a passive role towards solving actions and strategic approach (Bahli and Rivard 2017). 

 

Agency theory:

One of the most significant paradigms in management accounting is agency theory for the past 27 years. This theory helps in providing an effective theoretical framework in order to gain an insight of the business processes from the principal-agent viewpoint. As commented by Bosse and Phillips (2016), agency theory is a contractual relationship, where a single or more individuals (principal) hire one or more individuals (agent) for performing some actions in the favour of the principal. This needs the delegation of various decision-making powers to the agent. The agents and principals are considered as rational economic individuals, who are motivated due to self-interest and these might change based on conviction, preference and information. As the principal provides capital and bears the risk, while the agent performs the tasks, a decision is made in favour of the principal and the risk is transferred to the principal as well. 

 

Problem of agency theory:

The agency relationship encounters a fundamental issue that deals with the agent behaviour and desire for maximising the utility function and this might not be consistent with the principal objectives. This results in agency problem, in which the agent might not act in the best interest of the principal. Information asymmetry takes place when one party has more information than the other party (Dawar 2014). In majority of the cases, the agent has more information due to direct engagement in the daily operations of the organisation. Thus, it could be viewed as market failure, which results in ineffective distribution of available resources.

Another issue associated with the agency theory is the kind of shareholder-manager relationship. If the ownership and management is separated, a situation might take place, in which the shareholders could not observe the behaviours of the managers (Habib and Jiang 2015). As a result, the managers would not perform according to the best interests of the shareholders and they might behave opportunistically. Hence, the relationship between the shareholders and the managers is exposed to risk.

Principal-agent model:

The principal-agent model depends on the rational attitude of the individuals and it is assumed that these individuals have the ability to estimate and analyse the likelihood of future eventualities. According to Jones (2015), the principal-agent model benefits management accounting a way for assuring valuable and coherent framework, in which the management accounting issues could be viewed. In this model, there is an assumption of information asymmetry. The agent possesses some information to which the principal could not gain access costless and the agent is assumed as risk-averse.

Transaction cost economics model:

According to this model, the individuals perform activities based on their self-interest. This could be termed as opportunistic behaviour, since the individuals do not behave as per the rules (Libby and Thorne 2017). In this model, it is assumed that the individuals possess restricted opportunity. As a result, the individuals could not estimate all the probable future contingencies. Thus, in this model, it is assumed that the contracts are incomplete. This model gives a description of unusual relationships between firms aiming to develop or using monopoly power. Hence, it could be stated that this model concentrates on the resolution of contractual associations between organisations, which could lay additional stress on contractual associations within the organisation.

Rochester model:

This model is identical to the transaction cost economics model, which depicts transaction costs and opportunistic behaviour; however, it is developed on the theory of positive accounting. With the help of this model, situations could be identified where there are variations of interests between agent and principal inherent along with evaluation of cost-effectiveness in setting control mechanisms (Mitnick 2015). Another advantage of this model is that the framework could be applied to the agency problem and its intention is to gain an overview of the occurrence of agency problem and the ways it could be mitigated through the organisational culture. 

 

Implications of agency theory in management accounting:

The management accounting research is focused considerably on performance analysis and issues concerning the control of the organisation. This takes into account management incentives along with the behaviours of the agent and the principal. The agency theory has been deduced from a concept, which could estimate managerial and organisational output in association with the financial processes and information. The research, in this field, has focused on designing the optimum monitoring system. Thus, it is necessary for the principal in deciding the amount to be invested in the production system and in the monitoring system. It has been found out that if heavy investment is made on the production process on the part of the principal, the firm could invest in a monitoring system for minimising the agency problem (Pepper and Gore 2015).

The agency theory could be applied in organisations along with attempting to describe the relationships between them. A significant prerequisite is the contract imperfection, since it is not possible to include all future contract contingencies. However, the agency theory has the issue of information asymmetry. In order to deal with this specific issue, promoting information exchange would be a feasible idea between the firms. Hence, by combining the agency theory and managerial accounting, there is ardent need for tools to monitor the managerial behaviour. Moreover, a need is inherent to control and manage the monitoring costs. With the help of agency theory, an overview of the managerial behaviour could be obtained, which has direct influence on the value of information in management accounting (Rashid 2015). In case, the information of management accounting is not able to disclose this opportunistic behaviour depending on agency theory, additional costs have been incurred and the resources of the firm have gone in vain. The advantage of agency theory is that it urges the practice of considering the value of management accounting techniques (Song, Wang and Cavusgil 2015).

Conclusion:

From the above discussion, it has been found out that management accounting is developed on business practice and it needs to serve for promotion of business activities. One of the most significant paradigms in management accounting is agency theory for the past 27 years. This theory helps in providing an effective theoretical framework in order to gain an insight of the business processes from the principal-agent viewpoint. The agency theory could be applied in organisations along with attempting to describe the relationships between them. A significant prerequisite is the contract imperfection, since it is not possible to include all future contract contingencies. Hence, by combining the agency theory and managerial accounting, there is ardent need for tools to monitor the managerial behaviour. 

 

References:

Agoglia, C.P., Hatfield, R.C. and Lambert, T.A., 2015. Audit team time reporting: An agency theory perspective. Accounting, Organizations and Society, 44, pp.1-14.

Bahli, B. and Rivard, S., 2017. The Information Technology Outsourcing Risk: A Transaction Cost and Agency Theory-Based Perspective. In Outsourcing and Offshoring Business Services (pp. 53-77). Palgrave Macmillan, Cham.

Bosse, D.A. and Phillips, R.A., 2016. Agency theory and bounded self-interest. Academy of Management Review, 41(2), pp.276-297.

Bou?ková, M., 2015. Management accounting and agency theory. Procedia Economics and Finance, 25, pp.5-13.

Dawar, V., 2014. Agency theory, capital structure and firm performance: some Indian evidence. Managerial Finance, 40(12), pp.1190-1206.

Habib, A. and Jiang, H., 2015. Journal of International Accounting, Auditing and Taxation. Journal of International Accounting, Auditing and Taxation, 24, pp.29-45.

Jones, S. ed., 2015. The Routledge companion to financial accounting theory. Routledge.

Libby, T. and Thorne, L. eds., 2017. The Routledge Companion to Behavioural Accounting Research. Routledge.

Mitnick, B.M., 2015. Agency theory. Wiley Encyclopedia of Management.

Pepper, A. and Gore, J., 2015. Behavioral agency theory: New foundations for theorizing about executive compensation. Journal of management, 41(4), pp.1045-1068.

Rashid, A., 2015. Revisiting agency theory: Evidence of board independence and agency cost from Bangladesh. Journal of business ethics, 130(1), pp.181-198.

Song, J., Wang, R. and Cavusgil, S.T., 2015. State ownership and market orientation in China's public firms: An agency theory perspective. International Business Review, 24(4), pp.690-699.

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