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ACC80005 Financial Accounting Theory For Modernization Directive

Questions:

a) Explain why the 2003 Accounts Modernisation Directive should be amended? Your answer should be informed by scholarly academic research on corporate social responsibility, sustainability and integrated reporting. You are required to draw on at least two theories explaining voluntary corporate reporting when forming your answer. 

b) Out of the 5 scenarios discussed in the 5th Workshop, which one do you think is the most suitable option? When arriving at your conclusion, discuss the pros and cons of each of the 5 scenarios. Your discussion should go beyond the pros and cons highlighted in the case and draw on relevant theories you have learned in this unit of study. You should demonstrate that you have conducted sufficient research using both academic and non-academic sources to build insightful arguments.

Answer:

Introduction:

The report is prepared for explaining the reasons that is associated with making amendments to the 2003 accounts modernization directive. Such explanation is done by highlighting the theories of voluntary corporate reporting. In the later part of report, the five scenarios are discussed by briefly listing each scenario advantage and disadvantage. Analysis of all the scenarios helps in explaining and deciding on the best scenario by referring to relevant case studies.

Discussion:

Reasons why the 2003 accounts modernization directive should be amended:

The directive that was issued in year 2003 required organizations to report on their corporate social responsibilities activities along with their annual financial report. It took into account an understanding of the development, position and performance of company that considered the financial and non financial indicators that is relevant to any particular business along with the information relating to employees and environmental matters. The amendment to accounts modernization directive of 2003 is about making reporting economic, environmental and social activities (Bini et al., 2017).

The amendment of 2003 accounts modernization directive is intended to be done for the simplification of requirements of financial reporting for micro entities and environment of business for enhancing their competitiveness and releasing the potential for growth. Such amendment would have an impact in terms of adequate protection and safeguarding of stakeholder information along with reduced administrative burden and this would help in aligning the reporting requirements of micro entities with the need of preparers and users (Scott, 2015). The financial reporting environment in the European Union improved due to accounting directives. It


is required that the annual report of reporting entities as per the European Union directive should include a fair review of performance and development of business and position of company along with the description of uncertainties and principal risks faced by organization. A comprehensive and balanced analysis should form a part of review that should be consistent with the complexities and size of business (Luttermann, 2017). Moreover, the annual report of company should include additional explanations and references concerning the amount that is reported in the annual report. The amendment of European union accounts directive called for expanding the reporting obligations of company relating to the diversity information and non financial information by large companies in relation to two areas. In addition to this, the amendment is about ensuring transparency that helps in managing the non financial opportunities and risks in a better way so that the non financial information of companies gets improved. Large companies having more than five hundred employees are required to make disclosure of material and relevant social and environmental information in the section of non financial information of annual report (Baker & Burlaud, 2015).  In addition to this, they are also required to provide information on their policy of diversity by setting out the implementation and objectives of policy.

The voluntary corporate reporting by an organization is the institutional practice that leads to changes and adaption of the process. Existing voluntary practice for corporate reporting might be coerced so that it well aligned with the demands and expectation of stakeholders. There will be conformity in practices that is adopted by organization leading to some form of uniformity. Such amendment that would be made is explained in reference to the theories such as legitimacy theory and institutional theory (Carini et al., 2017).

Legitimacy theory is one of the theories that help in explaining the increased level of disclosures relating to social responsibility since year 1980s. However, the variables pertaining to external corporate governance that helps in explaining the decision relating to corporate social responsibility is excluded from the model the model. It is assumed in the theory that there should not be existence of any companies unless the operations of company are well aligned with the needs of society at large. According to this, a social contract is resembled between the society and company by the idea of legitimacy (Valentincic et al., 2017). The theory has helped in addressing how the corporate management addresses certain items while communicating with their outside audiences. Such integration of accounting studies in the theory has been because the objective of accounting is to provide users with such information that helps in decision making after accounting for social interest. The revision of accounts modernization directive 2003 requires organization to prepare corporate financial statement containing reference to code of corporate governance and a description of undertaking of the risk management and system of internal control pertaining to the process of financial reporting (Christensen et al., 2016).

As per the legitimacy theory, management of reporting organization is forced to make disclosure of information that would change opinion of external users regarding the company. One of the important sources of legitimation is the annual report and such legitimation occurs by way of mandatory disclosures and because of regulations as depicted in other sections of annual report. When incorporating this particular theory regarding the amendment of 2003 accounts modernization directive, it can been seen that the cost of litigation can be regarded as constraint against disclosure and considered as motivation to increase disclosure. On one hand, the inadequate amount of disclosures encourages managers to increase the voluntary disclosures that are not subjected to legal actions. Moreover, the managers regarding the disclosure of information would give due care concerning any unfavorable news for limiting litigation threat. On other hand, the voluntary disclosures of forward looking information gets reduced with the help of managers mainly when there is a risk of imposing penalty against the forecasts (Mami?-Sa?er, 2015). It is indicated by the notion of legitimacy theory that the operations of organization should be in compliance with the expectations and norms of community and it should be believed by them that their operations is in compliance with the social contracts.

It is broadly stated as per the institutional theory that the institutional field and environment governs the behavior of firms. The context of organization, network of social relationship and scope of activities are included in the institutional field. Business practice becomes uniformed using three mechanisms comprising of mimetic, coercive and normative. Mimetic practice refers to the pressure of firms for confirming to certain behavior. Mechanics of coercive refers to the techniques of pressure that helps in attaining the business practices in association with the expectations of society. Normative practices on other hand are about the belief internationalization about certain behavior suitability. Broadly, the agents of behavior are driven by aligning the societal norms and beliefs of agent with such alignment being caused by external pressure and norms internationalization. Theory of internationalization provides explanation of the mechanism that helps organization is seeking alliance of the characteristics and practices with cultural and social values. It is assumed by the perspective of institutional theory that new practice of sustainability reporting would be adopted by manager of organization. The isomorphic process of voluntary disclosure, reporting entities will become increasingly homogenous within given confirmation and domains of the wider institutional environment. It is indicated by three isomorphic processes that it helps organization in adopting management practices and similar structures irrespective of efficiency of organization.

Discussion of the scenarios as depicted in the 5th workshop:

The workshop was conducted to improve and promote the disclosure of information relating to environmental social and governance factors that would help in understanding the requirements of stakeholders. Five hypothetical scenarios that was discussed in the workshop is related to disclosure of ESG information that would help in facilitating coordination between disclosure initiatives of existing  ESG and deepening the understanding of the disclosure practices of relating to ESG. The first hypothetical scenario is about disclosure of performance of ESG that is a requirement criterion for organization being listed on stock exchange. The second and third hypothetical scenario was quite similar as it did not call for any changes in the accounts modernization directive of 2003. In this situation, a new directive was proposed requiring investment funds to make the disclosure of the fact whether the criteria of ESG would be accounted by the policy in investment decisions. A development of new voluntary European standard was proposed in this scenario that would help in creating a uniform process for reporting concerning ESG. The development of standardized mandatory principles was suggested in the forth scenario at the level of European Union (Luttermann, 2017).

Out of all the hypothetical scenarios, the most suitable option would be the forth hypothetical scenario that have suggested the development of mandatory principles that is strengthened by recognizing the two key performance indicators that are recognized internationally. This particular hypothetical scenario is considered as the most suitable option because it leads to revising the 2003 Accounts modernization directive for explaining or complying the provision. All the private companies reporting in the European Union needs to apply to the reporting proposal along with the public companies. The most material opportunities and risks pertaining to environmental, social and governance factors should be identified by companies (Ribeiro et al., 2016). Such risks would involve risks associated with bribery, emission of carbon dioxide corruption and human rights. Such risks are analyzed in relation to the operations of organizations and how the formulated strategy would be helpful in handling such issues.  The reporting requirement would be exempted on part of small and medium enterprises. Two sets of non key financial key performance indicators are developed that is recognized and widely accepted at international level. It is explained by one set of such indicators that the assessment of valuation of company is facilitated that would help in meeting the needs of capital market and economic stakeholders. The wider expectation of society as a whole can be met by separating set of indicators relating to social license to operate (Elzahar et al., 2015). It is identified by the scenario proponents that companies are provided with some degree of choice and freedom with the help of such regulations in determining the opportunities and risks that are most material to the business. However, there exist ambiguity between social license to operate and economic factors.

Pros and cons of scenario one:

  • Since the performance of ESG is required to be disclosed for being listed on the stock exchange, it would be ensured by organization that their operations are carried out by well aligning with the environmental factors.
  • A development of public online rating system for the disclosure quality of ESG would be developed and financed by European commission.
  • The company in lure of achieving highest ranking would boost the use of disclosure of ESG. This would make organization confused about the disclosure quality concerning ESG.

Pros and cons of scenario two and three:

  • A new directive relating to the investment funds is proposed without calling for any change to the accounts modernization directive.
  • The divergence between different national approaches would be circumvented by the implementation of process of standard settings. Another benefit is related to proposed industry specific key performance indicators (Valentincic et al., 2017).
  • However, this particular scenario was not successful in offering an improvement over the programs of voluntary reporting.

Pros and cons of scenario four:

  • The opportunities and risks relating to ESG would be identified by companies.
  • Assessment of valuation of company is designed in such a way that helps in meeting the wider expectations of society and needs of customers.
  • There exists ambiguity between social license to operate and key performance indicators for economic factors (Szabó & Sørensen, 2015).

Pros and cons of scenario five:

  • This particular scenario highlighted the significant amount of changes in regulations that is required.
  • A completely new directive on disclosures of European countries is proposed.

Conclusion:

The report is prepared for analyzing the relevance of voluntary corporate reporting in explaining the need of amendment to the 2003 directives of accounts modernization. Two theories that have been selected for explanation of such amendments involve legitimacy theory and institutional theory. It is depicted as per legitimacy theory that organization will not be considered legitimate if it fails to undertake the activities meeting the requirement o society.  Institutional theory on other hand indicates that new practices such as sustainability reporting need to be adopted by managers as per the perspective of institutional theory (Ramanauskait? & Gedminait?, 2014). It has been found that the most suitable options as identified from the workshop are situation four. This is so because it takes into account both financial and non financial performance indicators for evaluating the performance of company.

References list:

Baker, C. R., & Burlaud, A. (2015). The historical evolution from accounting theory to conceptual framework in financial standards setting. The CPA Journal, 85(8), 54.

Bini, L., Dainelli, F., & Giunta, F. (2017). Is a loosely specified regulatory intervention effective in disciplining management commentary? The case of performance indicator disclosure. Journal of Management & Governance, 21(1), 63-91.

Bublitz, B., Philipich, K., & Blatz, R. (2015). An example of the use of research methods and findings as an experiential learning exercise in an accounting theory course. Journal of Instructional Pedagogies, 16.

Carini, C., Rocca, L., Veneziani, M., & Teodori, C. (2017). The Regulation of Sustainability Information–The Contribution of Directive 2014/95.

Carini, C., Rocca, L., Veneziani, M., & Teodori, C. (2018). Ex-Ante Impact Assessment of Sustainability Information–The Directive 2014/95. Sustainability, 10(2), 560.

Christensen, H. B., Nikolaev, V. V., & WITTENBERG?MOERMAN, R. E. G. I. N. A. (2016). Accounting information in financial contracting: The incomplete contract theory perspective. Journal of accounting research, 54(2), 397-435.

Elzahar, H., Hussainey, K., Mazzi, F., & Tsalavoutas, I. (2015). Economic consequences of key performance indicators' disclosure quality. International Review of Financial Analysis, 39, 96-112.

Fülbier, R. U., & Klein, M. (2015). Balancing past and present: The impact of accounting internationalisation on German accounting regulations. Accounting History, 20(3), 342-374.

Luttermann, C. (2017). Accounting as the Documentary Proof of Good Corporate Governance. In German Corporate Governance in International and European Context (pp. 329-400). Springer, Berlin, Heidelberg.

Mami?-Sa?er, I. (2015). The regulatory framework of accounting and accounting standard-setting bodies in the European Union member states. Financial theory and practice, 39(4), 393-410.

Mundigl, S. (2014). Modernisation and consolidation of the European radiation protection legislation: the new Euratom Basic Safety Standards Directive. Radiation protection dosimetry, 164(1-2), 9-12.

Ramanauskait?, A., & Gedminait?, I. (2014). THE EVOLUTION OF INITIATIVES TO IMPLEMENT AND REGULATE THE SYSTEM OF ACCOUNTING AND REPORTING ON ENTERPRISE ‘S INTELLECTUAL CAPITAL. Science and Studies of Accounting and Finance: Problems and Perspectives, 9(1), 195-203.

Ribeiro, V. P. L., & da Silva Monteiro, S. M. (2015). Public and Private Sector Environmental Reporting. Review of Business and Legal Sciences/Revista de Ciências Empresariais e Jurídicas, (26), 231-271.

Richard, G., SCHROEDER, C., MYRTLE, W., & CATHEY, J. (2016). Financial Accounting Theory and Analysis: Text and Cases. JW WILEY.

Scott, W. R. (2015). Financial accounting theory (Vol. 2, No. 0, p. 0). Prentice Hall.

Szabó, D. G., & Sørensen, K. E. (2015). New EU directive on the disclosure of non-financial information (CSR).

Valentincic, A., Novak, A., & Kosi, U. (2017). Accounting quality in private firms during the transition towards international standards. Accounting in Europe, 14(3), 358-387.

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