Theory of Accounting and

Control
 ACCOUNTING AND CONTROL IN ORGANIZATIONS:
A CONTRACT THEORY

PART I:
CONTRACT THEORY OF THE FIRM
CHAPTER 1: INTRODUCTION
CHAPTER 2: ACCOUNTING AND CONTRACT MODEL OF THE FIRM

PART II:
MICROTHEORY OF ACCOUNTING AND CONTROL
CHAPTER 3: CONTRACTING FOR MANAGERIAL SKILLS
CHAPTER 4: MANAGERS AND ACCOUNTING DECISIONS
CHAPTER 5: INCOME AND ITS MANAGEMENT
CHAPTER 6: INVESTORS AND ACCOUNTING
CHAPTER 7: ACCOUNTING AND THE STOCK MARKET
CHAPTER 8: AUDITORS AND THE FIRM

PART III:
MACROTHEORY OF ACCOUNTING AND CONTROL
CHAPTER 9: CONVENTIONS AND CLASSIFICATION
CHAPTER 10: DECISION CRITERIA AND MECHANISMS
CHAPTER 11: STANDARDIZATION OF ACCOUNTING
CHAPTER 12: GOVERNMENT, LAW AND ACCOUNTING
CHAPTER 13: ACCOUNTING FOR PUBLIC GOOD ORGANIZATIONS
 ACCOUNTING AND CONTROL IN ORGANIZATIONS:
A CONTRACT THEORY
Part I: CONTRACT THEORY OF THE FIRM

Chapter 1: Introduction

THREE BASIC IDEAS

– Organizations as a Set of Contracts
– Shared Facts for Conflict Resolution g
– Control in Organizations as Balance and Equilibrium

MICROTHEORY OF ACCOUNTING AND CONTROL

– Functions of Accounting and Control
– Managers and Income
– Shareholders, Stock Markets, and Auditors

MACROTHEORY OF ACCOUNTING AND CONTROL

– Basic Features of Accounting
– Social Choice Criteria, Mechanisms, and Standardization
– Government and Public-Good Organizations

Chapter 1 References
Chapter 2: Accounting and the Contract Model of the Firm

THE FIRM AS A SET OF CONTRACTS

ACCOUNTING AND THE FIRM

– Measuring Contributions
– Measuring Entitlements
– Distribution of Information about Contract Fulfillment
– Liquidity of Markets for Contractual Slots
– Common Knowledge for Renegotiation of Contracts

CORRESPONDENCE BETWEEN ORGANIZATIONAL AND ACCOUNTING

FORMS
– Bookkeeping
– Managerial Accounting
– Financial Reporting

Chapter 2 References
Part II: MICROTHEORY OF ACCOUNTING AND CONTROL

Chapter 3: Contracting for Managerial Skills

CHARACTERISTICS OF MANAGERS
– Human Capital
– Measuring Managerial Contribution
– Contact with Other Agents

FORMS OF CONTRACTS FOR MANAGERS

– Manager’s Preferences
– Contracts of Top, Middle, and Lower Level Managers

Chapter 3 References
Chapter 4: Managers and Accounting Decisions

HIERARCHY OF ACCOUNTING DECISIONS

– Discretionary Decisions on Expensing-Capitalization of Costs
– Accounting Estimates
– Accounting Principles
– Disclosure Policy
– Internal Controls
– Accounting Standards

CERTAIN FEATURES OF CONTROL SYSTEMS

– Cost of Accounting
– Transfer Pricing
– Cost Allocations
– Participative Budgeting
– Standards and Variance Analysis

MANAGERIAL CONSEQUENCES OF ACCOUNTING DECISIONS

– The LIFO Puzzle
– Accounting for Leases
– The Restructuring of Troubled Loans
– Cost of Exploration, Research and Development
– Recognizing Option Value as Compensation Expense
– Rationality of Apparently Irrational Decisions

OBSERVABLE BEHAVIOR OF MANAGERS

– Preference for Status Quo
– Income Management
– Prediction of Accounting Methods by Firm Characteristics

Chapter 4 References
Chapter 5: Income and its Management

INTRODUCTION TO INCOME

FUNCTIONS OF INCOME IN A FIRM

– Assessing Viability of the Firm
– Managerial Evaluation and Contract Renegotiation

ATTITUDES OF AGENTS TOWARD INCOME

– Shareholders
– Managers
– Determination of Entitlements

MANAGEMENT OF INCOME
– Statistical Measures of Smoothness
– Income Processes: Smoothness vs. Smoothing
– Income-Smoothing vs. the “Big Bath” Hypotheses
– Instruments of Income Management
– Summary of Empirical Findings

Chapter 5 References
Chapter 6: Investors and Accounting

DESCRIPTION OF THE INVESTOR CLASS

– The Lack of Active Participation
– Transferability of Contract
– Heterogeneity of Preferences
– Information and Speed of Price Adjustments
– Information Intermediaries
– Creditors

INVESTOR ATTITUDES AND PREFERENCES

– Reporting on Contract Performance
– Incentives to Managers
– Aggregation Adds Information

ACCOUNTING CHOICE MECHANISMS FOR

INVESTORS
– Organization of the Firm
– Trading in Capital Markets
– Voting and Proxies
– Sociopolitical Institutions

CONSEQUENCES OF ACCOUNTING POLICY FOR

INVESTORS
– Accounting Information as Public Goods
– Production of Information By Intermediaries

Chapter 6 References
Chapter 7: Accounting and the Stock Market

INTRODUCTION
– Limited Role for Valuation Rules
– Role of Information Intermediaries

QUESTIONS ABOUT ACCOUNTING AND THE STOCK MARKET

– Money from Accounting Numbers
– Money from Advance Access to Accounting Numbers
– Effect of Accounting Methods on the Stock Market
– Effect of the Stock Market on Accounting
– Accounting Without the Stock Market
– The Stock Market Without Accounting

PROBLEMS OF INFERENCE
– The Needle in a Haystack Problem
– The Expectations Problem
– The Self-Selection Problem

Chapter 7 References
Chapter 8: Auditors and the Firm

INTRODUCTION

THE FUNCTION OF AUDIT IN THE FIRM

AUDITOR DECISIONS
- Allocation of Resources in an Audit Assignment
- Audit Opinion
- Pricing of Services and Bidding for Clients
- Audit Policies, Training, Quality Control, and Self Regulation
- Technology of Audit

Institutional Structure of the Audit Profession

- Development of Audit Standards
- Development of Accounting Standards
- Who Sets the Standards?
- Auditors’ Responsibility for Detection of Fraud
- Competition, Entry, Discipline

Chapter 8 References
 Part III: MACROTHEORY OF ACCOUNTING AND CONTROL

Chapter 9: Conventions and Classification

CONVENTIONS
- ACCOUNTING CONVENTIONS

ECONOMIC FEATURES OF ACCOUNTING

- Entity
- Going Concern or Continuity
- Period
- Valuation
- Accrual

TEMPORAL STABILITY OF ECONOMIC FEATURES

- Double Entry
- Economic Resources

UNIFORMITY AND CLASSIFICATION

Chapter 9 References
 Chapter 10: Decision Criteria and Mechanisms

CRITERIA FOR SOCIAL CHOICE

- Technological Efficiency
- Simple Economic Efficiency
- Multi-Person Economic Efficiency
- Multi-period Problem
- Uncertainty Problem

SOCIAL COST-BENEFIT ANALYSIS

- Which costs and which benefits?
- Problems of partial analysis
- Nonlinear utilities
- Measures of Efficiency

MECHANISMS FOR SOCIAL CHOICE

- Limitations of Voting Mechanisms
- Market Mechanisms in Accounting Standards
- Legal Rights and Markets

Chapter 10 References
 Chapter 11: Standardization of Accounting
RULES AND ECONOMIC DECISIONS
- Rules as Constraints
- Rules as Payoff Functions
- Voluntary and Mandatory Behavior
ECONOMICS OF RULES AND
STANDARDS
- Benefits
- Costs
- Distribution and Equity
- Adjustment to New Standards
ECONOMIC THEORIES OF
STANDARDS
- Monopoly and Limiting
Competition
- Provision of Public Good
ACCOUNTING STANDARDS
- Types of Standards
- Enforceability of Standards
- Market Argument
- Argument for Market Failure
- A Synthesis
INSTITUTIONS FOR SETTING
ACCOUNTING STANDARDS
- Models of Social Institutions
- Force of Standards
- Capture of Institutions
EFFECTS OF STANDARDS
• On Accounting Systems
• On Accounting Education
• On the Auditing Profession
Chapter 11 References
 Chapter 12: Government, Law, and Accounting

GOVERNMENT AS A CONTRACTING AGENT

- Government as Tax Collector
- Government as Customer

GOVERNMENT AS A SUPER-FIRM
- Charter of Firms
- Sale of Securities
- Certification, Licensing, and Discipline of Auditors

Chapter 12 References
Chapter 13: Accounting for Public Good Organizations

NOMENCLATURE AND CLASSIFICATION

ECONOMIC CHARACTERISTICS OF NRIOs
- Markets for Resources
- Agents

CHARACTERISTICS OF ACCOUNTING IN PUBLIC GOOD ORGANIZATIONS

- Entities and Funds

- Government Funds
- Proprietary Funds
- Fiduciary Funds
- Consolidation and Detail
- Recognition and Accrual
- Fixed Assets, Depreciation and Long Term Liabilities
- Budgets, Appropriations, and Encumbrances

INTERACTION BETWEEN ACCOUNTING FOR NRIOs AND ARIOs

Chapter 13 References
 CHAPTER 1

SHARED FACTS FOR CONFLICT RESOLUTION

Disputes, waste of resources
Role of evidence (shared info)
Common knowledge
- Theoretical abstraction
- Practical Approximation
Games of imperfect, incomplete information
Firm as a game of incomplete information
Role of public disclosure

CONTROL IN ORGANIZATION
Conflict and cooperation
Bargaining example
Balance & Equilibrium
Contrast from control OF organizations
 CHAPTER 3
CHARACTERISTIC OF MANAGERS
- Wealth as human capital
- Contribution hard to measure
- Procedural centrality

HUMAN CAPITAL
- Stock of human capital is inalienable
- Long term contracts are on flow, which are not enforceable
– Contracts must be self-enforcing
- Human capital used at work but not used up (actually it is accumulated at
work)
- Compensation: current + accretion of human capital
(Accounting is important for both)
- Short run supply of managerial human capital is inelastic
– Opportunity to extract rents
– Vulnerable to expropriation
- Managers cannot sell their job slots
- Managerial market transactions rely on reputation
– accounting permanence data
- Managers have an un-diversified portfolio of personal wealth which is
sensitive to small changes in current performance
- Performance data extrapolated by investors/superiors
- Performance smoothing by managers
MEASURING MANAGERIAL CONTRIBUTIONS
- Not directly measurable
- More difficult at higher levels
- Difficulty in designing their contacts

PROCEDURAL CENTRALITY:

CONTACT WITH OTHER AGENTS

- Procedural centrality of managers
- Managing contracts
- Surprises: nature, unanticipated behavior of others
- Privileged access to info about other contracts
- Info asymmetry in favor of managers
- Problems of adverse selection
– they know what others don’t
Moral hazard
– others do not know what they did
Could sell info to competitors for personal gain
Prohibition on sharing services of managers across competitors
 FORMS OF CONTRACTS FOR MANAGERS
Enforcement difficult because of
- Nature of work
- human capital
- involvement in contracts of others
Legal system could help if shared
information is available
HOW DO WE MAKE IT SELF-ENFORCING?
FLAT SALARY: IN PUBLIC GOOD
ORGANIZATIONS
EVEN OUTPUT IS DIFFICULT TO
MEASURE
POOR MOTIVATIONAL TOOL
PERFORMANCE CONTINGENT
CONTRACTS
NO SINGLE MEASURE IS PERFECT
FACTORS OUTSIDE MAN.
CONTROL
SUBJECT TO MAN.
MANIPULATION
CONDITIONS FOR JOB LOSS LEFT
UNSPECIFIED
RIGHT TO UNILATERAL
TERMINATION
WITHOUT CAUSE
ROLE OF ACCOUNTING IN
MANAGERIAL CONTRACTS
MANAGERS’ PREFERENCES
PECUNIARY VARIABLES
NONPECUNIARY VARIABLES
(FUTURE COMP.)
SALARY IS ABOUT HALF OF
TOTAL FOR CEOS
BENEFITS DRIVEN BY TAX LAW,
TRANS.
COSTS, SIGNALING
INTERACTION BETWEEN
PECUNIARY AND OTHERS
 Chapter 4
Managers and Accounting Decisions
Accounting and control includes Hierarchy of Accounting Decisions
– Basic data collection By frequency of decisions
– Performance reports Expensing-Capitalization decisions
– Financial reports – Managerial unique access to causes and
consequences
Choice of organizational form includes the choice of – Create facts by classification
accounting and control
– Discretion unavoidable, no perfectly
mechanical solution for classification is
Managers directly in charge of accounting and
possible
control
– Demarcation of capital improvements,
repairs, overhauls, rebuilding, salvaging
Other agents participate less directly
and maintenance
– Reacting and “voting with their feet”
– Managers can choose timing of
– Managers must anticipate and consider
such reactions transactions
– Law of conservation of income
Managers also participate in shaping accounting – Performance measures and contractual
regimes consequences
Consider the range of managerial accounting – Short-term contracts induce
decisions capitalization
– Review some features of accounting from – Countervailing factors: smoothing, longer
contract perspective term compensation plans, and auditing
– Consequences of accounting decisions
Accounting estimates
for managers
– Consequences for observable managerial – Bad debt allowance, warranty costs, NRV
behavior of byproducts, salvage values and
economic life
– Varying degrees of flexibility
– Same motivations as the expensing
decisions
Accounting Principles
– Short term consequences for
compensation
– Longer term consequences and
constraints
– Image and signal
– Auditing
Disclosure Policy
– Compliance with the law and
disclosure beyond the required
level
– Better information for
participating/other agents
– Temptation to disclose selectively
– Trade off between credibility and
cost of verification
– Effect on liquidity of factor markets
– Consequences of performance
forecasts by managers
– Competitors and investor
diversification
– (Competing against privately held
firms)
– Disclosure to limit opportunism of
managers
– Is less disclosure necessarily good
for managers?
– Is more disclosure necessarily good
for shareholders?
Internal Controls
– Broad managerial discretion
– Foreign Corrupt Practices Act 1977
requirements
– Sarbanes-Oxley 2002 requirements
– Cost Accounting Standards Board
for government vendors
– Manager is a principal as well as
an agent in different contractual
relationships within the firm
– Consistency of internal controls
helps balance motives
– Ideal: self-enforcing contract for
control
Accounting Standards
– SEC, FASB, IASB make rules
– Managers often participate on
behalf of the firm
– Can we distinguish managerial and
firm interests?
– Bank loan restructuring example
– Reflexivity of accounting: does it
only represent reality or does it
also create reality?
– What should be role of
firms/managers in setting
standards?
 Certain Features of Control Systems
Cost-benefit analysis of accounting and control systems
Transfer Pricing
Standard textbook solution discards the
problem
Essence of decentralization: trade-off
between benefits and costs
– Benefits of central coordination
– Informational disadvantage of the
center
Heart of organizational design problem
Cost Allocation
– Declared a dead issue many times,
but not dead yet
– Does allocation of sunk costs to
divisions make sense
– Ex post efficiency of resource
utilization versus ex ante efficiency
of resource acquisition decisions
Participating Budgeting
– Empowerment vs. dispersed
information argument
– Hayek: Information is dispersed in
the economy
– Trade-off: better decisions based on
more information
– Worse decisions shaded by
information agents choose to share
– Management consulting fads wax
and wane
– People bring their own expectations,
no blank slate
Standards and Variance Analysis
– Budgets and standards imply a
discontinuity in managerial reward
functions
– Anticipation by agents
– Complex non-linear dynamics
Managerial Consequences of
Accounting Decisions
– The LIFO Puzzle
– Accounting for Leases
– Restructuring of Troubled Loans
– Cost of Exploration, Research and
Development
– Recognizing Option Value as a
Compensation Expense
– Rationality of apparently irrational
decisions?
Observable Behavior of Managers
– Preference for status quo
– Income management
– Prediction of accounting methods
by firm characteristics
 Chapter 5
Income and Its Management
Firm as a source of “income” for all
participants
– Wage income
– Personal service income
– Interest income
– Land rent
– Sales income, etc.
– Each agent looks at own return from
the contributions
Shareholder income—a narrower perspective
What is special about shareholder income
– Residual nature
– Defined independently of others’ income
– The Degree of freedom problem—n
pieces of a pie
– Timing of transfer of income to
claimants: delay for shareholders’
– Other agents get their share on
predefined schedule
– Dividend is discretionary
– Diffuse of body of shareholders cannot
enforce contracts on timing of transfer
of income
– Taxation makes it difficult to
automatically transfer income
– Income to equity cannot be measured precisely
and in a timely manner
– No “ship accounting,” no periodic liquidation of
assets, continued long term asset investments
with imperfect and incomplete markets
– Indeterminacy of valuation, combined with the
control of management over
valuationèopportunity for income
management
– Difficulty of measuring managerial
inputèlinking compensation to
output/income è use of managerial discretion
for self-serving purposes
– Shareholders rely on information in possession
of the mangers but cannot be sure that
management will use this information only for
shareholders’ benefit
– Independent audits to put constraints
– Imperfections of monetary representation of
income vs. real income
 Law of Conservation of Income
Law of Conservation of Discounted Residual Income

Functions of Income in the Firm Determination of Entitlements

– Assessing viability Management of Income
– Everybody makes projections to the – Statistical measures of smoothness
future – Smoothing = smoothness?
– Income smoothing and big baths
– Managerial evaluation and contract
renegotiation – Instruments of income smoothing
– Incentives for covering the tracks
Attitudes of Agents towards Income
– Shareholders: money income as an estimate of real income
– Would like to get the first best estimate
– Fundamental model of valuation—relevance?

– Managers: Use of accounting to advance their own welfare (job security, level,
compensation, firm size all linked to corporate income), risk: dislike abrupt changes in
income
– Employment horizons shorter than firm horizon

Look at income management from the point of view of managers (bonus, options, could be
terminated before the fruits of labor appear in the financial statements)

– Managers’ expectations of what the shareholders would do

– Manager cannot iron out the kinks in the income streams (no retrospective adjustments)
– Limits on choice of accounting methods
– Not certain about the consequences of choices they make
How do you “smooth” a random walk series?
 CHAPTER 6
INVESTORS AND ACCOUNTING
WHAT IS SPECIAL
― PRECOMMITMENT
― TIME DELAY
― RESIDUAL CLAIM ONLY
― MEASUREMENT AND CONT.
FULFILLMENT CRUCIAL
DESCRIPTION
― LITTLE PARTICIPATION
― ON PURPOSE, DESIRABLE,
DIVERSIFICATION
― ROE ON OWNER MANAGED
FIRMS SAME
― TRANSFERABILITY
― MINIMAL COST, RAPID PRICE
ADJUSTMENT
― SYMMETRY OF INFO (PUBLIC
DISCL.)
― CONTRAST PRIVATELY HELD
FIRMS
― COST OF TAKING THEM PRIVATE
― PREFERENCE HETEROGENEITY
― LIQUID MARKET GIVES A UNIQUE
MEASURE
― PRICE ADJUSTMENTS TO
INFORMATION
― DETERMINE DISTRIBUTION OF
WEALTH
― EQUITABLE RELEASE OF
INFORMATION
― INFORMATION INTERMEDIARIES
― DEMAND FOR INFORMATION
― COST OF INFORMATION
― DIVERSIFICATION BY INDIVIDUAL
― INFORMATION INTERMEDIARIES
― PROBLEM OF EVAL.
PORTFOLIO MAN.
― DO NOT ASK FOR DISCL.
― ANALYSTS DEMAND
DISCLOSURE,
DETAIL
― CREDITORS
― NONPERMANENT COMMITMENT
― SHORT TERM CREDITORS
― SECURED CREDITORS
― UNSECURED LONG TERM
CREDITORS
― LARGE CREDITORS-LITTLE
INTEREST
― DESIGN OF DEBT COVENANTS--
GAAP
― WHY RELIANCE ON GAAP
― AUDIT COST
― INTERDEPENDENCE OF FIRM
CONTRACTS
― SPECIAL GAAP FOR EVERY
AGENT
INVESTOR ATTITUDES AND PREFERENCES
― REPORTING ON CONTRACT
PERFORMANCE
– IMPORTANCE OF CONTRACT
FULFILLMENT
– CONTROLS AND REDUNDANCY
– SYMMETRY OF INFO DISTRIBUTION
― INCENTIVES TO MANAGERS
– TOP MANAGER CONTRACTS
– LIMITS ON RELEVANCE AND RELIABILITY
– RRA IN OIL INDUSTRY
― AGGREGATION ADDS INFO
– INFORMATION IN AGGR. FUNCTION
ACCOUNTING CHOICE MECHANISM
― ORGANIZATION OF THE FIRM
– NATURE OF CHARTER
– GOING PUBLIC
― TRADING IN CAPITAL MARKETS
– DIVIDENDS AND VALUATION
– ANALOGY OF BUYERS AND CARS
– REACTIONARY MODE
– MANAGERS ANTICIPATE INVESTOR PREF.
― VOTING AND PROXIES
– NOT AN EFFECTIVE INSTRUMENT FOR
INV.
― SOCIO-POLITICAL INSTITUTIONS
– LEGISLATURE, REGULATORY BODIES
– CHANGES IN REGIME
CONSEQUENCES OF ACCOUNTING
POLICY FOR INV.
― ACCG. INFORMATION AS PUBLIC
GOOD
– UNDER PRODUCTION?
– COMMON COST OF CONTRACTS
– SPECIAL VULNERABILITY OF
INVESTORS
– NOT IN DIRECT TOUCH WITH
OPERATIONS
– FREE DIST. OF INFO--DYNAMIC
STABILITY
– ADVERTISING ANALOGY
― PRODUCTION BY
INTERMEDIARIES
– WHO PAYS, WHO BENEFITS
– EARLY EFFICIENT MARKET
EUPHORIA
– ECONOMICS OF INFORMATION
MARKET
– CRITICISM OF DETAILS FOR
ANALYSTS
- OPEN ENTRY TO ANALYST
MARKET
 Chapter 7: Accounting and the Stock Market
Accounting interface with
shareholders
1. Contributions: cash or real, made in
advance
2. Entitlements: real capital on basis of
accounting records, converted to
money in financial reports through
valuation rules
3. Reports of contract fulfillment:
unnecessary
4. Liquidity: verified reports to potential
investors
5. Public disclosure: to reduce
information asymmetry
Limited role for valuation rules
Entitles to real capital, not money
Imperfection of valuation rules,
vulnerability to manipulation
Only function (4) affected by
valuation rules
Role of information intermediaries
Primary, secondary and tertiary
markets: firm involved in P
Derived demand in P market, bankers’
compensation
Reputation of banker as protection
against collusion (effectiveness??)
Change of auditors, insurance
Money from Public Accounting
Numbers
Discovery and use of information
Competition in the market for
information
Trade off between the speed of
dissemination and depth of markets
Prospecting for gold
Academic studies vs. practical
implementation of money making
Impossibility of informationally efficient
markets
Money from Advance Access to
Accounting Numbers
- We would like to have direct evidence
about the money that can be made from
advance access
- Insider trading studies
- Ball & Brown (event studies) don’t quite
do it
Effect of Accounting Numbers on
Stock Market
- Investor expectations è stock prices
- Accounting data è investor
expectations
- Difficulty of doing studies on
formation of investor expectations
(not from field data)
- Role of accounting in preserving the
resources of the firm (control)
- Role of accounting in
managerial/employee motivation
- Linking investor and employee
behavior into an equilibrium
- Managerial selection
Effect of the Stock Market on
Accounting
- Not much research on the topic
- Beginning of efforts to standardize
accounting after creation of the SEC
- Reynolds example
- Managerial concerns about stock
market reaction (LIFO)
Accounting without Stock Market
- Choice of going public
Stock Market without Accounting
- Think about the question before the
next value relevance study
- Accounting a must for mutual
observables to contract on
- Stock market would be impossible
without accounting
Problems of Inference
- Needle in the Haystack Problem
- The Expectations Problem
- The Self-selection Problem
 Chapter 8: Auditors and the Firm

Functions of the Audit in the Firm

Auditor Decisions
- Allocation of resources in an audit assignment
- Audit Opinions
- Pricing audit services and bidding for clients
- Audit policies, training, quality control, and self-regulation

Institutional Structure of the Audit Profession

- Development of Audit Standards
- Development of Accounting Standards
- Who Sets the Standards?
- Auditors’ Responsibility for Detection of Fraud
- Competition, Entry and Discipline
 Chapter 9: Conventions and Classification
Examination of the traditional terms of
accounting in terms of contract
theory of the firm
- Link them to familiar social science
concepts
– Features of accounting as economic
choice of convention
– Temporal stability does not mean
convention
– Distinction is important for setting
accounting standards
- Rules as systems of classification
– Importance of the nature of
classification for standard setting
Conventions
- A coordinating device in a game
- Games in which coordination can yield
Pareto superior outcomes but
communication is difficult or
impossible
- Applied to recurrent situations
- Must be common knowledge
- It is in the interest of everyone that one
more person will conform to the
convention
- Existence of an alternative which is just as
good
– Driving on the right or left
– Debits on the right or left
– Balance sheet in order of decreasing or
increasing liquidity
- In accounting literature a lot of confusion
and confusing definitions of conventions
(Gilman, Kohler’s Dictionary)
- Stake in maintaining the status quo
- Differentiated from economic choices
Economic Features of Accounting
- Features which are not conventions
– Will changing the feature affect any
agent?
- Conservatism
- Entity
- Going concern: use and disposal values
- Period
- Valuation
- Accrual
- Accrual
Temporal Stability
Double Entry
- Causal and classificational interpretations
- Economic resources
- Uniformity and classification
 Chapter 10. Decision Criteria and Mechanisms

Criteria for social choice

- Technical efficiency
- Simple economic efficiency
- Multiperson economic efficiency
- Multiperiod problem
- Uncertainty problem
Social cost benefit analysis
- Which costs, which benefits?
- Problem of partial analysis
- Nonlinear utilities
- Measures of efficiency
Mechanisms for Social Choice
- Market or Political/Administrative
- Limitations of voting mechanisms
- Market mechanisms for accounting standards
- Legal rights and markets
 Outline of Current Research In Accounting

Contract Model of the Firm

- A Useful Framework for Organizing Accounting Research

Micro-Level Research
- Research on Decisions of Various Participants
- Research on Effects on Various Participants

Macro-Level Research
- Research on characteristics of the system
- Research on alternative designs of the system

Survey the research work being carried out in each category

- What are interesting questions in each category?
- What have we learned so far?
- What questions remain open?
- (Use of Table of Contents of the Sunder book manuscript)
Functions of accounting and control

Chapter 5:
Managers and income

- Difficulty of measurement
- Link compensation to output
- Choice of accounting methods
- Income: role in organization multiple management

Share holders, stock market & auditors

- Basic features: conventions, economic features
- Social choice mechanism &criteria
- Standards
- Government & law
- Accounting for public good organization