accounting theory 10

Prepared By: Dewan Mahboob Hossain

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System oriented theories to accounting practices

A presentation by Dewan Mahboob Hossain; Department of Accounting & Information Systems; University of Dhaka; Dhaka; Bangladesh.

From Deegan, C. and Samkin, G., Financial Accounting. McGraw-Hill

Irwin, New York


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Organization viewed as part of a wider social system

The organization

Media Govt.suppliers

consumers The publicInvestors

Industry bodiesemployees

Interest groups


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Two theories of system based perspective►Legitimacy theory; and►Stakeholder theory. Both these theories consider accounting

disclosure policies as a strategy to manage the relationship between the organization and other parties with which it interacts.

In recent years, stakeholder theory and legitimacy theory have been applied primarily to explain why organizations make certain social responsibility disclosures within their annual reports, rather than why they elect to adopt particular financial accounting methods.


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Social responsibility disclosure

►Disclosure of information on the interaction of an organization with its physical and social environment.


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Stakeholder theory

►Perspective that considers the importance of an organization’s survival of satisfying the demands of various stakeholders.

►Stakeholder theory has both an ethical (normative) and a managerial (positive) branch.


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Ethical branch of stakeholder theory

►Managers should manage the business for the benefit of all stakeholders.

►Firm is not a mechanism for increasing the stockholders’ financial returns but it is a vehicle for coordinating stakeholders’ interests .

►Management has a fiduciary relationship not only to the stockholders but to all stakeholders.

►Management must give equal consideration to the interests of all stakeholders and when these interests conflict, manage the business so as to attain the optimum balance among them.


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Ethical branch of stakeholder theory►In its normative form, the stakeholder

theory does imply that business has true social responsibilities.

►All stakeholders have a right to be provided with information about how the organization is affecting them even if they choose not to use the information and even if they cannot directly affect the fate of the organization.


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Managerial branch of stakeholder theory► The managerial branch of stakeholder theory seeks to

explain and predict how an organization will react to the demands of various stakeholder groups.

► The organization identifies its group of stakeholders, focusing on those that are considered to be important to the ongoing operations of the business.

► The greater the importance of particular stakeholders, the greater the expectation that the management of the form will take action to ‘manage’ relationships with those stakeholders.

► A major role of corporate management is to assess the importance of meeting stakeholder demands in order to achieve the strategic objectives of the firm.

► As the level of stakeholder power increases, the importance of meeting stakeholder demands increases also.


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Managerial branch of stakeholder theory►The power of stakeholders to influence

corporate management is viewed as a function of stakeholders’ degree of control over resources required by the organization.

►The more important the stakeholder-control over resources required by the organization, the greater the expectation that stakeholder demand will be addressed.

►A successful organization is considered to be one that satisfies the demands (sometimes conflicting) of various powerful stakeholder groups.


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Managerial branch of stakeholder theory► Stakeholders’ power will be stakeholder-organization-

specific, but might be tied to such things as command of limited resources (finance, labor), access to influential media, ability to legislate against the company, or ability to influence the consumption of the organization’s goods and services.

► According to stakeholder theory, information, including financial accounting information and information about the organization's social performance, is a tool in controlling the sometimes conflicting demands of various stakeholder groups.

► Information is a major element that can be employed by the organization to manage or manipulate the stakeholders in order to gain their support and approval, or to distract their opposition and disapproval.


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Legitimacy Theory

►Theory that proposes that organizations always seek to ensure that they operate within the bounds and norms of their societies.

►These bounds and norms are subject to change rather than being fixed.


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Legitimacy Theory►Social contract: Concept used to describe

the right to exist accorded organizations by society as long as they need society’s various implicit and explicit expectations about how an organization should conduct its operations.

►It is assumed that society allows the organization to continue operations as long as it generally meets society’s expectations.


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Legitimacy Theory►As Mathews (1993):“Social contract would exist between corporations

(usually limited companies) and individual members of society. Society (as a collection of individuals) provides corporations with their legal standings and attributes and the authority to own and use natural resources and to hire employees. Organizations draw on community resources and output both goods and services and waste products to the general environment. The organization has no inherent rights to this benefits and in order to allow their existence, society would expect the benefits to exceed the costs to society.”


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Legitimacy Theory► If an organization cannot justify its continued

operations the community might in a sense revoke the organization’s contract to continue its operations.

► For example, 1. reduction of demand for the products;2. Interruption of supply of material, labor and

financial capital;3. Increase tax and fines;4. Incorporate law by the government.


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Legitimacy Theory►Organizations will take various actions to

ensure their operations are perceived to be legitimate.

►For example, provide disclosure in the annual reports.

►From the perspective provided by the legitimacy theory, it is not only important that organizations operate in a manner consistent with community expectations, the organization must also disclose information to indicate that it is complying with community expectations.


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Legitimacy Gap

►The difference between the expectations of the relevant public of how an organization should act and how an organization does act.


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Legitimacy ► Lindblom (1994) defines legitimacy as a condition that

exists when an entity’s value system is congruent with the value system of the larger social system of which the entity is a part.

► This legitimacy is considered as a resource that helps the organization to continue to operate in a society.

► Any threat to this legitimacy can be harmful for the organization.

► Threats to an entity’s perceived legitimacy are predicted to lead to responsive actions by management who will try to minimize such impacts of legitimacy threats and one of these minimizing strategies is the disclosure-related strategies (Islam and Deegan, 2008 and Woodward et al, 1996).


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Disclosure and legitimacy ► Disclosure can be a solution to overcome the legitimacy

threats: “….a firm may provide information to counter or offset

negative news which may be publicly available, or it may simply provide information to inform the interested parties about attributes of the organization that were previously unknown. In addition, organizations may draw attentions to strengths, for instance, environmental awards won, or safety initiatives that have been implemented, while sometimes neglecting or downplaying information concerning negative implications of their activities, such as pollution or workplace accidents. ” (Deegan and Unerman, 2006, p.274).

accounting theory 10

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