REPORT

‘Why Financial Reports can never really be considered neutral (free from bias) or objective.’

Word Count: 2536

Introduction

The Framework for the preparation and presentation of financial statements specifies that information generated should “represent faithfully” and “be neutral… free from bias” (AASB Framework, para. 33; 36). Information that is not neutral can “influence the making of a decision or judgement in order to achieve a predetermined result or outcome” (AASB Framework, para. 36). Many scholars have discussed the theory that financial reporting is biased and subjective, using numerous examples as evidence to support their theories. This report will highlight just a few of the arguments to support the theory
To demonstrate the principles of PAT, take for example the use of bonus schemes to motivate managers to achieve a set target as is a common practice in most companies. Deegan (2009) notes that when implementing incentives based on accounting output: “…there is a possibility that rewarding managers on the basis of account ting profits may induce them to manipulate the related accounting numbers to improve their apparent performance and, importantly, their related rewards. That is accounting profits may not always provide an unbiased measure of firm performance or value” (p. 281).

The Agency theory is just one derivative of PAT. This theory bases its hypothesis on the relationship between one or more principles (e.g. business owner or shareholders) and their agents (managers/subordinates for which they delegate some responsibility for the running of the business). The agency model suggests that agencies will always be driven by self-interest, and as a result the principle will lack reasons to trust their agents (Institute of Chartered Accountants, 2005). The underlying cause of this issue is the differing interests and motivations of the principle and their agents. Principles will therefore question the reliability of financial reporting, assuming that bias has been imposed on the reporting process in order for the agent to achieve his or her own goals, such as wealth maximisation. When making