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Companies and financial accounting
Companies and financial accounting

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4 Three perspectives on the role of companies and financial reporting in society

The allocation of a bundle of property rights over shareholders, the company and the directors creates the possibility for conflicting interests. In addition, market imperfections, the limits of the law, and the company seeking to be perceived as legitimate by its stakeholders, create even greater scope for conflicting interests.

In this section you will consider the following three different views on what companies are, what their role in society should be, and what the purpose of company financial reporting should be:

  • the company as a legal fiction
  • the company as an institution in its own right
  • the company as an institution adding value to society.

The company as legal fiction

Some people regard companies as a legal fiction, which is to be used as a tool to increase the wealth of its shareholders and other equity investors. In this case, the directors must act in the best interests of the shareholders and equity investors whilst obeying the law.

Under the proprietary theory of the objective of financial accounting, financial accounting and reporting are primarily aimed at providing shareholders and other equity investors with information for their decisions.

The company as an institution in its own right

Others regard companies as institutions in their own right. A company has to survive by co-ordinating and reconciling the interests of its stakeholders. To this purpose, one would expect an ‘enlightened shareholder focus’ and/or a stakeholder management approach from the directors.

Under the entity theory, the objective of financial accounting and reporting is to provide information that is useful to shareholders and other investors as well as creditors and other users of financial statements.

The company as institution adding value to society

The third view is that companies derive their social legitimacy as an institution in their own right by adding value, and being responsible, to society at large or the community in which they operate. The directors of the company would have to aim at economic, social and ecological sustainability in the operations, financing and governance of the company.

Under the social theory, financial accounting and reporting have to be supplemented by other types of information that demonstrate that the company has operated sustainably, added value rather than created externalities, and has behaved ethically and responsibly.

Activity 9 Your perspective on the role of companies in society

Timing: Allow about 10 minutes

The purpose of this activity is to identify and express your opinion on the role of companies in society.

Think for a moment about which of the three perspectives you agree with, and why?

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The three answers represent, to a certain extent, value judgements. However, increasingly the idea is that a company should also be adding value to society.