question archive The Goal presents some examples of how managerial accounting information can be used poorly or ineffectively
The Goal presents some examples of how managerial accounting information can be used poorly or ineffectively
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The Goal presents some examples of how managerial accounting information can be used poorly or ineffectively. Agency theory is a theory from economics that examines the relationship between principles and agents. In particular, the potential issues that can arise from that relationship such as the "agency problem."
identify an example situation in which managerial accounting could be misused in an unethical manner. How might you overcome that issue as a manager?
but first read the below article to answer the above question.
Agency Theory
What Is Agency Theory?
Agency theory is a principle that is used to explain and resolve issues in the relationship between business principals and their agents. Most commonly, that relationship is the one between shareholders, as principals, and company executives, as agents.
KEY TAKEAWAYS
- Agency theory attempts to explain and resolve disputes over priorities between principals and their agents.
- Principals rely on agents to execute certain transactions, particularly financial, resulting in a difference in agreement on priorities and methods.
- The difference in priorities and interests between agents and principals is known as the principal-agent problem.
- Resolving the differences in expectations is called "reducing agency loss."
- Performance-based compensation is one way that is used to achieve a balance between principal and agent.
- Common principal-agent relationships included in agency theory include shareholders and management, financial planners and their clients, and lessees and lessors.
Understanding Agency Theory
An agency, in broad terms, is any relationship between two parties in which one, the agent, represents the other, the principal, in day-to-day transactions. The principal or principals have hired the agent to perform a service on their behalf.
Principals delegate decision-making authority to agents. Because many decisions that affect the principal financially are made by the agent, differences of opinion, and even differences in priorities and interests, can arise. Agency theory assumes that the interests of a principal and an agent are not always in alignment. This is sometimes referred to as the principal-agent problem.
By definition, an agent is using the resources of a principal. The principal has entrusted money but has little or no day-to-day input. The agent is the decision-maker but is incurring little or no risk because any losses will be borne by the principal.
Financial planners and portfolio managers are agents on behalf of their principals and are given responsibility for the principals' assets. A lessee may be in charge of protecting and safeguarding assets that do not belong to them. Even though the lessee is tasked with the job of taking care of the assets, the lessee has less interest in protecting the goods than the actual owners.
Areas of Dispute in Agency Theory
Agency theory addresses disputes that arise primarily in two key areas: A difference in goals or a difference in risk aversion.
For example, company executives may decide to expand a business into new markets. This will sacrifice the short-term profitability of the company in the expectation of growth and higher earnings in the future. However, shareholders may place a priority on short-term capital growth and oppose the company decision.
Another central issue often addressed by agency theory involves incompatible levels of risk tolerance between a principal and an agent. For example, shareholders in a bank may object that management has set the bar too low on loan approvals, thus taking on too great a risk of defaults.
Reducing Agency Loss
Various proponents of agency theory have proposed ways to resolve disputes between agents and principals. This is termed "reducing agency loss." Agency loss is the amount that the principal contends was lost due to the agent acting contrary to the principal's interests.
Chief among these strategies is the offering of incentives to corporate managers to maximize the profits of their principals. The stock options awarded to company executives have their origin in agency theory. These incentives seek a way to optimize the relationship between principals and agents. Other practices include tying executive compensation in part to shareholder returns. These are examples of how agency theory is used in corporate governance.
These practices have led to concerns that management will endanger long-term company growth in order to boost short-term profits and their own pay. This can often be seen in budget planning, where management reduces estimates in annual budgets so that they are guaranteed to meet performance goals. These concerns have led to yet another compensation scheme in which executive pay is partially deferred and to be determined according to long-term goals.
These solutions have their parallels in other agency relationships. Performance-based compensation is one example. Another is requiring that a bond is posted to guarantee delivery of the desired result. And then there is the last resort, which is simply firing the agent.
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Managerial accounting is the internal business role in charge of a company's financial information management. Managerial accounting is commonly used by company managers to assign expenses to products or services, plan operating budgets, and forecast production performance or revenue. Companies follow a code of ethics or conduct that discusses ethical issues/concerns for management accountants, which is an important aspect of managerial accounting. According to the September 2019 issue of the CPA Journal, managerial accountants' ethical dilemmas are growing as a result of big data, artificial intelligence, and other innovations.
Managerial ethics guarantees that all financial data is disclosed to the company's owners, administrators, and managers. Accountants who neglect to disclose negative information or who use a company's internal financial information for personal gain may put their employers in severe legal trouble. When analyzing business operations and making decisions, business owners often need all details, whether good or bad. Accounting ethics also means that each employee can be trusted with confidential company data.
In the business world, businesses can choose to behave unethically.
Business owners can decide that unethical conduct isn't always illegal, resulting in a gray area in the industry. When recording and reporting financial data, managerial accountants can constantly challenge ethical boundaries. To ensure adherence to IMA standards of practice, businesses should offer detailed explanations to those performing external audits about dubious accounting procedures.
Management accountants are responsible for all internal accounting data within a company. These individuals are also in charge of allocating production expenses, producing management reports, and assisting with administrative decisions. Managerial accounting practices can lead to ethical issues.
When working for a business, management accountants, like all professionals, must be ethical.
Most of the managerial accounting issues are associated with conflict of interest. A conflict of interest arises when a person's personal interests conflict with his responsibility to make decisions in the public interest or for an employer. Accountants normally operate in the company's best interests, not for the benefit of particular managers or executives. If a management accountant would boost his personal status by breaching this law, there is a conflict of interest.
For example, rather than maintaining the best operational ability for the company, a management accountant who helps operational managers fudge numbers may boost his personal role. Conflicts of interest can be avoided by making recommendations to develop the business as a whole rather than just one section.
Another example is when one party, known as the agent, is required to behave in the best interests of another party, known as the principal, the agency issue arises. Conflicts of interest may occur if the agent profits financially by not acting in the best interests of the principal. You can fix the agency issue in your organization by requiring total accountability, restricting the skills of the agent, and tying the pay structure to the performance of the principal.
Self-interest motivates both parties, including principals and agents, according to agency theory. The maximization of the utility of personal resources is known as self-interest. When dealing with all of your company's stakeholders, there is the possibility of a conflict of interest. To effectively deal with conflicts of interest, you must first establish a clear policy that explains what constitutes unethical behavior and how it will be addressed.
