CONSTRUCTING FINANCIAL STATEMENTS 79
function of accounting under agency theory is to improve efficiency by minimizing
the losses caused through moral hazard and adverse selection.
Seal (1995) gives the example of renting a holiday home that is used by the
owner only a few weeks of the year. The owner (the principal) may appoint a local
agent to let out the home. The agency problem is how to motivate and monitor
the agent in return for the commission earned by the agent. The owner will expect
regular accounts of income and expenditure. Agency theorists use this reasoning
to explain the development of financial accounting and auditing in more complex
agency relationships.
There are problems with agency theory, however. It ignores the effect of capital
markets by assuming a single owner rather than a group of owners. The model
focuses on single-period behaviour; many individuals violate the assumptions of
rational self-interested behaviour and the agency perspective is narrow because
there is no regard given to power, trust, ethical issues or equity, all of which may
affect behaviour. We consider alternative theories in the next chapter.
Conclusion
This chapter has covered the main financial statements. It has introduced the
regulations governing those statements and described the most important princi-
ples underlying the construction of accounts. The chapter has also discussed the
management of working capital. The chapter concluded with an introduction to
what has been historically one of the main theories underlying the construction
of financial statements, agency theory. In the next chapter, we introduce the tools
and techniques that are used to interpret financial statements and consider some
alternative theoretical perspectives.
References............................................
Blake, J. (1997).Accounting Standards. (6th edn). London: Financial Times/Pitman Publish-
ing.
Seal, W. (1995). Economics and control. In A. J. Berry, J. Broadbent and D. Otley (eds),
Management Control: Theories, Issues and Practices, London: Macmillan.