The Welfare Approach

The welfare approach

The welfare approach is an extension of the decision-making approaches, which considers the effects of decision making on social welfare. Basically, decision-making approaches limit the field of interest to the private use of accounting information. If accounting information had a relevance limited to private interests, the decision-making approaches would provide a sufficient analysis of information needs. It is because of the external social effects of decisions made on the basis of accounting information that there is imputed a social welfare dimension to accounting theory.

The theoretical objective of the welfare approach is the maximization of social welfare, which is defined as the benefits accruing to all members of society from decisions made by individuals about the use of resources under their control. In this respect, a disadvantage of the classical individual decision-making approach which hitherto has been reflected in the debate about accounting policies is that it does not provide a basis for developing accounting policies which would maximize social welfare. In this respect, the Trueblood Report took the view that the appropriate policy for accounting was the provision of information for making economic decisions (A.I.C.P.A., Study Group on Financial Objectives, 2003). Implicit in this view is that accounting should provide information for decision making by individuals, without any consideration of social welfare effects. As May and Sundem pointed out, such a delineation of what accounting policy makers should be concerned with precludes the possibility of making comparison among alternative policies having different social welfare effects (May and Sundem, 2006).

The welfare effects which are associated with the use of financial state-ments may be discussed from various standpoints.

(1) The effects of financial information on the welfare of individual decision makers may be deemed to be one important standpoint. Since investment decisions imply the comparison of alternative investments, external users of financial information require as much consistency and comparability as is practicable between the financial statements of enterprises generally. We shall discuss this point further in Part 4, but it may be mentioned at this stage that it was the lack of comparability between the financial statements of enterprises which lay at the root of much criticism of the accounting profession in the 2000s, and led to the setting up in the United Kingdom of the Accounting Standards Committee in 2000. The Press took the view that the accounting profession had a duty to increase the quality of reported financial information to give better protection to shareholders and other interested users of company financial reports.

(2) The effects of financial information on social welfare may also be seen from the standpoint of the distortion arising from the possession of superior knowledge by one segment of a particular group of users, which would have consequential changes in the distribution of wealth within the group. For example, if an investor has access to inside information about an enterprise, and this information is not freely available to other investors, he would be able to make decisions which may improve his welfare at the expense of other investors.

(3) The effects of financial information may also be viewed from the standpoint of the allocation of resources in the economy. The importance of accounting information as regards the allocation of scarce resources was discussed earlier. Financial statements provide the investors with data which assist in establishing the market price of company shares. There is research evidence to show that accounting data have an important effect on share prices. Ideally, financial reports should contain data which make it possible for investors to evaluate investment opportunities, if the allocation of resources throughout the economy is to maximize social welfare in accordance with classical economic theory.

(4) The approaches to accounting theory which have been mentioned so far assume that information is a free commodity, and therefore that no costs are incurred in producing information. Clearly, from a social welfare viewpoint, costs are significant in considering the level of information to be made available, given that resources are scarce and could be employed in other activities. The costs of collecting and processing data and distributing information should be taken into account in considering the level of information provided to users. The difficulty which stands in the way of developing this analysis further lies in the problem of defining and measuring the benefits associated with the use of information, for the optimum level of information output ought also to be seen from the perspective of the payoffs associated with costs. As we shall see below, some attempts have been made to define the payoffs which may be associated with information costs.

(5) The effects of financial information on welfare may be viewed from the standpoint of the vested interests of groups within an organization. It is evident that the alteration of accounting policies in favour of one group and away from another group will affect the distribution of income and wealth within society. In this respect, the movement towards disclosing information to employees and the concept of social responsibility accounting, are clearly causing such a change.

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Read on: The Normative Specific Approach

The normative specific approach

Unlike empirical research, which concentrates on how users of accounting information apply this information in decision making, the normative specific approach to theory construction is concerned with specifying the manner in which decisions ought to be made as a pre-condition to considering the information requirement.

The normative specific approach focuses on the decision models which should be used by decision makers seeking to make rational decisions. This focus is seen as providing insights on the information needs of decision makers, as... see: The Normative Specific Approach