Financial Accounting Theory: Analysis of Directive Amendments

This report delves into financial accounting theory, specifically examining the rationale behind amending the 2003 accounts modernization directive. It explores the significance of voluntary corporate reporting and how it influences the amendment process. The report highlights the directive's focus on corporate social responsibility and the inclusion of financial and non-financial indicators. It analyzes various scenarios related to ESG (Environmental, Social, and Governance) information disclosure, evaluating their advantages and disadvantages. The report then discusses the suitability of different scenarios, referencing relevant case studies to determine the most effective approach. The analysis considers theories such as legitimacy and institutional theory to explain the increased level of disclosures. The report emphasizes the importance of transparency, stakeholder information, and the simplification of financial reporting requirements. It concludes with a recommendation for the best scenario and its implications for companies operating within the European Union.

Running head: FINANCIAL ACCOUNTING THEORY
Financial accounting theory
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Author Note

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Introduction:
The report is prepared for explaining the reasons that is associated with making
amendments to the 2003 accounts modernization directive. Such explanation is done by
highlighting the theories of voluntary corporate reporting. In the later part of report, the five
scenarios are discussed by briefly listing each scenario advantage and disadvantage. Analysis
of all the scenarios helps in explaining and deciding on the best scenario by referring to
relevant case studies.
Discussion:
Reasons why the 2003 accounts modernization directive should be amended:
The directive that was issued in year 2003 required organizations to report on their
corporate social responsibilities activities along with their annual financial report. It took into
account an understanding of the development, position and performance of company that
considered the financial and non financial indicators that is relevant to any particular business
along with the information relating to employees and environmental matters. The amendment
to accounts modernization directive of 2003 is about making reporting economic,
environmental and social activities (Bini et al., 2017).
The amendment of 2003 accounts modernization directive is intended to be done for
the simplification of requirements of financial reporting for micro entities and environment of
business for enhancing their competitiveness and releasing the potential for growth. Such
amendment would have an impact in terms of adequate protection and safeguarding of
stakeholder information along with reduced administrative burden and this would help in
aligning the reporting requirements of micro entities with the need of preparers and users
(Scott, 2015). The financial reporting environment in the European Union improved due to

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accounting directives. It is required that the annual report of reporting entities as per the
European Union directive should include a fair review of performance and development of
business and position of company along with the description of uncertainties and principal
risks faced by organization. A comprehensive and balanced analysis should form a part of
review that should be consistent with the complexities and size of business (Luttermann,
2017). Moreover, the annual report of company should include additional explanations and
references concerning the amount that is reported in the annual report. The amendment of
European union accounts directive called for expanding the reporting obligations of company
relating to the diversity information and non financial information by large companies in
relation to two areas. In addition to this, the amendment is about ensuring transparency that
helps in managing the non financial opportunities and risks in a better way so that the non
financial information of companies gets improved. Large companies having more than five
hundred employees are required to make disclosure of material and relevant social and
environmental information in the section of non financial information of annual report (Baker
& Burlaud, 2015). In addition to this, they are also required to provide information on their
policy of diversity by setting out the implementation and objectives of policy.
The voluntary corporate reporting by an organization is the institutional practice that
leads to changes and adaption of the process. Existing voluntary practice for corporate
reporting might be coerced so that it well aligned with the demands and expectation of
stakeholders. There will be conformity in practices that is adopted by organization leading to
some form of uniformity. Such amendment that would be made is explained in reference to
the theories such as legitimacy theory and institutional theory (Carini et al., 2017).
Legitimacy theory is one of the theories that help in explaining the increased level of
disclosures relating to social responsibility since year 1980s. However, the variables
pertaining to external corporate governance that helps in explaining the decision relating to

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corporate social responsibility is excluded from the model the model. It is assumed in the
theory that there should not be existence of any companies unless the operations of company
are well aligned with the needs of society at large. According to this, a social contract is
resembled between the society and company by the idea of legitimacy (Valentincic et al.,
2017). The theory has helped in addressing how the corporate management addresses certain
items while communicating with their outside audiences. Such integration of accounting
studies in the theory has been because the objective of accounting is to provide users with
such information that helps in decision making after accounting for social interest. The
revision of accounts modernization directive 2003 requires organization to prepare corporate
financial statement containing reference to code of corporate governance and a description of
undertaking of the risk management and system of internal control pertaining to the process
of financial reporting (Christensen et al., 2016).
As per the legitimacy theory, management of reporting organization is forced to make
disclosure of information that would change opinion of external users regarding the company.
One of the important sources of legitimation is the annual report and such legitimation occurs
by way of mandatory disclosures and because of regulations as depicted in other sections of
annual report. When incorporating this particular theory regarding the amendment of 2003
accounts modernization directive, it can been seen that the cost of litigation can be regarded
as constraint against disclosure and considered as motivation to increase disclosure. On one
hand, the inadequate amount of disclosures encourages managers to increase the voluntary
disclosures that are not subjected to legal actions. Moreover, the managers regarding the
disclosure of information would give due care concerning any unfavorable news for limiting
litigation threat. On other hand, the voluntary disclosures of forward looking information gets
reduced with the help of managers mainly when there is a risk of imposing penalty against
the forecasts (Mamić-Sačer, 2015). It is indicated by the notion of legitimacy theory that the

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operations of organization should be in compliance with the expectations and norms of
community and it should be believed by them that their operations is in compliance with the
social contracts.
It is broadly stated as per the institutional theory that the institutional field and
environment governs the behavior of firms. The context of organization, network of social
relationship and scope of activities are included in the institutional field. Business practice
becomes uniformed using three mechanisms comprising of mimetic, coercive and normative.
Mimetic practice refers to the pressure of firms for confirming to certain behavior. Mechanics
of coercive refers to the techniques of pressure that helps in attaining the business practices in
association with the expectations of society. Normative practices on other hand are about the
belief internationalization about certain behavior suitability. Broadly, the agents of behavior
are driven by aligning the societal norms and beliefs of agent with such alignment being
caused by external pressure and norms internationalization. Theory of internationalization
provides explanation of the mechanism that helps organization is seeking alliance of the
characteristics and practices with cultural and social values. It is assumed by the perspective
of institutional theory that new practice of sustainability reporting would be adopted by
manager of organization. The isomorphic process of voluntary disclosure, reporting entities
will become increasingly homogenous within given confirmation and domains of the wider
institutional environment. It is indicated by three isomorphic processes that it helps
organization in adopting management practices and similar structures irrespective of
efficiency of organization.
Discussion of the scenarios as depicted in the 5th workshop:
The workshop was conducted to improve and promote the disclosure of information
relating to environmental social and governance factors that would help in understanding the

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requirements of stakeholders. Five hypothetical scenarios that was discussed in the workshop
is related to disclosure of ESG information that would help in facilitating coordination
between disclosure initiatives of existing ESG and deepening the understanding of the
disclosure practices of relating to ESG. The first hypothetical scenario is about disclosure of
performance of ESG that is a requirement criterion for organization being listed on stock
exchange. The second and third hypothetical scenario was quite similar as it did not call for
any changes in the accounts modernization directive of 2003. In this situation, a new directive
was proposed requiring investment funds to make the disclosure of the fact whether the
criteria of ESG would be accounted by the policy in investment decisions. A development of
new voluntary European standard was proposed in this scenario that would help in creating a
uniform process for reporting concerning ESG. The development of standardized mandatory
principles was suggested in the forth scenario at the level of European Union (Luttermann,
2017).
Out of all the hypothetical scenarios, the most suitable option would be the forth
hypothetical scenario that have suggested the development of mandatory principles that is
strengthened by recognizing the two key performance indicators that are recognized
internationally. This particular hypothetical scenario is considered as the most suitable option
because it leads to revising the 2003 Accounts modernization directive for explaining or
complying the provision. All the private companies reporting in the European Union needs to
apply to the reporting proposal along with the public companies. The most material
opportunities and risks pertaining to environmental, social and governance factors should be
identified by companies (Ribeiro et al., 2016). Such risks would involve risks associated with
bribery, emission of carbon dioxide corruption and human rights. Such risks are analyzed in
relation to the operations of organizations and how the formulated strategy would be helpful
in handling such issues. The reporting requirement would be exempted on part of small and

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medium enterprises. Two sets of non key financial key performance indicators are developed
that is recognized and widely accepted at international level. It is explained by one set of such
indicators that the assessment of valuation of company is facilitated that would help in
meeting the needs of capital market and economic stakeholders. The wider expectation of
society as a whole can be met by separating set of indicators relating to social license to
operate (Elzahar et al., 2015). It is identified by the scenario proponents that companies are
provided with some degree of choice and freedom with the help of such regulations in
determining the opportunities and risks that are most material to the business. However, there
exist ambiguity between social license to operate and economic factors.
Pros and cons of scenario one:
 Since the performance of ESG is required to be disclosed for being listed on the stock
exchange, it would be ensured by organization that their operations are carried out by
well aligning with the environmental factors.
 A development of public online rating system for the disclosure quality of ESG would
be developed and financed by European commission.
 The company in lure of achieving highest ranking would boost the use of disclosure
of ESG. This would make organization confused about the disclosure quality
concerning ESG.
Pros and cons of scenario two and three:
 A new directive relating to the investment funds is proposed without calling for any
change to the accounts modernization directive.
 The divergence between different national approaches would be circumvented by the
implementation of process of standard settings. Another benefit is related to proposed
industry specific key performance indicators (Valentincic et al., 2017).

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 However, this particular scenario was not successful in offering an improvement over
the programs of voluntary reporting.
Pros and cons of scenario four:
 The opportunities and risks relating to ESG would be identified by companies.
 Assessment of valuation of company is designed in such a way that helps in meeting
the wider expectations of society and needs of customers.
 There exists ambiguity between social license to operate and key performance
indicators for economic factors (Szabó & Sørensen, 2015).
Pros and cons of scenario five:
 This particular scenario highlighted the significant amount of changes in regulations
that is required.
 A completely new directive on disclosures of European countries is proposed.
Conclusion:
The report is prepared for analyzing the relevance of voluntary corporate reporting in
explaining the need of amendment to the 2003 directives of accounts modernization. Two
theories that have been selected for explanation of such amendments involve legitimacy
theory and institutional theory. It is depicted as per legitimacy theory that organization will
not be considered legitimate if it fails to undertake the activities meeting the requirement o
society. Institutional theory on other hand indicates that new practices such as sustainability
reporting need to be adopted by managers as per the perspective of institutional theory
(Ramanauskaitė & Gedminaitė, 2014). It has been found that the most suitable options as
identified from the workshop are situation four. This is so because it takes into account both

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financial and non financial performance indicators for evaluating the performance of
company.

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