ACCT20074 Contemporary Accounting Theory

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Question:

Explain the relevance and application of the social contract to Legitimacy Theory in accounting.
Discuss about social contract, stakeholder theory, institutional theory, and positive accounting theory under legitimacy theory.
Critically summarize how all these theories to act legitimately for social contract.
Discuss about corporate social responsibility, societies expectation and it’s relation to social contract.

Answer:

Introduction

The report has been prepared to do the review of Legitimacy Theory in accounting and presence of Social Contracts. The roadmap of the review has been explained using the appropriate headings and sub-headings with the intention to find the applicability of social contracts and different associated theories along with legitimacy theory on corporate disclosures made by the company. The review has been started with aim and meaning of social contracts which explains the relationship of the society and the people present in the society to solve any danger situation which may occur in the society. The social contracts find the place in philosophy at the era of start of philosophy in history and many researchers support the arguments containing the presence of the social contracts in every point in the society. The next part describes the Legitimacy theory which enables the business to disclose full and accurate information and awareness about the business goals and objectives among the people in the society. The implication of the legitimacy theory along with triple bottom line framework which supports corporate social responsibility and corporate sustainability has been described in relation to reaction of business towards its duties and responsibilities. The next section explains the different other theories which are integral and interrelated to legitimacy theory in the field of accounting. The whole aim of the review has concluded stating that improvements in disclosures and solving of questions rose in the society about the business with the usage of different accounting theory. With these intentions, the review has been prepared using the effective and reliable secondary data available on relevant sources.

Through this review, the relevance of the social contracts has been explained in the current world and described with the reference of the theories as to how the social contracts and legitimacy theory have come into place and are applicable in every field.   

  1. Meaning, History and Aim– Social is referred to as the society or the community of the country that are presently living in that country. Social is sometimes also referred as by the name of the Government. It is nothing but the group of the people that belong to the same community which are living therein and who have selected there representative to get their life being managed in the simple manner with the better living and the working conditions (Elahi, 2005). Thus, social contract is defined as the arrangement that has been entered by the Government, company or any other similar body or authority with the people belonging to the same country from where the so called Government and company and other authority operates (Cruess, 2008 and Dunfee, 2009). The main essence of this contract is that the life of every individual living in the country and the environment present in this world shall be protected and saved from the damages that may be caused by the individuals living in the country or the companies operating in that country only.             

The importance of the term of social contract has arisen since the starting phase of this world and more importantly when every country was facing the fear of becoming the slaves of the acquirers who used to acquire the country and start ruling them and engage all the people present and living in that country only in their own and take out all the maximum benefits that they can reap from their efforts. In that phase any contract which has been made for the safety of the people living therein and has been entered into by them only has been termed as the Social Contract (Baker, 2013). It is has not been so that like these type of contracts have been developed during the war period rather though it has been developed in the earlier phases of life but have gained the importance in the period when every country was facing the period of war. These social contracts that have been made for the safety of the people of the country along with that safety also the term has been added for the better living condition of the people which has made the people of the country oblige to the terms and have to abide by the terms and conditions of the social contract and in case of any breach thereof from the terms and conditions so made then he or she may be held liable with not only the monetary penalty but also may sometimes lead to the imprisonment.

The importance of the social contract has firstly been noticed during the period or era of enlightenment. This is the period when new and innovative theorists have come into place and have provided different meanings to the term of the social contract. Before discussing about the theories of the enlightenment, the thinking of one of great philosopher of that time shall be discussed and is known by the name of Socrates. In his theory he has explained the social contract by citing two examples which is commonly referred to as the dialogues. The first dialogue has been named as the Crito. Socrates argued that as to why and on what basis Crito has accepted the imprisonment in jail for the specified period and why he has not even think of escaping from the prison and have accepted the even death penalty knowing he will not be there after some moment of time and will be dead and instead of that why he has not left the Greek City. Socrates has explained that Crito has been in the Athens since its birth and have grown up there only and have sentimental feelings with the city of Greek. He further added that Crito has been the result of his parents and that too born and brought up in the city of Athens and he says that Crito is because of the Athens and he is fully oblige to the city in the manner that he has received the better living, education and working condition in Athens only. And if some mistake has been done by him then he shall be penalized for that irrespective of his financial condition and the mental health. It is because of this fact he has accepted the imprisonment for the period and even the punishment of death with true heart and has not raised his voice against the same rather has accepted death penalty as the tribute to the City of Athens for providing the better living and working condition. Thus, such a relationship of Crito with the Government of that country exhibits the form of social contract only. Another dialogue that has been explained by the Socrates is that the justice is in total the outcome of the social contracts and named it as republic. The same view has been rejected by the Socrates himself. He states that every human being is rational in his behavior and because of this behavior he acts and does actions in the limited and defined manner and that too in accordance with the terms of the abiding law (Friend, 2016 and Frazer, 2017). Thus, justice has not its source from the term of the social contract rather it depicts that justice exhibits the self centered and self regulated soul of every individual. In this way, both the dialogues have given an insight of the social contracts (Jos, 2006).                   

During the enlightenment period, two theorists have come and were known by the name of Thomas Hobbes and Jean Jacques Rousseau (Leeson, 2009).

As per Thomas Hobbes, during the period of war every individual was in the move to surrender their freedom to the single person who can maintain their lives and let them able to survive in the country. It is because during the period of war the communities residing in that country was facing the problem of becoming slaves of the conqueror which will turn their current situation to worst. The single person is referred to as the Ruler or king (Leonard and Samantar, 2011). At the same time, there has been more relying on the distribution of power and responsibilities between the monarch and the government which is known by the name of Parliament (Mccarthy and Puffer, 2008). He has rejected and compromise on both the views of the citizens stating that ruler shall be the God and every act of his will be for the betterment of the community residing in that country. On the other hand, the views of the distribution of powers are rejected due to the presence of the self centered behavior of the individuals. Thus, at the end it is mentioned and stated by him that there shall be one ruler or king in the country (Smith, 2009).

Second enlightenment theory was given by Jean Jacques Rousseau. He has stated the evolution of life and how at each stage the community has been entering into contract with the group of people to have better living and working conditions. He has stated all the phases of the civilization and has reached the stage of bifurcation between the rich and poor people. The justice is only for the rich people and that too at the cost of poor people. He at the last stated that there shall be social contract which envisage equitable justice for all irrespective of the matter that whether he belongs to rich family or poor family. (Skyrms, 2014).

Apart from these theories, some modern theories have been laid down which has explained the social contract relevance in the field of accounting and the environment. 

  1. Purpose to Accounting Field and Society:  The social contract as explained has received importance from the beginning of the era but has very much relevance in the field of accounting. It is in the sense that it makes the management of the company to prepare the financial statements of their company in such a manner that represents the actual picture of the working of the company and operations thereon. This social contract has been done by the companies operating in the country with the Government of that country and with the society of the people. The contract also facilitates that the companies are required to maintain the interest of their stakeholders and will not do anything through which their interest can be lost. In this manner the term social contract has been made applicable to the field of accounting. History has the example where the social contract has been broken by the company and leading to their failure and thereby closure. The example pertains to the case of Lehman Brothers who was engaged in the accounting fraud and has led to the closure of the company because of violation of the social contract that they have entered into with the stakeholders of the company.      

Along with the accounting field the social contract is linked with the society. Though social contract is applicable in all the fields but the main area is related to the society. The society includes not only the people but also includes the environment within which every person lives or company survives. The environment consists of trees, rivers and other similar things which are related to the state of nature. Every person and the company have the responsibility towards the preservation and the maintenance of these. This responsibility has been backed by the social contract only. The different laws, statutes, procedures and other provisions that have been defined are the social contracts only like Corporations Act 2001, Environment Safety provisions, etc. For instance environment safety regulations states that the environment needs to be protected and conserved and for that the company shall not produce any hazardous gas and pour that in the environment. Because of this regulation, the emphasis has been laid on the social contract efficiency.

Legitimacy Theory

  1. Meaning, History and Aim– As per the common parlance and generally accepted definition, the word legitimate means something which can be mentioned and described as the lawful. Thus, legitimacy theory entails and goes forward with the description that all the acts which have been taken by the individual or the company or any other person is deemed to be lawful, free from any error or bias and is useful for the users of that acts and more importantly the acts which have been done are within the limits of social infrastructure that have been developed according to the beliefs, faith and values of each and every individual (Patten, 2012). Thus, in this manner the legitimacy theory has come into place. It has not been developed suddenly rather it has been developed from the development of social and cultural beliefs that has been developed across the World. (Burlea, 2013). The main area where the legitimacy theory applied in today’s world is the accounting. Under the accounting, the legitimacy theory entails that all the companies working in the industry are reporting the correct financial position and the financial performance of the company and the auditors authentication on the same depicts that the presence of legitimacy theory in the financial statements have been solicited. Thus in this manner the legitimacy theory is related to the financial accounting (Freeman, Harrison, Wicks, Parmar and Colle, 2010). In the forgoing paragraph, the base of the legitimacy theory has been discussed.
  2. Four theories In one platform-The legitimacy theory has been based on the major four theories which include the stakeholder theory, the institutional theory, the management theory and positive accounting theory.
    • The stakeholder theory states that the company shall work in such a manner that the value of the stakeholder or shareholder of the company will be increased. By increasing the value of the stakeholder or shareholder of the company, the meaning has been given to the usefulness of the financial statements of the company to the stakeholders have been listed and mentioned. It denotes that the financial statements shall be useful for the stakeholders of the company so that they can take useful decision on the same.
    • Second theory is related to the institutional theory which denotes that every company or every organization shall work within the defined structures, processes and beliefs. These structures are created out of the social contract that has been entered into by the company with the respective laws of the government and with the community. It entails the purposeful presentation of information that is required by the users of the financial statements.
    • Third theory pertains to the management theory which details that all the objectives of the company shall be informed to the managers of the company who in turn will direct all the efforts of the employees towards the achievement of the objectives.
    • Fourth theory is positive accounting theory. The positive accounting helps in understanding the cause and effect relationship of the human behavior in the work related to account settings. It helps in understanding why the accountant has made the particular accounting entry in the different way and tries to find out the chances of manipulation if any.  

The aforesaid three theories have laid down the basis for formation of the legitimacy theory (Patten, 2012). It is because all the four theories collectively states that the acts of the company shall be done in accordance with the rules and procedures as defined and is useful to the stakeholder and entails that all the acts are lawful and most importantly helps in understanding the causes for each and every fact and thus formed the basis for legitimacy theory in accounting (Makarkin, 2011).

  1. Overlapping by four theories on Social Contract–

All the above theories are the basis of the legitimacy theory. These theories have also laid down the foundation to understand the social contract. As the social contract is defined as the contract that has been entered into by the government or companies with the society or community in which that government is functioning or company is operation. The above four theories have covered the half part of the social contract in the following ways:

  • Through the presence of the stakeholder theory, the social contract in its definition itself has laid that the interest of the stakeholder including the society shall be considered at priority. That’s why social contract has mainly entered to protect the interests of the people living in society.
  • Through the presence of the institutional theory, the companies and the government have become able to perform their functions within the defined structures, framework and the procedures and that too based on the social beliefs and faith of the society.
  • Through the presence of the management theory, the objectives of the working of the government and the companies are communicated to each and every employee engaged therein which in turn leads to better and effective results.
  • Through the positive accounting theory, the cause and effect relationship can be identified and in case any corrective action is required then the company or the government as the case may be will take accordingly.

Thus, in this way all the four theories have covered more than half of the purpose of the social contract that has been entered into.

Society Related Disclosures

  1. Corporate Social Responsibility– The term corporate social responsibility states that the companies operating in the industry have duty towards the society of the country in which they are operating. It consists not only of the ascertainment of duty only but to fulfill that duty is the requirement of this term. The companies have to come up to the satisfaction of the society otherwise the company will sooner fail. It is related to the quality of products delivered to the customers, the pollution if any caused by the factory, etc.
  2. Triple Bottom Line Accounting Framework– Along with the corporate social responsibility, the companies have adopted the triple bottom line accounting framework. Under this approach, the company considers the three factors namely economic, social and environment. All these factors are considered by the companies in the sense that the single approach can lead to the satisfaction of all the needs of the different persons. The triple bottom line index is measured through the indices which in turn is calculated with respect to the different factors like
    • Economic – How much the company has been able to earn the increase in the profit as compared to the last year, how much value has been increased of the stakeholder and how much income has been distributed to the people of the society, etc.
    • Environment – Whether the company is generating the hazardous gas which will be very harmful to not only for the society but also for the trees and plants.
    • Social– Whether the company has been able to generate the employment rate, helped in decreasing the occupation related diseases and so on.
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With this framework the accountability of the company gets increased and in turn itself get enters into the social contract.

  1. Society Expectation and Its Relation– Society expects that the company shall be in a position to deliver the goods and services to their customers with their best quality and the deliverance, the company shall not do anything which can harm the society like pollution and shall disclosed all the relevant financial and non financial information to the society as and when it is required. These expectations are related to the social contract in very close terms. It is because the expectation that the society have from the companies is natural and in accordance with the laws of the government the companies have to fulfill these needs of the society.      

Relevancy To Legitimacy Theory

The social contracts as have the same basis of formation and the legitimacy theory and are applied and relevant to legitimacy theory in every field whether it is accounting or science. In the given part, the relevancy has been detailed on account of social contract to the legitimacy theory in accounting. Legitimacy theory is present in any entity when that entity is continuously working as per defined norms and guidelines in the society. It can be defined that proper and appropriate opinion and assumption of the management that the company is moving with social values, rules and regulations lay down by the society in which company is operating. Legitimacy theory can be applied in social environment and accounting by removing the entity gap which is result of actual performance not complied with expected performance in the society. The legitimacy theory implication in the organization can be taken from the following points:

  • By having change in the results of the company including its goals and objectives so that these change will provide the same disclosures as expected by society and should notify the same to different stakeholders in the society
  • By providing education, awareness and information about the existing goals, objectives and results of the entity to different stakeholders and changed any of them as per needs of society
  • By having business combination with some known brands so that expectation from existing business can change.
  • By having different society in place of existing society in which the company is operating.

The above explains that for apply legitimacy theory in the culture of the company including its roles in society; the management should use any of the above strategies to enhance the legitimacy level in the social contract and society (Mäkelä and Näsi, 2010). The management of the company should also be encouraged for confessions which are questionable in the society so that full disclosures as per legitimacy theory can be implemented in the company. The implication of the same can be viewed from different points listed below:

  • The relationship between investors and the management of the company is the application of the social contract by which investors invests money in the company to have returns from the company. The reaction of the management in making confessions about the affairs of the company to the investor in full and accurate form is the claim of presence of legitimacy theory. The encouragement of the management in making the investor aware about the each and every actions of the company along with rate of return earned by them is the submission that legitimacy theory is present in social contract.
  • Financial Institutions like banks and non financial institutions demand have an agreement with the company that by lending some funds to the company they will get interest at regular internal and money back after agreed time. The agreement creates a social contract among them by one will have risk of losing the money and other will do all necessary steps to protect the money lend. The information about the company performances along with answers to different questionnaire of lender is application of the legitimacy theory in this social agreement.
  • The Public as a whole is also having a implied contract with management of the company in relation that the company will do all necessary to actions to protect and safeguards the environment and interest of the public by fulfilling its social responsibilities. This agreement encourages the management of the company to disclose all the information about the actions taken by the company as social responsibility activities to enhance the reliability of public is application of legitimacy theory in the social contract (Rosenfeld, 2014).

It is assessed from the above defined points that the legitimacy theory in very relevant and important in accounting and social contracts. Although it is the choice of the management of the company to apply legitimacy theory while making disclosures to society but the fulfillment of duties imposed by social contracts among the management and different stakeholders can only happened by having legitimacy theory application as core principle of the company. 

Conclusion

As the times passes, the business are changing to fulfill the requirement of the society and cater the fast changing competitions. The social contracts are true spirit of the business and are present in every action of the business from start of company or even before the start of company. Social contracts find their place in the researchers’ theory eighteen centaury and from then remarkable findings are added to it to have commendable social contract between society, people, public and the business. With the introduction of different theories like stakeholders’ theory, institutional theory and positive accounting which are interrelated to legitimacy theory, the expectation of the society has increased from the business operating in the society. Although,  the concepts have been developed in terms of accounting and environmental field they provides more sophisticated disclosures to the different stakeholders of the society with more appropriate results. The information so provided by use of different theories and requirements from social contract obligation helps the stakeholders in making fair and correct decisions about the working, actions, goals, objectives, growth opportunities of the business.

Thus, Legitimacy theory along with other theories of accounting provides the new area to researchers to understand and improve the corporate disclosures so that the expectation of the society from the social contract between society and business can be met and corporate responsibilities levied on the business can be fulfilled to have corporate sustainability.

References 

Burlea S, (2013), “Legitimacy Theory” available onhttps://www.researchgate.net/publication/303928907_Legitimacy_Theory accessed on 28/05/2017.

Baker E, (2013), “Social Contract, Essays by Locke, Hume and Rousseau” Read Books Ltd., p 34 -43 

Cruess R L, (2008), “Expectations and obligations: professionalism and medicines social

Contract with society. Perspectives in Biology and Medicine”, 51(4), 579-598.

Donaldson T, & Preston, L. E, (2005), “The stakeholder theory of the corporation: Concepts,

Evidence, and implications Academy of management Review” 20(1), 65-91. 

Dunfee T W, (2009), “Integrative social contracts theory Economics and philosophy”11(01), 85-112. 

Elahi M, (2005), “What is Social Contract Theory” available athttps://www.google.co.in/url?sa=t&rct=j&q=&edata-src=s&source=web&cd=15&cad=rja&uact=8&sqi=2&ved=0ahUKEwipipyCoO3TAhXIqI8KHXhSBrIQFghzMA4&url=http%3A%2F%2Fwww.sophia-project.org%2Fuploads%2F1%2F3%2F9%2F5%2F13955288%2Felahi_socialcontract.pdf&usg=AFQjCNEcYcluj-6Uu9cqabXu74HtJmE2pQ&sig2=Fbncb8iwPyPfPXma3NihEA accessed on 28/05/2017.

Frazer, M. L. (2017). Ryan Muldoon, Social Contract Theory for a Diverse World: Beyond

Tolerance, Routledge, 2016, 131pp, $140.00 (hbk), ISBN 9781138681361 Notre Dame Philosophical Reviews.

Friend C, (2016), “Social Contract Theory”, available at https://www.iep.utm.edu/soc-cont/ accessed on 28/05/2017.

Freeman, R. E., Harrison, J. S., Wicks, A. C., Parmar, B. L., & De Colle, S. (2010). Stakeholder theory: The state of the art. Cambridge University Press.,p 5-10 

Jos, P. H. (2006). Social contract theory: implications for professional ethics. The American Review of Public Administration, 36(2), 139-155. 

Laplume O,  Sonpar K, & Litz R. A, (2008) “Stakeholder theory: Reviewing a theory that moves us Journal of management” 34(6), 1152-1189.

Leeson, P. T. (2009). The calculus of piratical consent: the myth of the myth of social contract. Public Choice, 139(3), 443-459.

Leonard, D. K., & Samantar, M. S. (2011). What Does the Somali Experience Teach Us about the Social Contract and the State?. Development and Change, 42(2), 559-584. 

Mäkelä, H., & Näsi, S. (2010). Social responsibilities of MNCs in downsizing operations: A Finnish forest sector case analysed from the stakeholder, social contract and legitimacy theory point of view Accounting, Auditing & Accountability Journal, 23(2), 149-174.

Makarkin A,(2011), “The Russian social contract and regime legitimacy International Affairs” 87(6), 1459-1474.

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Decisions in Russia: Utilizing integrative social contracts theory to evaluate the relevance of agency theory norms. Academy of Management Review, 33(1), 11-31.

Patten M (2012) “Intra-industry environmental disclosures in response to the Alaskan oil spill: a Note on legitimacy theory. Accounting, organizations and Society, 17(5), 471-475.

Rosenfeld, M (2014). Contract and Justice: The Relation between Classical Contract Law and Social Contract Theory. Iowa L. Rev., 70, 769. 

Smith C, (2009) “Social contracts and marketing ethics The Journal of Marketing”, 14-32

Skyrms, B. (2014) “Evolution of the social contract. Cambridge University Press”, p 3-6

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