Introduction
Accounting information is prepared to aid decisions about economic resource allocation. Decisions on how to allocate these scarce resources are made daily by different parties. This information enables them to predict the uncertainty and timing of cash flows associated with business entities or projects. There are several reports that are used to present accounting information (Agee 2001). In the case of external users, the major reports are the Statement of Financial Position, Statement of Comprehensive Income and Statement of Cash flows. There are no standard reports for internal users. Every entity prepares reports as needed in the most convenient format.
Some attributes contribute to the usefulness of accounting information in decision-making. The information must be relevant to the user’s decision. It must also be from a reliable source. Information that is not from reliable sources is highly likely to be inaccurate, hence unreliable (Titman, Martin, & Keown 2010). Finally, the information should be provided in a timely manner. It should not be outdated. Only current information is useful information. Accountants put controls over the accounting system in order to ensure that these qualities are maintained.
Preparation of accounting information is a costly process. It involves collecting economic data about an entity. Accountants then summarize and classify the data appropriately. Finally, they prepare the relevant reports. The process is also very time-consuming. There is a possibility that the cost of preparation of the information may exceed the benefits obtained from it. Therefore, only that information which costs less to produce and is highly useful should be included. This is called the cost-benefit principle.
Models of Decision Making
The Subjective Expected Utility Model
This model attempts to explain the process individuals go through in making a decision with different alternatives during risky and uncertain times. Savage advanced it in the early 1950s. It was an improvement on the Expected Utility Model. It proposes that individuals try to maximize their utility from a decision. They consider their most preferred outcome and its probability of occurrence.
First, the decision-maker identifies all the possible alternatives. Secondly, he determines the probability that the alternatives will occur. Finally, the decision-maker chooses the alternative that is most likely to fulfil his needs and has the highest probability of occurrence (Watts & Zimmerman 1983).
However, this theory has some weaknesses. It assumes the condition of bounded rationality. This means that decision-makers are constrained by information availability, time, and brain capacity. Thus, they will never make rational decisions. Rather, their decisions will be subjective, influenced by other factors in their environment (Barrow 2011). The concept of bounded rationality emphasizes the fact that even if decision-makers have information, it is most probably inaccurate and therefore unreliable. They have limited time to make decisions. Therefore, they cannot afford to consider all the variables involved. Finally, decisions are often too complex and include too many variables for the human mind to process. Therefore, the decision-maker will choose which variables to consider and which to ignore. This process is quite subjective.
The Subjective Utility Model and bounded rationality explain some of the limitations that decision-makers face. Therefore, preparers of accounting information should try to improve these limitations, thereby making decision-making more credible.
Theory of the Firm
The Stakeholder Theory of the Firm emphasizes the fact that a business entity (company) is composed of different stakeholders with different interests. Some stakeholders are internal while others are external. Examples of stakeholders in a company include shareholders, government, society, creditors, employees, and management. Each stakeholder has different interests. These interests affect the stakeholder’s decision-making process (Weetman 2007). Creditors look for businesses that will be able to repay their loans and principles, shareholders search for highly profitable companies, while employees search for high-paying companies.
The major constraint of group decision-making is the differing interests of stakeholders. Each stakeholder will try to maximize his or her interests, often at the expense of other stakeholders. This is evident in the principle-agent relationship between shareholders and management. In order to limit the skewed relationship, auditors are employed.
In the case of a company divided into divisions, there is a conflict of interest between the different departments (Atrill 2011). This is especially if performance measures promote divisional success over corporate well-being. Divisional managers might maximize their performance in order to get rewards while destroying company value. Accounting information should aid in reducing these limitations.
The Role of Accounting Information in Aiding Decision Making
Accounting information aids both individual and group decision-making by reducing their limitations. Individuals face the constraints of time, reliable information, and information overload. Accounting information should be relevant. This reduces the chances of burdening individuals with a lot of unnecessary information. The relevance of information depends on the decision at hand. For example, a creditor would be more interested in the profit a business makes than its specific market segments.
Secondly, accounting information should be understandable. It should not be too complex that the decision-maker cannot employ it in their situation. It should be tailor-made to the decision-makers’ objectives. For example, ratios can be computed to enable investors to understand financial statements (Fankhauser 2011).
Entities should issue timely accounting information. Time makes a big difference in the allocation of economic resources. A good investment today may be a very poor investment one year from now. Therefore, it is imperative that decision-makers work with the most current information. This will increase the quality of their decisions. In order to promote this, accounting information should be prepared as regularly as is economically feasible (Brigham & Ehrhardt 2008). For most companies, this period is one year. However, companies can continue to issue interim accounting information during the year.
Corporate decisions are affected by conflict of interest. This can be solved by using appropriate measures in creating accounting information. For example, if a company is divided into divisions, the opportunity cost transfer price can be used in order to avoid distorting one division’s performance (Wild & Shaw 2011). Directors can also design performance measures that incorporate both shareholder value and company growth. Such measures include Economic Value Added (EVA).
Conclusion
Accounting information can be considered a means to an end. It aids users in making economic decisions about resource allocation. However, users are faced with several constraints. Individual users are limited by the scope of their brain, availability of time and information. Group users are limited by the conflict of interest. Accounting information can help resolve these conflicts by providing timely, relevant, and understandable information to users.
References
Agee, M 2001, Quantitative Analysis for Management Decisions, Prentice Hall, Sydney.
Atrill, P 2011, Financial Management for Decision Makers,Prentice Hall, Chicago.
Barrow, C 2011, Practical Financial Management: Key Financial Statements Tools of Financial Analysis Business Planning and Budgeting, Kogan Page, New York.
Brigham, E, & Ehrhardt, M 2008, Financial Management: Theory and Practice, South-Western, Division of Thomson Learning, New York.
Titman, S, Martin, J, & Keown, A 2010, Financial Management: Principles and Applications, Pearson, London.
Watts, R, & Zimmerman, J 1983, Agency problems, Auditing and Theory of the Firm : Some Empirical Evidence, Journal of Law& Economics , 26 (3), 613-633.
Weetman, P 2007, Financial and Management Accounting: An Introduction, Prentice Hall, Chicago.
Wild, J., & Shaw, K. (2011), Managerial Accounting, McGraw-Hill, London.