ACC8000 : Accounting Assessment- Research of Accounting Practice

Accounting Assessment

Case Scenario/ Task

Part I

Bill Strong is the founding director and Chief Executive Officer (CEO) of the Strong Built Construction Company. After an extensive executive search, Susan Bold has recently appointed as the new Chief Financial Officer (CFO) of the Strong Built Construction Company. At a recent board meeting discussions arose about profitability and the compensation of executives. The construction industry has been in a downturn due to government austerity measures. Bill has a high public profile and is well-known in the construction industry. His dynamic personality and leadership charisma are attributed to the success of the Strong Built Construction Company in maintaining revenue at similar levels for the last two years, while other construction companies have faced drops in revenue. Although the Strong Built Construction Company has been successful in maintaining its revenue levels, profit before tax has fallen. A recent employee survey revealed falling levels of employee motivation. Members of the board have been questioning the current approach to executive compensation that rewards employees with company shares that are held in trust for three years before employees are able to sell the shares. Bill Strong is trained in economics and argues that the conventional agency theory approach to executive compensation where employees receive monetary benefits helps motivate employees. Susan Bold explains that intrinsic considerations need to be taken into account in determining executive compensation.

Required: You are Susan’s assistant and you have been asked to prepare a report that is backed by scholarly literature addressing the following issues regarding approaches to compensation:

Typical elements of compensation packages

b. Outline the key assumptions of traditional agency theory and theirinfluence on approaches to compensation

c. Explain the difference between extrinsic and intrinsic motivation and therelationship between the two motivations

d. How might an employee’s attitude to risk influence their desiredcompensation package?

e. How might the time period when employee receives a financial benefitinfluence they desire for the benefit?

f. What role do fairness considerations have when determiningcompensation?

g. Why an executive compensation committee may provide benefits indetermining compensation.

h. How to structure an executive compensation committee to achieve thebest outcomes.

i. Conclusion: use the information in your previous answers to develop recommendations for determining compensation that enhance job satisfaction and work motivation.

j. Appropriate report formatting (title page, table of contents, introductionand appropriate headings)

k. Adequate in-text references and reference list following Harvard style

Part I

(i) Read the paper by Gold, Gronewold and Pott (2012):

What is the aim of the research paper/project?

b. Draw a table to illustrate the 2 x 3 design (p. 292) showing the six groups and the different information that each group received.

c. What was the purpose of the manipulation checks?

(ii) Read the study by Agyei, Aye and Owusu-Yeboah (2013); along withthe study by Okafor and Otalor (2013):

a. Briefly outline the research aims of each study

b. Explain how each study attempts to measure the audit expectation gap and comment on which approach you think is more rigorous, stating reasons why you believe one approach is superior in its rigor.

c. Explain how each study selects the research participants and comment on which approach you think is more rigorous, stating reasons why you believe one approach is superior.

d. Outline the response rate in each study and whether you think theresponse rates are adequate in each study.

e. Explain how each study goes about analysing the data that is collected and comment on which approach you think is more rigorous, stating reasons why you believe one approach is superior in its rigor.

f. Briefly outline two other significant flaws that you have noticed in thestudies.

Part 1

Introduction

The design of the compensation package for a company is often based on the premises of the agency theory, motivation theories and the management perception and attitude including the company culture and the global scenario regarding the compensation.

The report addresses financial accounting issues regarding approaches to compensation in terms of elements of the compensation package, influence of traditional agency theory on approaches to compensation , the difference and relation between extrinsic and intrinsic motivation , influence of employee’s attitude to risk on compensation package , influence of time period and fairness considerations for determination of the compensation package, importance and structure of executive compensation based on academic literature for the Strong Built Construction Company followed by recommendation on the ideal compensation package that motivates the employees of the company.

A Typical elements of compensation packages

Salary and wagesThis forms the most important and largest element of the compensation package. The parameters used for the element are skills, experience, performance, and contribution to the company. Sometimes, variable incentives in the marketing fields are also based on the percentage of salary.

BonusThis component is normally paid in a single lump at the year end and may take the form of individual performance incentives for meeting or exceeding targets or a profit-sharing plan for the team.

Long-term incentive These may be in the form of Stock options and aid in retaining employees for a sufficiently long period of time depending on the tenure of the incentive.

Health insurance this component is very important to employees as it guarantees them coverage for their health problems. This motivates them and positively increases employee productivity.

Life insurancethis component is very important to employees as it guarantees them coverage for their dependants. This motivates them and positively increases employee productivity.

Retirement plans.These may take the form of superannuation plans that are easy to administer.

Time off and flexible schedules This element includes holidays and sick days and is normally fixed per employee per year. Employees need certain personal leaves and look forward to this component.

Miscellaneous compensation this may take the form of discounts; the use of a company transport; and any other perks and incentives that motivate employees(Editors, 2010)

B Key assumptions of traditional agency theory and their influence on approaches to compensation

The key assumptions of the Agency theory include viewing the corporate as a nexus of contracts whereby an agency relationship arises between principal and agent vis-à-vis service performed. The theory recognizes two primary agency relationships i.e. between stockholders and managers and between debt holders and stockholders. The theory aims to resolve conflicts of interest between agents and principals with regard to corporate governance and business ethics. (Referenceforbusiness.com, 2016)

The theory considers the presence of agency costs, incurred in order to sustain the relationship which may take the form of performance incentives and other elements of compensation package. The theory underpins compensation by making the employee/management as equity holders and believes that employees must be given incentive to work in the best interest of the company. The theory also recognizes the sub optimal decision making where excessive package is cited as the cause.(Bebchuk and Fried, n.d.) However, the theory rewards outcomes and performances without considering the sustainability of the decision or process. Managers are rewarded for perceived risk management rather than effective risk management. Therefore the theory fails to link increased employee incentive to better performance. Research suggests that managerial influence shapes executive compensation to a greater extent (Armstrong, Ittner and Larcker, n.d.)

C Difference between extrinsic and intrinsic motivation and the relationship

Intrinsic motivation is a reflection of the natural human nature. However, extrinsic motivation is a reflection of external control or self control. Both the motives are ultimately linked to the needs of autonomy and competence. Intrinsic Motivation as per research results in better performance, while a negative relationship emerged between Extrinsic Motivation and performance (Lemos and Veríssimo, 2014) these are entirely opposite ways to motivate employees.Extrinsic motivation deals with motivations like salary, bonus, and perks that are external and need to be acquired whileintrinsic motivationdeals with the passion and self esteem needs and include rewards in the form of job satisfaction.

Intrinsic motivation is considered stronger than extrinsic. It urges employers to focus on getting employees intrinsically involved in theirwork. An intrinsically motivated employee does not need reward or control. As per Fredrick Taylor; the father of scientific management; Linking extrinsic executive compensation to performance may motivate employees together with a positive culture satisfying his intrinsic needs(Academia.edu, 2016)

D Employee’s attitude to risk and influence on compensation package

A risk adverse employee may prefer a larger component of a fixed compensation package while a risk taker may not mind a variable compensation package where his pay is linked to the outcome of his decisions and actions. However , taking reference from The Motivation-Hygiene Theory developed by Frederick Herzberg , employees are affected by Motivator Factors like work responsibility, growth and recognition and Hygiene Factors like compensation , relationships and job security among others. Presence of hygiene factors does not increase employee motivation while their absence negatively impacts motivation.The intrinsic motivator factors strongly impact employee performance and motivation. The employee’s attitude to risk is more of a hygiene factor and may not influence his desired compensation package as long as the hygiene factors are adequately being provided. (Managementstudyguide.com, 2016)

E Influence of Time period of receipt of financial benefit

No evidence has been found to suggest a positive relation between the time period when employee receives a financial benefit and their desire for the benefit. Monetary incentives, time limits, and knowledge of results may not affect the desire for the benefit as well as the resulting performance level. The employee goals and intentions are independent of the time period. (Locke, 1968)

However, it may be pertinent to mention that a long term incentive like Stock options may induce in retaining employees for a sufficiently long period of time depending on the tenure and amount of the incentive.

F Role of fairness considerations in determining compensation

The role of fairness considerations in determining compensation is paramount as employees regard a fair compensation structure a high esteem. A fair compensation not only covers basic living expenses but accounts for inflation with increments over time.

Employees also consider the internal and external equity in terms of fairness between employees at same levels and between other similar companies. Where the equity is imbalanced, the employer may perceive low productivity and motivation levels. (Nature.berkeley.edu, 2016)

Fairness is also considered in a distributive sense implying equality in reward allocation, procedural sense in terms of consistent reward process and interactional sense in terms of employee perception where employee perceives the compensation as fair or otherwise (HR Daily Advisor, 2013)

G Benefits of executive compensation committee

An executive compensation committee may provide benefits in determining compensation in the following ways

• Review and audit of the Company’s compensation policy.
• Review, evaluation and approval of executive compensation plans and programs including incentive and equity based plans.
• Reporting on executive compensation as required by Securities and Investment Commission.
• Review and approval of each executive officer’s compensation, long-term incentives and other perks.
• Identification of objectives relevant to executive compensation as in the cost to the Company of executive’s compensation.
• Evaluation of each executive’s performance in light of objectives and setting compensation accordingly
• Determination of long-term incentive component based on factors like previous awards, Company’s performance, stockholder return and the policy in this regard of the competitors (Biolargo, Inc., 2009)

H Ideal structure of the executive compensation committee

The structure of an executive compensation committee to achieve the best outcomes is best decided and appointed by the Board of the company as per recommendation of the Corporate Governance Committee. The Compensation Committee ought to have at least two members, one of whom shall be a non-employee director and the other as an outside director.

The members shall be independent and devoid of any personal financial interest and should have the knowledge, skill and experience to take wise compensation decisions (Reda, n.d.)

Recommendations for determining compensation that enhance job satisfaction and work motivation

Apart from the salary, wage component and retirement benefit; the following may enhance job satisfaction and motivation levels of employees

• Long-term incentive in the form of Stock options aid in retaining employees for a sufficiently long period of time depending on the tenure of the incentive.
• Health insurance and life insurance component is very important to employees as it guarantees them coverage for their health problems and dependents coverage. This motivates them and positively increases employee productivity.
• Time off and flexible schedules are looked forward by employees.
• Intrinsic motivation is considered stronger than extrinsic. An intrinsically motivated employee does not need reward or control. As per Fredrick Taylor; the father of scientific management, linking extrinsic executive compensation to performance may motivate employees together with a positive culture satisfying his intrinsic needs
• The employee’s attitude to risk is more of a hygiene factor and may not influence his desired compensation package as long as the hygiene factors are adequately being provided.
• Employees also consider the internal and external equity of compensation in terms of fairness between employees at same levels and between other similar companies. Where the equity is imbalanced, the employee may perceive low productivity and motivation levels.
• An executive compensation committee may review and audit the Company’s compensation policy, plans and programs including incentive and equity based plans, reporting on executive compensation as required by Securities and Investment Commission and review and approval of each executive officer’s compensation, long-term incentives and other perks.
• The structure of an executive compensation committee to achieve the best outcomes shall best be decided and appointed by the Board of the company as per recommendation of the Corporate Governance Commit.

Part 2

1 Research paper by Gold, Gronewold and Pott (2012)

A Aim

The aim of the research paper by Gold, Gronewold and Pott (2012) was to study and reach a conclusion on the effectiveness of the explanations as mandated by ISA 700 dealing with Auditors report in reducing the audit expectation gap. The idea was to elicit participating auditors and users perceptions regarding the auditor and management responsibility on one hand and reliability of the financial statements on the other hand.

B Information received

The six respondent groups and the information that each group received are presented below:

C The purpose of the manipulation checks

The purpose of the manipulation checks which were a part of the study was to verify the effectiveness of the manipulation of the absence or presence of the explanation in the auditor’s report. This would help in judging auditors and user’s perceptions regarding the auditor and management responsibility on one hand and reliability of the financial statements on the other hand. The whole idea behind these manipulations was to reach a conclusion on the effectiveness of the explanations as mandated by ISA 700 dealing with Auditors report in reducing the audit expectation gap. (Gold, Gronewold & Pott,2012)

2 Study by Agyei, Aye and Owusu-Yeboah (2013) and Okafor and Otalor (2013)

A Aim

Aim of the study by Agyei, Aye and Owusu-Yeboah (2013) was to conduct an Audit expectation gap study i.e. The difference between the public expectations from auditors and actual auditor performance, specifically for the country of Ghana The study was confined specifically to Ghana.

The aim of the study by Okafor and Otalor (2013) was to research and ascertain the role played by the auditing profession in narrowing the audit expectation gap by implying the technique of questionnaires and descriptive and statistical analysis.

B Measurement of the audit expectation gap

The study by Agyei, Aye and Owusu-Yeboah (2013) attempts to measure the audit expectation gap based on utilizing questionnaires on the technique suggested by Best, Bucky and Tan (2001) and Bogdanoviciute (2011) with closed ended questions to be ranked on a scale of 1 to 5. The sample size was twenty auditors and twenty stockbrokers which were each given a set of fifty questionnaires. Sampling techniques were also used. The questions were based to reach a conclusion on the following hypothesis

• Auditor’s responsibility for fraud detection.
• Auditor’s responsibility for soundness of internal control structure.
• Auditor’s responsibility for fairness and completeness of financial statements.
• Auditor’s responsibility for the maintenance of accounting records.

The study by Okafor and Otalor (2013) attempts to measure the audit expectation gap by implying the technique of questionnaires and descriptive and statistical analysis. The sample population consisted of accounting students, teachers, accountants and investing public. The questions were based to reach a conclusion on the following hypothesis

• The audit expectation gap is not caused due to lack of user knowledge on the legal, regulatory and professional pronouncements concerning auditors.
• The audit expectation gap is not caused due to public expectation from the auditor regarding the performance of his duties.

Out of the two; the second mentioned study is presumably more rigorous in its approach as it is not confined to one particular country or state and has about 130 participants. This is a huge and more representative sample compared to the first mentioned study which sampled only twenty auditors and twenty stockbrokers. Also, the aim of second study was broader so as to ascertain the role played by the auditing profession in narrowing the audit expectation compared to the Ghana study; the aim of which was to make an assessment of the audit expectation gap in Ghana.

C Research participants

The study by Agyei, Aye and Owusu-Yeboah (2013) selected the research participants i.e. auditors and stockbrokers from Greater Accra region of Ghana. The sample auditors were selected from the Central Business District of Accra which is regarded as the hub of auditing firms. The stockbrokers were selected based on the list of brokerage companies trading on the Ghana Stock Exchange.

The study by Okafor and Otalor (2013) selected the research participants randomly from accounting students and teachers of the University of Benin, Benson Idahoan University and Ambrose Ally University, Acoma, Accountants in Practice and the investing public in Edo State.

The approach adopted by Okafor and Otalor is presumably superior as the sample was more representative in terms of the people which actually participate in gauging the audit expectation gap. Secondly, the number of participants was also greater in number. The other study is limited to stockbrokers as the user group and may not be reflective of the use preferences regarding the objective of the study. Users like consultants, bankers, etc were totally ignored for the purpose of the study.

D Response rate

The response rate in the study by Agyei, Aye and Owusu-Yeboah was 30 out of 50 questionnaires from the auditors group (average response rate of 60%) and 35 out of 50 questionnaires from the stockbrokers group (average response rate of 70%). Out of these, twenty questionnaires from each group were selected. This response rate from the representative sample is satisfactory enough to make reasonable conclusions on the purpose of the study. Further, by equating the responses on an equal 20 by 20 basis, the study gave equal weigtage to both participating groups.

The response rate in the by Okafor and Otalor study was 94 out of 130 questionnaires averaging to a response rate of 72 %. This response rate from the representative sample is large enough to make reasonable conclusions on the purpose of the study.

E Analysis of collected data

The study by Agyei, Aye and Owusu-Yeboah involved analysis of the primary data; the questions were loosely based on the attributes and attitudes of the respondents. Part A covered the demography of respondents and part B covered the objective of the study. The questionnaire based on Best, Bucky and Tan (2001) and Bogdanoviciute (2011) included closed ended questions to be ranked on the five point Likert scale. The questionnaires were personally administered and the responses were judged on single dimension and arrayed on equal interval. The data was analysed descriptively with the help Statistical Package for Social Sciences, (SPSS Version 14.0)

The study by Okafor and Otalor also analyzed the data using descriptive and statistical analysis as per (SPSS 16.0). Parametric statistical method – Analysis of Variance were used to investigate the relationship between the variables and econometric analysis was used to empirically investigate the direction of the hypothesis through regression analysis in order to extrapolate and accept the opinions of the relevant interest group. Mann-Witney test was used to establish the effect of the difference in opinions of the interest group. The questionnaires were self administered.

The approach followed by Agyei, Aye and Owusu-Yeboah is certainly more rigorous and superior compared to the other study as the quality of the questionnaire was better. The Okafor and Otalor study also employed questionnaires but these were not as better framed as the first mentioned study.

F Significant flaws

Two other significant flaws noticed in the Agyei, Aye and Owusu-Yeboah study apart from the ones discussed include

• The demography of the respondents showed 60% with an experience of 5 years and below, this kind of experience may make the sample less representative.
• Secondly, the use of purposive sampling for the choice of respondents by the researchers may bring an element of subjectivity and bias in the research.

Two other significant flaws noticed in the Okafor and Otalor study apart from the ones discussed include

• The self administration of questionnaires may have caused respondents to reply to questions on a partial or no understanding totally defeating the purposes of the study.

Secondly, the hypothesis ought to have also included an examination of the role played by the corporate as well in reducing the audit expectation gap(Agyei, Aye, & Owusu-Yeboah, 2013)(Okafor & Otalor, 2013).